short selling

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pages: 369 words: 128,349

Beyond the Random Walk: A Guide to Stock Market Anomalies and Low Risk Investing by Vijay Singal

3Com Palm IPO, Andrei Shleifer, asset allocation, buy and hold, capital asset pricing model, correlation coefficient, cross-subsidies, Daniel Kahneman / Amos Tversky, diversified portfolio, endowment effect, fixed income, index arbitrage, index fund, information asymmetry, liberal capitalism, locking in a profit, Long Term Capital Management, loss aversion, margin call, market friction, market microstructure, mental accounting, merger arbitrage, Myron Scholes, new economy, prediction markets, price stability, profit motive, random walk, Richard Thaler, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, survivorship bias, transaction costs, Vanguard fund

Large brokerage houses will generally disallow short selling of lowpriced stocks (less than $5) because they tend to be illiquid and highly volatile, increasing the risk for the broker. While the process of short selling is complicated, it becomes easier to implement once a short seller has executed a couple of trades. Note that short selling is also riskier than going long. In the arbitrage strategies described, the short position will always be hedged to minimize that risk, but the hedge may break. For example, in stock mergers, a short position on the bidder is hedged with a long position on the target. However, if the merger is called off, the long position ceases to be a hedge. 325 326 Appendix B: Short Selling RESTRAINTS ON SHORT SELLING There are several reasons why short selling is complicated and discouraged.

The evidence presented above supports the role of speculative short sellers in contributing to the weekend effect. Some other observed facts related to the weekend effect are also consistent with the short-selling explanation: • The weekend effect has been in existence for more than a hundred years: Short selling has been permitted on U.S. exchanges since 1858. After the stock market crash in 1929, there was an attempt to curb the practice. However, short selling was actually disallowed on only two days in 1931. New rules governing short selling were introduced by the SEC under the Securities and Exchange Act of 1934. • Friday returns are lower when there is Saturday trading: Consistent with the short selling explanation, short sellers may wait until Saturday to close their positions, reducing the Friday return. • The weekend effect is larger around long weekends: When the market is closed for a holiday weekend, more short sellers are likely to close short positions by buying back on the last trading day of the week and reopen their positions after the market reopens.

But investors must include foreign stocks. 13% to 15% per year Mutual funds Individual stocks; short selling is optional Individual stocks; shortselling is optional Individual stocks; short selling only for stock mergers Mutual funds; American Depository Receipts; ETFs Currency futures Easy with funds already identified; difficult to find new funds Not difficult without shortselling Easy without short-selling Easy for cash mergers; marginally difficult for stock mergers Easy Easy 30 minutes one hour two hours three hours one hour three hours 15–50 Many About 50 20 to 100 A few 10–12 *Abnormal return is the return in excess of the normal return associated with this level of risk. xiii xiv Preface Buying stocks or selling stocks that you own is easy. However, short selling (selling stocks that you do not own) is a somewhat different and more complex strategy and is described in that appendix.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

activist fund / activist shareholder / activist investor, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

—Bernard Baruch, testimony before the Committee on Rules, House of Representatives, 1917 Furthermore, short-selling comes with other benefits. It allows hedging. It makes markets far more liquid, reducing investors’ transaction costs. Short-selling makes markets more liquid by making market prices more informative, by increasing turnover, and by allowing market makers to provide liquidity on both sides of the market while hedging their risks. Hence, overall allowing short-selling is clearly the right decision as short-selling is for the better. Does this mean that short-selling can never be associated with misbehavior? Of course not. If short sellers are trying to manipulate the market, this is clearly wrong and illegal, but price manipulation is wrong and illegal both when traders are buying and when they are short-selling—so this is not specific to short-selling (e.g., “pump and dump” is price manipulation on the long side).

—David Einhorn Policy makers and the general public also sometimes want to fight short sellers: Policymakers and the general public seem to have an instinctive reaction that short selling is morally wrong. Short selling has been characterized as inhuman, un-American, and against God (Proverbs 24:17: “Do not rejoice when your enemy falls, and do not let your heart be glad when he stumbles”). Hostility against short selling is not limited to the United States. In 1995, the Finance Ministry in Malaysia proposed mandatory caning as the punishment for short sellers. —Lamont (2012) Lamont (2012) further documents how the U.S. Congress held hearings in 1989 on the problems with short-selling, during which a representative described short-selling as “blatant thuggery.” During the hearings, however, an SEC official testified that many of the complaints we receive about alleged illegal short selling come from companies and corporate officers who are themselves under investigation by the Commission or others for possible violations of the securities or other laws.

People start with the idea: How can you sell something you don’t own? And then once you start down that path, it’s much harder to get people to think about it, in the form of the marketplace. But then I point out to them that insurance is a giant short-selling scheme. Much of agriculture is a giant short-selling scheme. You’re selling forward what you don’t have yet, with the idea that you will replace it later at a profit. When an airline sells you an advance purchase ticket, they’re short-selling you a seat. All kinds of business are done on a short sell basis, where you get money up front, and you get the goods or services later. People often make the analogy that short-selling is like taking fire insurance out on someone else’s house, but there is an important difference. The difference is that if you imagine a person taking insurance out on someone else’s house, then you’re making the next leap of faith that the person is going to commit arson.


pages: 193 words: 11,060

Ethics in Investment Banking by John N. Reynolds, Edmund Newell

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, banking crisis, collapse of Lehman Brothers, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, discounted cash flows, financial independence, index fund, invisible hand, light touch regulation, margin call, moral hazard, Nick Leeson, Northern Rock, quantitative easing, shareholder value, short selling, South Sea Bubble, stem cell, the market place, The Wealth of Nations by Adam Smith, too big to fail, zero-sum game

As neither (i) selling a share, nor (ii) being in a short position is in itself normally unethical, it is difficult to see the act of short-selling a share (or an index or a commodity) as intrinsically problematic from an ethical perspective, although this is not to say that shorting cannot be abusive for reasons already stated. It is likely that all major banks and investment banks participate in some of their activities either in short-selling or in facilitating short-selling. Short-selling: Market evidence Both the US and the UK implemented short-term bans on shortselling. Both bans were subsequently terminated. In September 2008, short-selling was seen as a contributing factor to undesirable market volatility in the US and subsequently was prohibited in the US by the SEC. The SEC banned for three weeks short-selling on 799 financial stocks to boost investor confidence and stabilise those companies.

These ethical problems are akin to unauthorised trading, in that they are clearly unethical, rather than being ethically more complex, as with short-selling. Short-selling At the time the financial crisis was unfolding, short-selling was presented by some politicians and parts of the media as one of the major “abuses” of the financial crisis. It was blamed by some banks and Governments for destroying, or attempting to destroy, (quoted) banks. As such, it is in a different position from other practices, in that it was not illegal in most jurisdictions at the time, although it had previously been subject to some ethical concerns. Recent Ethical Issues in Investment Banking 95 The ethical position of short-selling is straightforward: it is not, in itself, unethical. Shorting can be broken down into two clear component actions: selling a share, and owing a share.

To owe something is also not unethical. However, shorting as part of some other unethical activity, such as market manipulation or insider dealing, would normally be unethical from the perspective of both intention and consequences. The actual act of short-selling is no more than selling a share. It is difficult to consider this in itself as unethical. The driver for short-selling is to profit from share price movements. Profiting from a different investment view is a component of buying shares, as well as shorting, and is a well-understood fundamental basis of economic behaviour. It is true that short-selling can be abused: it can be used to move market prices for abusive reasons, for example in cases where an investor stands to profit from the insolvency of a company due to a short position (or holding credit default insurance such as CDS); it can be used to facilitate insider dealing; and it can be used to deliberately create distress in a company or for an investor.


Mathematics for Finance: An Introduction to Financial Engineering by Marek Capinski, Tomasz Zastawniak

Black-Scholes formula, Brownian motion, capital asset pricing model, cellular automata, delta neutral, discounted cash flows, discrete time, diversified portfolio, fixed income, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, margin call, martingale, quantitative trading / quantitative finance, random walk, short selling, stochastic process, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

Example 5.12 (3 securities without short selling) For the same three securities as in Examples 5.10 and 5.11, Figure 5.8 shows what happens if no short selling is allowed. All portfolios without short selling are represented by the interior and boundary of the triangle on the w1 , w2 plane and by the shaded area with boundary on the σ, µ plane. The minimum variance line without short selling is shown as a bold line in both plots. For comparison, the minimum variance line with short selling is shown as a broken line. 114 Mathematics for Finance Figure 5.8 Portfolios without short selling Exercise 5.14 For portfolios constructed with and without short selling from the three securities in Exercise 5.12 compute the minimum variance line parametrised by the expected return and sketch it a) on the w2 , w3 plane and b) on the σ, µ plane. Also sketch the set of all attainable portfolios with and without short selling. 5.3.2 Efficient Frontier Given the choice between two securities a rational investor will, if possible, choose that with higher expected return and lower standard deviation, that is, lower risk.

In this case the portfolio with minimum variance that corresponds to s0 involves short selling of security 1 and satisfies σV < σ1 . For s ≥ s0 the variance σV is an increasing function of s, which means that σV > σ1 for every portfolio without short selling. The above corollary is important because it shows when it is possible to construct a portfolio with risk lower than that of any of its components. In case 1) this is possible without short selling. In case 3) this is also possible, but only if short selling is allowed. In case 2) it is impossible to construct such a portfolio. Example 5.9 Suppose that σ12 = 0.0041, σ22 = 0.0121, ρ12 = 0.9796. Clearly, σ1 < σ2 and σσ12 < ρ12 < 1, so this is case 3) in Corollary 5.6. Our task will be to find the portfolio with minimum risk with and without short selling. 106 Mathematics for Finance Using Theorem 5.5, we compute s0 ∼ = −1.1663, smin = 0.

Exercise 4.5 Consider a market with a risk-free asset such that A(0) = 100, A(1) = 110, A(2) = 121 dollars and a risky asset, the price of which can follow three possible scenarios, Scenario ω1 ω2 ω3 S(0) 100 100 100 S(1) 120 120 90 S(2) 144 96 96 Is there an arbitrage opportunity if a) there are no restrictions on short selling, and b) no short selling of the risky asset is allowed? 4. Discrete Time Market Models 81 Exercise 4.6 Given the bond and stock prices in Exercise 4.5, is there an arbitrage strategy if short selling of stock is allowed, but the number of units of each asset in a portfolio must be an integer? Exercise 4.7 Given the bond and stock prices in Exercise 4.5, is there an arbitrage strategy if short selling of stock is allowed, but transaction costs of 5% of the transaction volume apply whenever stock is traded. 4.1.3 Application to the Binomial Tree Model We shall see that in the binomial tree model with several time steps Condition 3.2 is equivalent to the lack of arbitrage.


pages: 202 words: 66,742

The Payoff by Jeff Connaughton

algorithmic trading, bank run, banking crisis, Bernie Madoff, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, desegregation, Flash crash, locking in a profit, London Interbank Offered Rate, London Whale, Long Term Capital Management, naked short selling, Neil Kinnock, plutocrats, Plutocrats, Ponzi scheme, risk tolerance, Robert Bork, short selling, Silicon Valley, too big to fail, two-sided market, young professional

But I laughed a few minutes later when I got a call from Ted’s press secretary, who was with him: “I’m glad most people still don’t know what Ted looks like. Two elderly ladies were standing nearby when he yelled that.” The pushback from the Blue Team was followed by pushback from The Blob. I received an e-mail from a lobbyist (and former Dodd staffer) who represented a large hedge fund well known for short selling. She warned me that it would be bad for my career if Ted and I went after short selling. She added that Ted and I looked like deranged conspiracy theorists for seeking to explore whether short selling had played a role in the downfall of firms like Lehman Brothers. Let me be clear: The Blob isn’t the mob. I didn’t fear for my kneecaps. But the hedge fund lobbyist was clearly trying to get me to back down by making me wonder whether not backing down would harm my career. Sometime later a friend of mine mentioned my name to a top member of The Blob, Mark Patterson, who used to be a lobbyist for Goldman Sachs and is now Treasury Secretary Geithner’s chief of staff.

They added that they couldn’t give us any details of the investigation but warned us that it’s almost impossible to prove intent under the current rule (that is, the reasonable-belief standard). Under this rule, anyone accused of naked short selling can simply say: “I reasonably believed I could find the stock in time.” In essence, the SEC lawyers confirmed our view that the rule against naked short selling was unenforceable and that they knew it. Most stock trades in the United States are cleared by a Wall Street backroom firm called the Depository Trust Clearing Corporation (DTCC). I suspected that the DTCC had extensive data on short selling. After a series of enquiries, I finally arranged for the DTCC’s general counsel (Larry Thompson) and one of its managing directors (Bill Hodash) to meet with me in Washington. We’d chatted for about fifteen minutes when Larry startled me by saying, “We want to be part of the solution, and we think we have a proposal that will work.”

Within a month of hearing about the DTCC’s idea, I’d helped Kaufman recruit seven other senators to write to the SEC endorsing the idea as a potential solution to abusive short selling. The letter was signed by Ted, Isakson, Levin, Jon Tester (D-MT), Sherrod Brown (D-OH), Orrin Hatch (R-UT), and Robert Menendez (D-NJ). Senator Arlen Specter (R-PA) wrote a follow-up letter concurring with it. Supremely confident (and a bit naïve), I said to Ted: “We’re going to change the way stocks are traded in this country.” Not long after receiving the letter, the SEC announced it would hold a public roundtable to discuss naked short selling and possible solutions on September 24, 2009. I was convinced we were making progress. We must have been. Because major banks like Goldman Sachs started lobbying furiously against any restrictions on short selling. The day before I was to meet with Goldman, an Isakson staffer told me that he’d received data from Goldman.


Beat the Market by Edward Thorp

beat the dealer, buy and hold, compound rate of return, Edward Thorp, margin call, Paul Samuelson, RAND corporation, short selling, transaction costs

We now discuss risks in using the basic system. Short Squeezes From the legendary bear raids of the early Wall Street buccaneers many have drawn the moral that short selling is bad. Some say short selling is dangerous because of unlimited potential losses, and that in return it offers only limited potential gains. (Appendix A shows this need not be so.) Some say selling short is unpatriotic; it means the seller has a pessimistic view of American enterprise. This is naïve and untrue. The interests of the economy are best served if stock prices reflect potential future earnings. If informed short selling guides prices to such levels, then short selling may even be called a public duty. We shall not pursue this argument. We wish to discuss the risk involved in selling warrants short. If someone corners the market (see page 60) in a warrant, the short sellers of that warrant can be forced to pay outrageous prices to cover.

Steady profits in bust and boom. 2 WARRANTS: OPTIONS ON THE FUTURE 15 Rediscovery of the system: Ed Thorp under a tree. What is a warrant? Get rich quick? The warrant-stock diagram. The two basic rules relating warrant prices to stock prices. Adjusted warrants and adjusted exercise price. Reading the financial pages. Checking the two rules. The warrant-stock law: predictability in the stock market. 3 SHORT SELLING: PROFITS IN BAD TIMES 33 Short selling. Selling warrants short. Molybdenum warrants and the avalanche effect. 4 THE BASIC SYSTEM Hedging: high profit with low risk. Changing the mix. Deeper insight into the basic system. The basic system: preview. An incredible meeting. 43 vi Contents 5 THE SYSTEM IN ACTION: $100,000 DOUBLES 51 The Molybdenum story. Moly coda. Bunker-Ramo (Teleregister). Catskill conference: Sperry Rand. 6 HOW TO USE THE BASIC SYSTEM 71 Identifying the listed warrants.

Consequently, I studied the past behavior of both the Textron warrants and the common stock, attempting to find the relationship between them. I also noticed other warrants and charted their activity. I sought “cheap” warrants that might advance dramatically in price. None seemed attractive at the time. Molybdenum seemed to be the most overpriced warrant of all. I wanted to sell the Molybdenum warrants short, which is a method for profiting from a fall in price. (Short selling is explained in Chapter 3.) The Wall Street mythology characterizes short selling as both dangerous and subversive, so I hesitated. Besides, I would lose if the common rose substantially and the warrant consequently advanced. The Moment of Discovery One evening as I studied my charts of the possible price relationships between the Molybdenum warrant and common stock, I realized that an investment could be made that seemed to insure tremendous profit whether the common rose dramatically or became worthless.


Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager

Asian financial crisis, banking crisis, barriers to entry, beat the dealer, Black-Scholes formula, commodity trading advisor, computer vision, East Village, Edward Thorp, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John Meriwether, John von Neumann, locking in a profit, Long Term Capital Management, margin call, money market fund, Myron Scholes, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K

Another obstacle faced by shorts is that positions can be implemented only on an uptick (when the stock trades up from its last sale price)—a rule that can cause a trade to be executed at a much worse price that the prevailing market price when the order was entered. 59. The Why of Short Selling With all the disadvantages of short selling, it would appear reasonable to conclude that it is foolhardy to ever go short. Reasonable, but wrong. As proof, consider this amazing fact: thirteen of the fourteen traders interviewed in this book incorporate short selling! (The only exception is Lescarbeau.) Obviously, there must be some very compelling reason for short selling. The key to understanding the raison d'etre for short selling is to view these trades within the context of the total portfolio rather than as standalone transactions. With all their inherent disadvantages, short positions have one powerful attribute: they are inversely correlated to the rest of the portfolio (they will tend to make money when long holdings are losing and vice versa).

If a trader can make a net profit on short positions, then short selling offers the opportunity to both reduce risk and increase return. Actually, short selling offers the opportunity to increase returns without increasing risk, even if the short positions themselves only break even. * How? By trading long positions with greater leverage (using margin if the trader is fully invested)—a step that can be taken without increasing risk because the short positions are a hedge against the rest of the portfolio. It should now be clear why so many of the traders interviewed supplement their long positions with short trades: It allows them to increase their return/risk levels (lower risk, or higher return, or some combination of the two). If short selling can help reduce portfolio risk, why is it so often considered to be exactly the opposite: a high-risk endeavor?

For example, Lauer will typically hold long positions for six to twelve months, or even longer, but he will usually be out of short positions within a couple of weeks or less. 61. Identifying Short-Selling Candidates (or Stocks to Avoid for Long-Only Traders) Galante, whose total focus is on short selling, looks for the following red flags in finding potential shorts: > high receivables (large outstanding billings for goods and services); > change in accountants; > high turnover in chief financial officers; >• a company blaming short sellers for their stock's decline; *• a company completely changing their core business to take advantage of a prevailing hot trend. The stocks flagged must meet three additional conditions to qualify for an actual short sale: WIZARD LESSONS >• very high P/E ratio; > a catalyst that will make the stock vulnerable over the near term; > an uptrend that has stalled or reversed. Watson's ideal short-selling candidate is a high-priced, one product company.


pages: 280 words: 73,420

Crapshoot Investing: How Tech-Savvy Traders and Clueless Regulators Turned the Stock Market Into a Casino by Jim McTague

algorithmic trading, automated trading system, Bernie Madoff, Bernie Sanders, Bretton Woods, buttonwood tree, buy and hold, computerized trading, corporate raider, creative destruction, credit crunch, Credit Default Swap, financial innovation, fixed income, Flash crash, High speed trading, housing crisis, index arbitrage, locking in a profit, Long Term Capital Management, margin call, market bubble, market fragmentation, market fundamentalism, Myron Scholes, naked short selling, pattern recognition, Ponzi scheme, quantitative trading / quantitative finance, Renaissance Technologies, Ronald Reagan, Sergey Aleynikov, short selling, Small Order Execution System, statistical arbitrage, technology bubble, transaction costs, Vanguard fund, Y2K

“I was just horrified at a whole series of things that they had done. One of them was their treatment of short selling. There’s nothing wrong with short selling. I’ve done it myself,” he said. But he was appalled that Cox had done away with the uptick rule, which made it more difficult to sell stocks short—and thus drive down prices when the market was in a free fall. Cox and the commission had eliminated the Depression-era Uptick Rule in 2007, arguing that the regulation had been ineffective since 2001 when the stock market under pressure from President Bill Clinton’s SEC Chairman Arthur Levitt had shifted from trading in eighths (12.5 cents) and sixteenths (6.25 cents) to decimals (1 cent). Under decimalization, an uptick of a mere penny would allow short-selling to begin. The rule had become obsolete, in Cox’s estimation. The creators of inverse exchange-traded funds, which increased in value as the market dropped, added that the uptick rule had interfered with the returns on their new, popular products.

The creators of inverse exchange-traded funds, which increased in value as the market dropped, added that the uptick rule had interfered with the returns on their new, popular products. As soon as the rule disappeared, traders began engaging in a practice known as “naked” short selling, where speculators sold short stocks they didn’t physically possess. Actual shares are supposed to be borrowed from other investors in a short-selling transaction and returned when the short seller closes out his position with a purchase, but some investors were bending the rules. With naked short selling, it was theoretically possible to short more shares than a particular company actually had outstanding. In effect, it was a license to print stock certificates. This also was a violation of the law. The SEC could have sued them. Instead, Cox urged the SEC to revisit the rule and change the uptick requirement to a nickel.

But beyond that, and more germane to present policies up for determination, is the condition of the markets during the pilot program. The SEC never tested the elimination of the Uptick Rule during the market sentiments that derived the origination of the Uptick Rule in the first place—the bear market.” Instead of reinstituting the rule, however, the SEC opted for a temporary ban in short selling of 799 financial stocks. Members of Congress wanted to prevent short sellers from driving down the stock prices of weak banks that were beneficiaries of federal bailout dollars. In October 2009, when the ban expired, program traders again engaged in naked short selling. In fact, the market plunged the day after the temporary ban was lifted. Connaughton came up with an idea for Kaufman to have a voice in reforming Wall Street even though he wasn’t a member of the Banking Committee: He convinced Kaufman to pretend that he was a member over the next two years.


Hedgehogging by Barton Biggs

activist fund / activist shareholder / activist investor, asset allocation, backtesting, barriers to entry, Bretton Woods, British Empire, business cycle, buy and hold, diversification, diversified portfolio, Elliott wave, family office, financial independence, fixed income, full employment, hiring and firing, index fund, Isaac Newton, job satisfaction, margin call, market bubble, Mikhail Gorbachev, new economy, oil shale / tar sands, paradox of thrift, Paul Samuelson, Ponzi scheme, random walk, Ronald Reagan, secular stagnation, Sharpe ratio, short selling, Silicon Valley, transaction costs, upwardly mobile, value at risk, Vanguard fund, zero-sum game, éminence grise

HG4530.B516 2006 332.64′5—dc22 2005026139 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 ftoc.qxd 12/5/05 4:29 PM Page v CONTENTS Introduction CHAPTER ix ONE The Triangle Investment Club Dinner: Hacking Through the Hedgehog Jungle CHAPTER TWO The New Hedgehogs May Have Been Golden Boys, but They Still Bleed Red CHAPTER 63 SEVEN The Run-Up and Haunted by Remembrances and Doubt CHAPTER 46 SIX The Roadshow Grind: Blood, Sweat, Toil, and Tears CHAPTER 34 FIVE The Odyssey of Starting a Hedge Fund: A Desperate, Frantic Adventure CHAPTER 21 FOUR Short Selling Is Not for Sissies CHAPTER 9 THREE Short Selling Oil: The Crude Joke Was on Us CHAPTER 1 80 EIGHT Hedgehogs Come in All Sizes and Shapes 95 v ftoc.qxd 12/5/05 4:29 PM Page vi vi CHAPTER CONTENTS NINE The Violence of Secular Market Cycles CHAPTER TEN The Battle for Investment Survival: Only Egotists or Fools Try to Pick Tops and Bottoms CHAPTER 239 EIGHTEEN The Trouble with Being Big CHAPTER 219 SEVENTEEN Three Investment Religions: Growth, Value, and Agnostic CHAPTER 204 SIXTEEN Once You Have a Fortune, How Can You Hang On to It?

That said, professional hedge funds do two different kinds of short selling. One is to sell major indexes short to hedge long positions or to protect the fund if they are bearish. Many of the best managers use this tactic. They are very confident they can apply fundamental analysis to select stocks that will go up, but they have learned the hard way that picking stocks that will go down is considerably more difficult. Currently, the hedge fund industry in general is disillusioned with its ability to earn alpha on the short side. Shorting indexes is passive, they concede, but shorting individual issues or sectors is hazardous. 21 ccc_biggs_ch03_21-33.qxd 22 11/29/05 6:58 AM Page 22 HEDGEHOGGING Nevertheless, specific short selling has its appeal.There are far fewer short sellers than there are long investors, so the short space theoretically should be less populated and, therefore, more inefficient.This is intellectually attractive to those investors who relish being different.

Another reason that the short space is less inhabited is that it is temperamentally stressful; being short something always leaves the seller with an uneasy, queasy feeling. The old saw, “He that sells what isn’t his’n must give it back or go to prison,” echoes back across the centuries. However, short selling appeals to the contrarian instincts of investors, especially those with a skeptical and sardonic view of the innate intelligence of humankind.Thus, the practice endures, but with a relatively high number of casualties. The other type of short selling involves the few dedicated shortbias hedge funds. As this is being written, a guy I know who runs a $500 million short-bias fund tells me that he thinks total short-bias assets currently under management amount to about $3 billion, down from $6 billion a couple of years ago.


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, business cycle, butter production in bangladesh, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, stocks for the long run, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

It’s only when the option holders do something to directly affect the value of the options that the lure of leverage turns lurid. Short-Selling, Margin Buying, and Familial Finances An old Wall Street couplet says, “He who sells what isn’t his’n must buy it back or go to prison.” The lines allude to “short-selling,” the selling of stocks one doesn’t own in the hope that the price will decline and one can buy the shares back at a lower price in the future. The practice is very risky because the price might rise precipitously in the interim, but many frown upon short-selling for another reason. They consider it hostile or anti-social to bet that a stock will decline. You can bet that your favorite horse wins by a length, not that some other horse breaks its leg. A simple example, however, suggests that short-selling can be a necessary corrective to the sometimes overly optimistic bias of the market.

The usual claim is that the money will enable them and their gullible respondents to share in enormous, but frozen foreign accounts. The bear market analogue to pumping and dumping is shorting and distorting. Instead of buying, touting, and selling on the jump in price, shorters and distorters sell, lambast, and buy on the decline in price. They first short-sell the stock in question. As mentioned, that is the practice of selling shares one doesn’t own in the hope that the price of the shares will decline when it comes time to pay the broker for the borrowed shares. (Short-selling is perfectly legal and also serves a useful purpose in maintaining markets and limiting risk.) After short-selling the stock, the scamsters lambast it in a misleading hyperbolical way (that is, distort its prospects). They spread false rumors of writedowns, unsecured debts, technology problems, employee morale, legal proceedings. When the stock’s price declines in response to this concerted campaign, they buy the shares at the lower price and keep the difference.

In general, who is going to buy the stock? It will generally be those whose evaluations are in the 7 to 10 range. Their average valuation will be, let’s assume, 8 or 9. But if those investors in the 1 to 4 range who are quite dubious of the stock were as likely to short sell X as those in the 7 to 10 range were to buy it, then the average valuation might be a more realistic 5 or 6. Another positive way to look at short-selling is as a way to double the number of stock tips you receive. Tips about a bad stock become as useful as tips about a good one, assuming that you believe any tips. Short-selling is occasionally referred to as “selling on margin,” and it is closely related to “buying on margin,” the practice of buying stock with money borrowed from your broker. To illustrate the latter, assume you own 5,000 shares of WCOM and it’s selling at $20 per share (ah, remembrance of riches past).


pages: 302 words: 86,614

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

activist fund / activist shareholder / activist investor, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bernie Madoff, Bretton Woods, business process, call centre, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, fixed income, high net worth, interest rate derivative, Isaac Newton, Long Term Capital Management, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Myron Scholes, NetJets, oil shock, pattern recognition, Ponzi scheme, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, systematic trading, zero-sum game

In a year or two he may lose one or two people on a team of 20 analysts. “Our analysts are analysts through and through,” he says. “We’re looking for people that love to do research.” The Secret Sauce of Short-Selling First, some basics about short-selling. It’s a tough business. In bull markets, where a rising tide lifts even the weakest performers to high valuation levels, shorts must be right more often than they are wrong. The stocks may be hard to borrow. Governments have been imposing restraints and bans on certain short-selling activity, using short-sellers as scapegoats for the implosion of investment banks and sovereign debt woes. While a percentage of short-selling is directional, meaning the investor has an adverse view of a company’s valuation based on an analysis of its financial statements or a sector outlook and hopes to profit when the stock falls or the sector weakens, hedging is another reason.

These returns got him noticed and the fund grew as investors sought out Third Point for its stellar returns. Along the way, Loeb made a name for himself in single-name short-selling, finding both value plays and specializing in what he calls the “Three Fs: fads, frauds, and failures.” As the tech bubble burst, Loeb was correctly positioned short and made a killing. In 2000, he beat the Standard & Poor’s (S&P) by 26.2 percent. In 2001, he beat the S&P by 26.8 percent. Today, Third Point has a dedicated team of short sellers who consistently generate alpha regardless of market conditions. Unlike many hedge funds that use shorting only as a method of hedging, Loeb instills the discipline of the art of alpha-generating short-selling in each of his team members and this approach has given the firm an important means of profit making throughout the years.

Contents Foreword: The Less Mysterious World of Hedge Funds Preface Disclaimer Chapter 1: The Global Macro Maven The Makings of a Maven Coming of Age through a Crisis Building Bridgewater Winning Over the World Bank Belly Up: Learning from the Bad Calculating Crises Foreseeing the Financial Crisis Extracting Alpha Bringing Home the Alpha Fund in Focus Procuring the Principles Watchful Eye on the World Today Going After What You Want Chapter 2: Man versus Machine Tim Wong: The Engineer Pierre Lagrange: The Money Maker Chapter 3: The Risk Arbitrageur The Making of a Risk Arbitrageur It’s Not All Numbers The Stuff of Legends Knowing What You Don’t Know “I’m Sort of an Independent Person” The Greatest Trade Ever Mispriced Risk: Dow/Rohm & Haas Jumping into the Deep End: Citigroup Good as Gold A Little Help from His Friends Fighting Back Chapter 4: Distressed Debt’s Value Seekers The Auto Bailout Brother-and-Sister Partnership Catching the Eye of Robert Bass Killer Combination Detecting Diamonds in the Rough Extracting the Value Chapter 5: The Fearless First Mover Gearing Up at Goldman Pulling in the Profits “A” for Appaloosa The Early Days No “A’s” in High School Learning and Earning Fierce and Fearless Titanic Track Record International Intrigue Russian Roulette Bullish on Bankruptcies Delphi Dilemma WaMu Winner The Force Behind Financials The ABC’s: AIG, BAC, and C Sizing Up the Sweet Spot Chapter 6: The Activist Answer Bright Beginnings Getting Gotham Going The School of Rock Making a Name for Himself Return on Invested Brain Damage Buying the Farm Rising from the Ashes Fast Food, Building Record Results Making Cents at McDonald’s Borders and Target: A Couple of Clunkers Zeroing in on Target MBIA A Dud The Greatest Trade A Penney for His Thoughts Canadian Pacific on the Rails What Makes an Activist Chapter 7: The Poison Pen The Young Whippersnapper Finds His Way Catching the Big Wave in the Storm Evolution and Revolution The Third Point Tao and Team Approach Chapter 8: The Cynical Sleuth Cause for Cynicism The Contrarian Investor The Secret Sauce of Short-Selling Defending an Investment Strategy China’s Coming Crisis Back to Business School Basics Chapter 9: The Derivatives Pioneer The Rise of a Trailblazer “Lehman Weekend” at the Fed The Technicalities of the Trade Afterword Appendix References Acknowledgments About the Author Index Copyright © 2012 by Maneet Ahuja. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey.


pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, break the buck, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, Rubik’s Cube, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

The effect was highly constricting; as Russo noted, “banks will hoard capital unless and until they can borrow the money.” The surest sign of Wall Street’s unease was the prickliness with which Fuld and Russo, along with executives at other banks, responded to the phenomenon of short-sellers—hedge funds and others who were betting against their stocks. Short-selling is a legal and also a justifiable feature of markets, allowing traders to register negative as well as positive convictions. Indeed, Wall Street firms had been active promoters of short-selling, so long as the stocks being shorted were not their own. Now those same CEOs were haranguing the SEC, demanding a crackdown. In the CEOs’ defense, they had just seen Bear all but die, and the shorts’ campaigns against the other Wall Street firms—especially Lehman—had the same predatory edge. There were frequent charges of “naked shorting,” an abusive tactic with greater potential for manipulating prices.x Short-sellers publicized biting critiques of their targets, often involving complex accounting issues, the truth of which was difficult to determine.

He scoured the globe for capital, he vigorously lobbied Washington for help, and he retaliated against well-armed competitors. He protested to Jamie Dimon that JPMorgan was stealing his hedge fund clients; he made similar calls to swaps dealers. On the same Wednesday, he called Chris Cox at the SEC, as well as the two New York senators, Hillary Clinton and Charles Schumer, to demand that the SEC intervene against short-selling. He rang Lloyd Blankfein, who had maintained only a few days earlier that curbs on short-selling weren’t needed. Now, with Goldman’s stock plunging 14 percent on Wednesday, and his firm also suffering a degree of asset flight, Blankfein joined the lobbying campaign. Both banks also raised with Geithner the idea of converting to a commercial bank—another strategy once floated by Lehman. Officials were noticeably more receptive to Mack and Blankfein than they had been to Dick Fuld.

The war with hedge funds was Wall Street’s war with itself, a revolt against a financing stratagem that the banks had conceived and long exploited. After the meeting, Roach made a scheduled presentation to Julian Robertson, the legendary founder of Tiger Management. Robertson was livid over Mack’s drive to curtail short-selling. The courtly North Carolinian (born in Salisbury, a half-hour’s drive from what was to be Mack’s hometown) fumed at Roach: “Do you know a man named John Mack? Well you tell him his campaign against short-selling is going to cost him the goose that laid the golden egg. The hedge fund industry produced the revenues that drove Morgan Stanley’s prime brokerage business.” Roach coolly replied, “Correct me if I’m wrong, but in the stock market crash of 1987, a lot of hedge funds, including Tiger, had liquidity problems.


pages: 162 words: 50,108

The Little Book of Hedge Funds by Anthony Scaramucci

Andrei Shleifer, asset allocation, Bernie Madoff, business process, carried interest, corporate raider, Credit Default Swap, diversification, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, fixed income, follow your passion, Gordon Gekko, high net worth, index fund, John Meriwether, Long Term Capital Management, mail merge, margin call, mass immigration, merger arbitrage, money market fund, Myron Scholes, NetJets, Ponzi scheme, profit motive, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, risk/return, Ronald Reagan, Saturday Night Live, Sharpe ratio, short selling, Silicon Valley, Thales and the olive presses, Thales of Miletus, the new new thing, too big to fail, transaction costs, Vanguard fund, Y2K, Yogi Berra, zero-sum game

In an effort to avoid the limelight, Jones relied on word-of-mouth advertising and dinner party referrals and avoided advertising or the public solicitation of business. As such, he is credited with having changed the entity from a general partnership to a limited partnership and having put on the hedge fund cloak of mystery. Short Selling + Leverage Perhaps most important, Jones’ most profound influence on the hedge fund industry is his alternative and contrarian strategy of using short selling + leverage to achieve profits regardless of market conditions. Often referred to as the redheaded stepchild, short selling, which involves speculating on the prospect of corporate failure was seen as un-American in 1950. And yet, Jones embraced this “little known procedure that scares away users for no good reason” and viewed it as “speculative means for conservative ends.”

This practice has become harder and harder to operate as government intervention in markets is making it harder for these sorts of managers to demonstrate their prowess. What Is Short Selling? As discussed in the beginning of this Little Book, one of the core features that defines hedge funds is short selling. Traditionally, money managers and investors take long positions in a stock, that is, they buy (hopefully undervalued) stocks with the expectation that the stock will increase in value. In simplistic terms, here’s how it works: Analyze a company, develop a predictive model on future cash flow streams, and then buy the stocks that you think are undervalued based upon the fundamentals of their future. Short selling is a completely different beast. Hedge funds managers who exercise the freedom to go short put the investing world in overdrive.

Investment Strategies: The Long and the Short of It As an alternative investment, hedge funds are able to operate in almost any type of market and use almost any type of investment strategy. Although the New York Times once referred to hedge funds’ use of these instruments as “exotic and risky,” it should be noted that most financial institutions use these “exotic” instruments . . . albeit in different capacities. Short Selling Generally, mutual fund managers are only able to hold “long” positions—in other words, they buy a security, such as a stock, bond, or any other money-market instrument, with the expectation that the asset will appreciate in value. They load up on “hot” stocks when the market is expected to go up and then sell these hot stocks when the market is expected to go down. Under this umbrella, investors usually shop a 60/40 portfolio—60 percent in stocks and 40 percent in bonds.


pages: 246 words: 74,341

Financial Fiasco: How America's Infatuation With Homeownership and Easy Money Created the Economic Crisis by Johan Norberg

accounting loophole / creative accounting, bank run, banking crisis, Bernie Madoff, Black Swan, business cycle, capital controls, central bank independence, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Brooks, diversification, financial deregulation, financial innovation, helicopter parent, Home mortgage interest deduction, housing crisis, Howard Zinn, Hyman Minsky, Isaac Newton, Joseph Schumpeter, Long Term Capital Management, market bubble, Martin Wolf, Mexican peso crisis / tequila crisis, millennium bug, money market fund, moral hazard, mortgage tax deduction, Naomi Klein, new economy, Northern Rock, Own Your Own Home, price stability, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail

Blum, From the Morgenthau Diaries, pp. 24-25. 27. Whaples, "Where Is There Consensus?" 28. Rothbard, America's Great Depression, pp. 219, 241. 29. Staley, Art of Short Selling, p. 247. 30. New York Times, "Shortselling." 31. Tsang, "Short Sellers under Fire." 32. Sorkin, "As No-Short-Selling List Grows." JMP Securities also asked to be struck from the list. 33. The Economist, "Shifting the Balance." 34. Lejland, "Finansravarna" (quotation translated). 35. Chanos, "Short Sellers Keep the Markets Honest"; Tsang, "Short Sellers under Fire." 36. Donovan, "Investment Bankers of the World, Unite!" 37. Oakley, "Short-Selling Ban Has Minimal Effect." 38. Younglai, "SEC's Cox Regrets Short-Selling Ban." 39. Nocera, "Alarm Led to Action." 40. For critical scrutiny of her book, see Norberg, "The Klein Doctrine" (and for more exhaustive treatment of the issue in Swedish, Benulic and Norberg, Allt oni Naomi Kleins nakenchock). 41.

An Inquiry into the Nature and Causes of the Wealth of Nations. Indianapolis: Liberty Fund, 1981. First published 1776. Solomon, Deborah, and David Enrich. "Devil Is in Bailout's Details." Wall Street Journal, October 15, 2008. Sorkin, Andrew Ross, ed. "As No-Short-Selling List Grows, Another Firm Chooses to Leave." Dealbook blog/New York Times, September 23, 2008. http://deal book.blogs.nytimes.com/2008/09/23 /as-no-short-selling-list-grows-another-firm- chooses-to-leave/?pagemode =print. Stafford, Philip. "Traders Blind to Mounting Worries." Financial Times, September 19, 2007. Staley, Kathryn. The Art of Short Selling. New York: John Wiley & Sons, 1997 Stelzer, Irwin M. "Do Deficits Matter?" Weekly Standard, February 15, 2005. Stevenson, Richard. "The Velvet Fist of Fannie Mae." New York Times, April 20, 1997. Stiglitz, Joseph.

The administration and the Fed had recently given out improvised electric shocks to get the economy beating again, but to no avail. Bernanke and Paulson now felt an overall approach was necessary. The program that they proposed to Congress-and that its leaders now quickly endorsed-was intended as a defibrillator working at maximum power. They wanted the government to guarantee the money-market funds and to ban the shorting (selling stocks you do not own) of shares in financial companies, and above all, they wanted $700 billion. The largest bailout package in history would enable the treasury secretary to buy bad mortgages from the banks, so that the markets would regain confidence in them and they would be able to start circulating again. The difficult question, of course, was how much the government should pay for the mortgages.


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

3Com Palm IPO, asset allocation, Bernie Madoff, Brownian motion, buy and hold, collateralized debt obligation, commodity trading advisor, computerized trading, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index arbitrage, index fund, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, survivorship bias, transaction costs, two-sided market, value at risk, yield curve

Jones felt that one of the flaws of conventional long-only investing was that it made it difficult for investors to hold on to their positions through steep market corrections. He saw that short selling could be used as a risk control tool. Jones referred to short selling as a “speculative technique for conservative ends.” For Jones, the attractiveness of short selling was not the potential gains it provided from stock market declines, but rather its role as a market hedge that made it more feasible to hold on to and profit from good long positions, since the short positions provided the investor with some protection on market declines. Jones’s ability to grasp that when used to counterbalance long positions, short selling was a risk-reducing rather than speculative tool demonstrated remarkable insight for a financial novice. Although short selling was an essential component of Jones’s strategy, he felt that short trades were inherently inferior to long trades for many reasons.

These reasons included the inability to get long-term gains on short trades, the necessity of paying dividends while holding shorts, the restriction of not being able to go short except on an uptick, and the paucity of research on short-selling ideas because of Wall Street’s almost exclusive focus on buy recommendations. For these reasons, Jones clearly preferred the long side, but his short trades were useful as an aid in profiting from his long positions. In a report Jones wrote to investors, he took aim at the prevailing notion that short selling was somehow “immoral or antisocial”—some things never change. Jones called this perspective “an illusion.” As Jones explained, “The successful short seller is performing a useful market function in that he arrests an unjustified market rise in a stock by selling it, and then later cushions its fall by buying it back, thus moderating its fluctuations.” Jones’s use of short selling to offset the risk of long positions gave him the ammunition to increase the magnitude of his long position vis-à-vis what it would have been without the short hedge, while still reducing the risk on balance.

Whereas mutual funds are highly homogeneous, consisting primarily of long equity or long bond investments (or a combination of the two), hedge funds encompass a broad range of strategies—a diversity made possible by the wide spectrum of financial instruments in which hedge funds can invest, combined with an ability to use the tools of short selling and leverage. The next section provides a synopsis of the major categories of hedge fund strategies. Ability to diversify a multifund portfolio. Creating a diversified mutual fund portfolio is virtually impossible, as nearly all mutual funds are highly correlated to either the stock market or the bond market. In contrast, the large number of different hedge fund strategies makes it possible to create a portfolio with significant internal diversification. The ability to meaningfully diversify a portfolio is the key reason why equity drawdowns in hedge funds of funds are muted compared with the magnitude of retracements witnessed in mutual funds. Shorting. Short selling is an integral component of most hedge funds. The incorporation of short selling means that the success of the hedge fund manager is no longer necessarily tied to a rising market (although it may be if the manager so chooses).


pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, John Meriwether, Kenneth Rogoff, Kickstarter, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, Paul Samuelson, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Mercer, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs

If the market falls by 20 percent, and if the stocks selected by the two investors beat the market average by the same ten-point margin, the returns come out like this: In sum, the hedged fund does better in a bull market despite the lesser risk it has assumed; and the hedged fund does better in a bear market because of the lesser risk it has assumed. Of course, the calculations work only if the investors pick good stocks; a poor stock picker could have his incompetence magnified under Jones’s arrangement. Still, given the advantages of the hedged format, the question was why other fund managers failed to emulate it. The answer began with short selling, which, as Jones observed in his report to investors, was “a little known procedure that scares away users for no good reason.”30 A stigma had attached to short selling ever since the crash and was to survive years into the future; amid the panic of 2008, regulators slapped restrictions on the practice. But as Jones patiently explained, the successful short seller performs a socially useful contrarian function: By selling stocks that rise higher than seems justified, he can dampen bubbles as they emerge; by repurchasing the same stocks later as they fall, he can provide a soft landing.

In 1984, for example, the S&P 500 index rose just 6.3 percent while Tiger returned 20.2 percent; more than half of Robertson’s returns came from his short investments.18 The following year a portfolio manager named Patrick Duff began to suspect that a hotel chain called Prime Motor Inns was in a rather worse position than its accounts suggested. Duff did nothing about it, because he was working for a conventional pension fund at the time; but when he joined Tiger in 1989, he persuaded Robertson to short the company. Within a year, Prime Motor Inns fell from $28 to $1, demonstrating how profitable short selling could be. Robertson had an arrow in his quiver that conventional funds lacked. “It’s me and the patsies,” he once told an associate.19 But Tiger’s defiance of efficient-market presumptions cannot be explained entirely by short selling. In most years Robertson would have beaten the market even without the profits from his shorts, suggesting that he had an edge precisely where the theory said no edge was possible: in traditional stock buying. Moreover, Robertson’s record, like Buffett’s record, was not an isolated phenomenon.

As their stock prices cratered on Wednesday, the two firms worked the phones; and by the end of the day, both New York senators, Chuck Schumer and Hillary Clinton, were calling on the Securities and Exchange Commission to give Morgan and Goldman the short-selling ban that they demanded. On Thursday SEC chairman Christopher Cox expressed doubts about helping the bankers, but he found himself alone. “You have to save them now or they’ll be gone while you’re still thinking about it,” insisted the Treasury secretary Hank Paulson.29 At around 1:00 P.M., the Financial Services Authority in London announced a thirty-day ban on short selling of twenty-nine financial firms, signaling that the authorities would now do whatever it might take to save flagship companies. On Goldman’s trading floor, some three dozen traders greeted the news like infantrymen who have been rescued by air power: They stood up, placed their hands over their hearts, and sang along to “The Star-Spangled Banner,” which someone was playing over the loudspeaker system.30 Later that evening, the SEC went one better than London, banning the short selling of shares in about eight hundred financial companies.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

activist fund / activist shareholder / activist investor, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, business cycle, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, plutocrats, Plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

Short sellers can likewise have an important social function. Consider the case of a financially stressed company that wants to raise capital. Many investors will be willing to buy its IOUs on the basis that they will hedge the risk of holding the debt by taking an offsetting short position in the company’s shares. If the company runs into trouble, the profit on the short-selling transaction will offset the losses on the debt. That would strike many people as morally acceptable. And most short selling, incidentally, consists of arbitrage trades like this rather than straight bets on companies performing badly. Yet it arouses passionate (and selective) criticism. The same people who are delighted if short sellers in the oil market bring down the price of oil will criticise those who go short of shares in an oil company. Chairmen and chief executives are among the more virulent because they hate the negative verdict on their own performance and fear that a sharp fall in the share price may undermine their job security.

They identified the weaknesses of Enron and Lehman, and the resulting slide in their share prices was an accurate reflection of economic reality as these sorely mismanaged outfits approached collapse. That fundamental point has, incidentally, been well understood by great novelists. The dramatic dénouement of Zola’s late nineteenth-century work L’Argent consists of a short-selling operation in which a brilliant financier realises that a rival’s bank is fraudulent, and brings about its demise. While Zola was anxious to convey the financial sleaze and corruption of the French Second Empire and to emphasise the terrible effects of speculation on ordinary people, he nonetheless showed how short selling could uncover the unpalatable truth. Milton Friedman, economist and great propagandist for free market capitalism, argued that speculation was a stabilising influence in markets generally. And there is widespread acceptance among economists that stabilising speculation can dampen volatility in markets because speculators are prepared to take a contrary view.

Speculators tried to corner stocks to create artificial scarcity and were adept at other forms of share manipulation, short selling and, with the help of corrupt journalists, false rumour mongering. It was not until the twentieth century that such practices were vigorously, but by no means completely, reined in by regulation. Much of the regulation was introduced in response to the 1929 crash. And it is worth noting, in passing, that Richard Whitney, the great defender of speculation, ultimately went to jail for embezzlement. As with capitalism itself, speculation has made progress towards a degree of respectability. This started, predictably enough, in the US, where the epitome of the respectable speculator was Bernard Baruch, who made a fortune in the sugar market around the start of the twentieth century. Baruch’s view on speculation and short selling, expressed before the Committee on Rules of the US House of Representatives in 1917, was that ‘to enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears.


Risk Management in Trading by Davis Edwards

asset allocation, asset-backed security, backtesting, Black-Scholes formula, Brownian motion, business cycle, computerized trading, correlation coefficient, Credit Default Swap, discrete time, diversified portfolio, fixed income, implied volatility, intangible asset, interest rate swap, iterative process, John Meriwether, London Whale, Long Term Capital Management, margin call, Myron Scholes, Nick Leeson, p-value, paper trading, pattern recognition, random walk, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, statistical model, stochastic process, systematic trading, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

While this can be as simple as finding a trading partner and signing a contract, the customized nature of many contracts prevents them from being traded (transferred to another trader for a cash payment). As a result, it is common for traders to use resources that can help them find trading partners and sign standardized trading contracts. (See Table 1.2, Types of Trading Venues.) KEY CONCEPT: REGULATIONS AROUND SHORT SELLING Many countries and markets have restrictions on short selling. In those markets, specific actions, those designated as “short selling,” might have regulatory and compliance implications. Depending on how the regulations are written, there may be little relationship between “short selling” as a trading concept and “short selling” as a regulatory concept. 17 Trading and Hedge Funds TABLE 1.2 Types of Trading Venues Bilateral Broker Dealer Exchange Traders directly find one another. Traders are introduced to each other through use of a broker. Traders transact directly with a dealer Traders are matched up on an exchange.

The farmer’s obligation is to acquire corn before the delivery and not necessarily to grow it himself. 16 RISK MANAGEMENT IN TRADING KEY CONCEPT: REQUIREMENTS FOR TRADING Trading requires: ■ ■ ■ A buyer or a seller willing to take the other side of the transaction The ability to both buy and sell without a substantial loss of value. A substantial loss of value might be defined as 10 percent. The ability to define standard products which can be interchanged with one another (these are called fungible products) Other markets also allow short selling. In the stock market, short selling is made possible by borrowing shares and agreeing to repay them at some point in the future. If done for purely speculative purposes, short selling is a way of betting that prices will decline over time. However, short selling can be used for a variety of other purposes. For example, a broker might short a stock to allow a customer to make an immediate transaction. The broker would then have to purchase in a later transaction. This can help small investors who want a one‐stop solution for trading.

By taking advantage of markets that allow short selling, these strategies can make profits in both rising and falling markets. Many global macro strategies are based on an analysis of economic trends. In particular, traders study when trends are likely to persist and when they are likely to reverse. Through modeling, or intuition, the traders will rebalance their trading portfolios in an attempt to properly time the market. Relative Value Relative Value strategies make bets based on spreads between assets. Typically, these are long/short strategies where traders simultaneously buy one asset while shorting another. Shortingg is making a trade that benefits the trader when the price of an asset falls. This can be done by borrowing an asset from another trader and selling it (called short selling g) or by entering 8 RISK MANAGEMENT IN TRADING into a derivative contract (like an agreement to sell an asset expected to be owned in the future at a fixed price).


pages: 232 words: 71,965

Dead Companies Walking by Scott Fearon

bank run, Bernie Madoff, business cycle, corporate raider, creative destruction, crony capitalism, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, Golden Gate Park, hiring and firing, housing crisis, index fund, Jeff Bezos, Joseph Schumpeter, late fees, McMansion, moral hazard, new economy, pets.com, Ponzi scheme, Ronald Reagan, short selling, Silicon Valley, Snapchat, South of Market, San Francisco, Steve Jobs, survivorship bias, Upton Sinclair, Vanguard fund, young professional

Long ago, I learned to appreciate one of the most enduring and important American business traditions: failure. While most of my fund’s investments are in the stocks of companies I believe are undervalued, I also look for stocks that are overvalued by the markets. My specialty is identifying what I call “dead companies walking”—businesses on their way to bankruptcy and a zeroed-out share price. To the noninvestor, earning money on losing stocks might sound counterintuitive. But short selling is a routine, if widely misunderstood, investment strategy. And while it may seem macabre to profit on the misfortunes of others, investors like me make our markets stronger and more efficient. We Americans like to think we have the greatest economy in the history of the world. And we do. But most people don’t really understand why. It’s not just because of our plentiful natural resources or our global dominance or our business-friendly politics.

Even after Cal Coastal went into Chapter 11, people continued to hope against hope that it would make a comeback. One prominent money manager started to buy Cal Coastal like it was a hot new start-up. There were roughly eleven million common shares of the company. By the time his spree came to an end, this guy had acquired more than two million of them—just in time for the final bankruptcy settlement to wipe out every cent of value they had. How I Make Money on Falling Stocks The mechanics of short selling are relatively simple. My prime broker borrows a certain number of shares in a company on my behalf. My fund then sells these borrowed shares at the current market price. Normally, at some point in the future, I would be obligated to purchase that number of shares so that I can “cover” my position. If the stock in question goes down in value, as I’m expecting, I will be able to buy those shares at a lower price than I sold them for.

Theoretically, there is an infinite amount of risk. If you buy a stock selling at $10, the most you can possibly lose is $10. If you short that same stock, however, and it winds up being the next Apple or Exxon or Berkshire Hathaway, you stand to lose a whole lot more if you don’t cover in time. Ideally, I don’t have to worry about covering my positions at all. That’s because, unlike most other short-selling investors out there, I don’t seek out stocks I think are just going to dip a little bit in the near term (as I did with my very first short of TGI Fridays). I look for genuine failures, companies like Cal Coastal, that seem destined for one outcome: bankruptcy and a zeroed-out stock price. Neither the analyst nor the fund manager was up to anything underhanded or crooked. They were just catastrophically wrong.


pages: 468 words: 145,998

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson

asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, buy and hold, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, fixed income, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, Northern Rock, price discovery process, price mechanism, regulatory arbitrage, Ronald Reagan, Saturday Night Live, short selling, sovereign wealth fund, technology bubble, too big to fail, trade liberalization, young professional

I wanted the SEC to investigate what looked to me to be predatory, collusive behavior as our banks were being attacked one by one. Chris was considering various steps the SEC could take, including a temporary ban on short selling, but his board was divided. He wanted Tim, Ben, and me to support him on the need for a ban. The short-selling debate was another of those issues where I found myself forced to do the opposite of what I had believed for my entire career. Short selling is a crucial element in price discovery and transparency—after all, David Einhorn, the hedge fund manager who shorted Lehman, had ultimately been proved right. I had long compared banning short selling to burning books, but now I recognized short selling as a big problem. I concluded that even though an outright ban would lead to all sorts of unintended consequences, it couldn’t be worse than what we were experiencing just then.

What he had predicted Sunday night had come to pass: investors were losing confidence, and the short sellers were after his bank. His cash reserves were evaporating, and he was doing everything he could to hold things together. “Hank,” John said, “the SEC needs to act before the short sellers destroy Morgan Stanley.” Since Monday he had been calling senators, congressmen, the White House, and me, trying to persuade everyone to push the SEC to do something about abusive short selling. He wasn’t alone. John Thain also called that afternoon to press about short selling. Shareholders had not yet approved Merrill’s deal with Bank of America, and he was taking nothing for granted. But his immediate concern was Morgan Stanley. The failure of another major institution, he knew, would be devastating. Ben and I had arranged to meet with congressional leaders that evening, but first Tim and I had to call AIG chief Bob Willumstad to confirm that the Fed was on track to make the loan—and to tell him that he was being replaced.

He didn’t know what I could do, but he said he felt obliged to tell me, point-blank, that he was not sure Morgan Stanley was going to make it. Coming from Bob, always calm and levelheaded, this was an alarming message. I alerted Tim Geithner and then called Chris Cox to urge him again to do something to end abusive short selling. I had been pressing Chris with increasing intensity since Monday. We’d spoken seven times Wednesday and would speak just as frequently Thursday on the subject. I implored him not to sit idly by while our financial system was destroyed by speculators. Any other time, I would have argued strongly against a ban, but my reasoning now was pragmatic: our short-selling rules hadn’t been written for these conditions, and whatever we chose to do couldn’t be worse than the panic we were now seeing. Chris worried about unintended consequences to the market. “If you wait any longer,” I said, “there won’t be a market left to regulate.”


Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, price anchoring, price stability, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

bern_c10.qxd 3/23/07 9:07 AM Page 143 Barclays Global Investors 143 The biggest step forward was the introduction of long/short strategies in 1996, promoted by a few people on the staff who were big believers. This approach—an aggressive idea without much acceptance at the time—appeared to BGI to be a more efficient way to manage money than under long-only conditions. Short-selling offered a major increase in Breadth, and therefore in the critically important Information Ratio, because selling stocks short instead of just buying them doubled the opportunities to put return forecasts to good use. Short-selling turned out to be even more effective in fixed-income management. With stocks, the upside may be infinite and the downside may be zero, but as a practical matter the upside and downside are roughly equal. Not so with bonds. The ultimate bond payoff at par is a powerful anchor holding prices close to 100.

In my experience as a money manager in the late 1960s and as a consultant and observer since then, bubbles are more often made by clients than by managers, because it is scary for a manager to remain steadfast when long-time clients start walking out the door. Only the most toughminded can resist that kind of pressure. And what of the future? Grossman believes much has been learned from the experience with the bubble. The terrible losses incurred in the crash made short-selling appear much more respectable. On the other hand, short-selling and the rapid growth of the hedge fund universe are making the market more efficiently priced as mispricings disappear bern_c10.qxd 3/23/07 9:07 AM Page 147 Barclays Global Investors 147 more rapidly. So the market is even more difficult to beat than it was in the first place. Alpha does not grow on trees, ripe for the picking, even for management organizations as sophisticated as BGI.

The principles of corporate finance have undergone important changes; indeed, Modigliani–Miller’s bold concepts may have had a greater impact on the bubble of the 1990s and its aftermath than many observers realize. Alpha and beta—once upon a time the unpalatable language of the Capital Asset Pricing Model—have become critical ingredients of the most sophisticated forms of portfolio management and investment performance measurement. New portfolio structures, most notably in the form of hedge funds and the increasing acceptance of short-selling, are increasingly important, but all of them have deep roots in Capital Ideas. Finally, the proliferation of products, strategies, and innovation stemming from the options pricing model—what Eugene Fama has called “the biggest idea in economics of the century”—has been explosive, and may still have a long way to go.6 As just one example, the total notional amount of derivatives outstanding at the end of 2006 was $370 trillion, a number to make one’s head spin.* The book begins by facing up front the attack on Capital Ideas by the proponents of Behavioral Finance—and especially on the idea of the Efficient Market Hypothesis.


pages: 326 words: 106,053

The Wisdom of Crowds by James Surowiecki

AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, coronavirus, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, John Meriwether, Joseph Schumpeter, knowledge economy, lone genius, Long Term Capital Management, market bubble, market clearing, market design, Monkeys Reject Unequal Pay, moral hazard, Myron Scholes, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, Yogi Berra, zero-sum game

But the chances that the spread was wrong would be greater than if people were allowed to bet on both teams, because there’d be a greater chance that those who were betting would have similar biases, and therefore would make similar mistakes. And when bettors were wrong, they would be really wrong. The same is true of the stock market. Limiting short selling increases the chance that prices will be off, but what it really increases is the chance that if the price of a stock gets out of whack, it will get really out of whack. Internet stocks, for instance, were almost impossible to short, and that may have something to do with why their prices went into orbit. Short selling isn’t one of the “great commercial evils of the day.” The lack of short selling is. II Chanos’s assertion that one reason why there isn’t more short selling is that most people are not psychologically built to endure constant scorn struck me, when I first heard it, as correct. And most people would probably find the idea unexceptionable that emotion or psychology might affect the way individuals invest.

While the Malaysian minister’s suggestion that short sellers should be physically thrashed may have been novel, the hostility that provoked the suggestion was not. In fact, short sellers have been the target of investor and government anger since at least the seventeenth century. Napoleon deemed the short seller “an enemy of the state.” Short selling was illegal in New York State in the early 1800s, while England banned it outright in 1733 and did not make it legal again until the middle of the nineteenth century (though all indications are that the ban was quietly circumvented). The noisiest backlash against short selling came, perhaps predictably, in the wake of the Great Crash of 1929, when short sellers were made national scapegoats for the country’s economic woes. Shorting was denounced on the Senate floor as one of “the great commercial evils of the day” and “a major cause of prolonging the depression.”

Congress, too, weighed in, holding hearings into short sellers’ alleged nefarious activities. But the congressmen came away empty-handed, since it became clear that most of the real villains of the crash had been on the long side, inflating stock prices with hyped-up rumors and stock-buying pools and then getting out before the bubble burst. Nonetheless, the skepticism about short selling did not abate, and soon after, federal regulations were put in place that made short selling more difficult, including a rule that banned mutual funds from selling stocks short (a rule that stayed in place until 1997). In the decades that followed, many things about investing in America changed, but the hatred of short sellers was not one of them. In the popular imagination even today, short sellers are conniving sharpies, spreading false rumors and victimizing innocent companies with what Dennis Hastert, before he became Speaker of the House, called “blatant thuggery.”


The Great Crash 1929 by John Kenneth Galbraith

Bernie Madoff, business cycle, Everybody Ought to Be Rich, full employment, housing crisis, invention of the wheel, joint-stock company, margin call, market fundamentalism, short selling, South Sea Bubble, the market place

With the cooperation of the Paris police, the news was withheld until the market closed. Later a congressional committee was exceedingly critical of this delay, and Al Smith's action was cited in the defense. In the case of Kreuger, it should be added, the security system of the Paris police was less than perfect. It is fairly certain that there was heavy selling that morning—including heavy short selling—of Kreuger and Toll by continental interests.2 II In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss.

On November 13 there was another Rockefeller story: it was said that the family had entered a million-share buying order to peg Standard Oil of New Jersey at 50. During the rest of November and December the course of the market was moderately up. The decline had run its course. However, the end coincided with one last effort at reassurance. No one can say for sure that it did no good. One part was the announcement by the New York Stock Exchange of an investigation of short selling. Inevitably in the preceding weeks there had been rumors of bear raids on the market and of fortunes being made by the shorts. The benign people known as "they," who once had put the market up, were now a malign influence putting it down and making money out of the common disaster. In the early days of the crash it was widely believed that Jesse L. Livermore, a Bostonian with a large and unquestionably exaggerated reputation for bear operations, was heading a syndicate that was driving the market down.

So persistent did these rumors become that Livermore, whom few had thought sensitive to public opinion, issued a formal denial that he was involved in any deflationary plot. "What little business I have done in the stock market," he said, "has always been as an individual and will continue to be done on such basis." As early as October 24, The Wall Street Journal, then somewhat less reserved in its view of the world than now, complained that "there has been a lot of short selling, a lot of forced selling, and a lot of selling to make the market look bad." Such suspicions the Exchange authorities now sought to dispel. Nothing came of the study. A more important effort at reassurance was made by President Hoover. Presumably he was still indifferent to the fate of the stock market. But he could not be indifferent to the much publicized fundamentals, which by now were behaving worse each week.


pages: 117 words: 31,221

Fred Schwed's Where Are the Customers' Yachts?: A Modern-Day Interpretation of an Investment Classic by Leo Gough

Albert Einstein, banking crisis, Bernie Madoff, corporate governance, discounted cash flows, diversification, fixed income, index fund, Long Term Capital Management, Northern Rock, passive investing, Ralph Waldo Emerson, random walk, short selling, South Sea Bubble, The Nature of the Firm, the rule of 72, The Wealth of Nations by Adam Smith, transaction costs, young professional

EXCEPTIONS ARE THE RULE 23. FUNDAMENTAL ANALYSIS 24. NEW ISSUES 25. TRUSTEES, EXECUTORS AND LAWYERS 26. RETIREMENT PLANNING 27. INDEX INVESTING 28. DON’T INVEST ON A HIGH 29. COMPANIES DON’T OFTEN TURN AROUND 30. RIDE THE WINNERS 31. THE TROUBLE WITH TRANSACTION COSTS 32. CROOKS 33. AVOIDING THE BIG COLLAPSES 34. COUNTER-CYCLICAL INVESTMENT 35. GLOBALISATION 36. NUMERACY REQUIRED 37. SHORT SELLING 38. THOSE CRAZY REGULATORS 39. COLLECTIVE INVESTMENTS 40. MERGERS AND ACQUISITIONS 41. MASSAGING THE FIGURES 42. LOOKING FOR BARGAINS 43. DISCOUNTED CASH FLOW 44. STOCK MARKET NEWSLETTERS 45. LIFE PLAN 46. HEDGE FUNDS 47. SOME IMPORTANT BASICS 48. BEHAVIOURAL FINANCE 49. BUSINESS IS HARD 50. LOSS 51. THE ‘FAT, STUPID PLEASANT’ APPROACH 52. BOOKS ON THE STOCK MARKET INDEX INTRODUCTION In 1940 Fred Schwed, a stockbroker whose father had lost everything as a short seller on Wall Street during the Roaring Twenties, published this timeless classic on how the stock market really works.

HERE’S AN IDEA FOR YOU… When you look at price charts you often see quite fantastic leaps and drops, often for reasons you can’t fathom. You may not know where the price is going to go next year, but you can work out the variance of its performance in the past, which gives you an estimate of how wildly this stock might leap. You might want to stick to steady stocks with the same long term performance. 37 SHORT SELLING ‘Before October 1929 no-one objected to short sellers except their own families. They objected to going bankrupt.’ Fred Schwed devotes a good deal of his book to defending short sellers, who got a lot of blame for the Wall Street Crash of 1929. It is hilarious to find the same kinds of attacks on short sellers happening today, 90 years and umpteen crashes later. DEFINING IDEA… But now that prices are coming down, I don’t hear anybody saying hedge funds have done a good job bringing down the price of oil

Bear raiders don’t have to manipulate the shares of a company that is on the way out – they just have to make the bet. Short sellers provide liquidity to the market and take enormous risks when doing so. They really are not a bad thing. Even Warren Buffett, who doesn’t short much himself, thinks they are useful because they seek out problems in companies, especially in their accounts, that other people are trying to keep under wraps. HERE’S AN IDEA FOR YOU… Short selling really, really isn’t for amateurs, because timing is everything; if you are just a little bit wrong you can lose a packet. Don’t try it – but if you must, why not try shorting through a spread betting company? Then at least any profits that you make will be tax free. 38 THOSE CRAZY REGULATORS ‘I find myself wishing that the [Securities and] Exchange Commission would perform its functions with a little less zip and hurrah.’


How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business cycle, business process, butter production in bangladesh, buy and hold, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

We were also fully aware of the cost of constraints on short selling, but we did not think short selling would be acceptable to pension fund clients. Soon after we began managing portfolios, however, some clients asked about shorting stocks. With their encouragement, we ran analyses on the stocks at the bottom of our return prediction rankings and found that they did underperform the market. Jacobs Levy soon became one of the first money managers to exploit the potential of short selling within a disciplined framework when we began offering long-short portfolios in 1990. Engineered long-short portfolios offer the benefits of shorting within the risk-controlled environment of quantitative portfolio construction. The ability to sell stocks short can benefit both security selection and portfolio construction. To begin with, short selling expands the list of implementable ideas to include both “winning” and “losing” securities.

It also does not give the manager much leeway to JWPR007-Lindsey 276 May 28, 2007 15:46 h ow i b e cam e a quant distinguish between degrees of negative opinions; a stock about which the manager holds an extremely negative view is likely to have roughly the same underweight as a stock about which the manager holds only a mildly negative view. Short selling removes this constraint on underweighting. Significant stock underweights can be established as easily as stock overweights. The ability to short thus enhances the manager’s ability to implement all the insights from the investment process, insights about potential losers as well as winners. Short selling also improves the ability to control risk. Benchmark weights are the starting point for determining a long-only portfolio’s residual risk. Departures from benchmark weights introduce residual risk, so a long-only portfolio tends to converge toward the weights of the stocks in its underlying benchmark in order to control risk.

., 162 Sargent, Thomas, 188 Savine, Antoine, 167 Sayles, Loomis, 33 SBCC, 285 Scholes, Myron, 11, 88, 177, 336 input, 217 Schulman, Evan, 67–82 Schwartz, Robert J., 293, 320 Secret, classification, 16–18 Securities Act of 1933, 147 Securities Exchange Act of 1934, 147 Security replication, probability (usage), 122 SETS, 77 Settlement delays, 174 Seymour, Carl, 175–176 Shareholder value creation, questions, 98 Sharpe, William, 34, 254 algorithm, 257–258 modification, 258 Shaw, Julian, 227–242 Sherring, Mike, 232 Short selling, 275–276 Short selling, risk-reducing/returnenhancing benefits, 277 Short-term reversal strategy, 198–199 Shubik, Martin, 288–289, 291, 293 Siegel’s Paradox, 321–322 Sklar’s theorem, 240 Slawsky, Al, 40–41 Small-cap stocks, purchase, 268 Smoothing, 192–193 Sobol’ numbers, 173–173 Social Sciences Research Network (SSRN), 122 Social Security system, bankruptcy, 148 Society for Quantitative Analysis (SQA), 253 Spatt, Chester, 252 Spot volatility, parameter, 89–90 Standard & Poor’s futures, price (relationship), 75 INDEX Start-up company, excitement, 24–25 Statistical data analysis, 213–214 Statistical error, 228 Sterge, Andrew J., 317–327 Stevens, Ross, 201 Stochastic calculus, 239 Stock market crash (1987), 282 Stocks portfolio trading, path trace, 129 stories, analogy, 23–26 Strategic Business Development (RiskMetrics Group), 49 Sugimoto, E., 171 Summer experience, impact, 57 Sun Unix workstation, 22 Surplus insurance, usage, 255–256 Swaps rate, Black volatilities, 172 usage, 292–293 Sweeney, Richard, 190 Symbolics, 16, 18 Taleb, Nassim, 132 Tenenbein, Aaron, 252 Textbook learning, expansion, 144 Theoretical biases, 103 Theory, usage/improvement, 182–185 Thornton, Dan, 139 Time diversification, myths, 258 Top secret, classification, 16–18 Tracking error, focus, 80–81 Trading, 72–73 Transaction cost, 129 absence, 247 impact, 273–274 Transaction pricing, decision-making process, 248 Transistor experiment (TX), 11 Transistorized Experimental Computer Zero (tixo), usage, 86 Treynor, Jack, 34, 254 Trigger, usage, 117–118 Trimability, 281 TRS-80 (Radio Shack), usage, 50, 52, 113 Trust companies, individually managed accounts (growth), 79 Tucker, Alan, 334 Uncertainty examination, 149–150 resolution, 323–324 Unit initialization, 172 Universal Investment Reasoning, 19–20 Upstream Technologies, LLC, 67 U.S. individual stock data, research, 201–202 Value-at-Risk (VaR), 195. calculation possibility tails, changes, 100 design, 293 evolution, 235 measurement, 196 number, emergence, 235 van Eyseren, Olivier, 173–175 Vanilla interest swaptions, 172 VarianceCoVariance (VCV), 235 Variance reduction techniques, 174 Vector auto-regression (VAR), 188 Venture capital investments, call options (analogy), 145–146 Volatility, 100, 174, 193–194 Volcker, Paul, 32 von Neumann, John, 319 Waddill, Marcellus, 318 Wall Street business, arrival, 61–65 interest, 160–162 move, shift, 125–127 quant search, genesis, 32 roots, 83–85 Wanless, Derek, 173 Wavelets, 239 Weisman, Andrew B., 187–196 Wells Fargo Nikko Investment Advisors, Grinold (attachment), 44 Westlaw database, 146–148 “What Practitioners Need to Know” (Kritzman), 255 Wigner, Eugene, 54 Wiles, Andrew, 112 Wilson, Thomas C., 95–105 Windham Capital Management LLC, 251, 254 Wires, rat consumption (prevention), 20–23 Within-horizon risk, usage, 256 Worker longevity, increase, 148 Wyckoff, Richard D., 321 Wyle, Steven, 18 Yield, defining, 182 Yield curve, 89–90, 174 Zimmer, Bob, 131–132


pages: 351 words: 102,379

Too big to fail: the inside story of how Wall Street and Washington fought to save the financial system from crisis--and themselves by Andrew Ross Sorkin

affirmative action, Andy Kessler, Asian financial crisis, Berlin Wall, break the buck, BRICs, business cycle, collapse of Lehman Brothers, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Emanuel Derman, Fall of the Berlin Wall, fear of failure, fixed income, Goldman Sachs: Vampire Squid, housing crisis, indoor plumbing, invisible hand, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Mikhail Gorbachev, money market fund, moral hazard, naked short selling, NetJets, Northern Rock, oil shock, paper trading, risk tolerance, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, savings glut, shareholder value, short selling, sovereign wealth fund, supply-chain management, too big to fail, value at risk, éminence grise

Mack was reviewing draft language for the statement he would publish the following day in support of Cuomo’s investigation into short selling. Though he knew full well that his language would infuriate his clients and send even more of them packing, Mack didn’t believe he had a choice but to lend his support: Morgan Stanley applauds Attorney General Cuomo for taking strong action to root out improper short selling of financial stocks. By initiating a wide-ranging investigation of this manipulative and fraudulent conduct, Attorney General Cuomo is showing decisive leadership in trying to help stabilize the financial markets. We also support his call for the SEC to impose a temporary freeze on short selling of financial stocks, given the extreme and unprecedented movements in the market that are unsupported by the fundamentals of individual stocks.

“Fannie Mae and Freddie Mac play a central role”: “Paulson Announces GSE Initiatives,” press release, Department of the Treasury, July 13, 2008. See http://www.treas.gov/press/ releases/hp1079.htm. “Our proposal”: “Part I, Part II of a Hearing of the Senate Banking, Housing and Urban Affairs Committee,” Federal News Service, July 15, 2008. SEC to begin cracking down on improper short selling: The SEC issued an emergency diktat to halt “unlawful manipulation through ‘naked’ short selling,” which was set to start that Monday, July 21, 2008, and expire after thirty days. Kara Scannell and Jenny Strasburg, “SEC Moves to Curb Short-Selling,” Wall Street Journal, July 16, 2008. Lehman’s board: Dennis K. Berman, “Where Was Lehman’s Board?” WSJ Blog/Deal Journal, September 15, 2008. Ken Wilson was standing in line at Westchester County Airport: Susanne Craig, “In Ken Wilson, Paulson Gets Direction from the Go-To Banker of Wall Street,” Wall Street Journal, July 22, 2008.

Congress to increase the debt ceiling: The “debt ceiling” was a political hot potato that would require Congress to vote to increase the amount of debt the country could take on, and Congress had just increased the amount to $10.615 trillion in July. “The market is trading under the assumption”: “European Shares Rise after Central Bank Plan, Asia Losses,” Agence France-Presse, September 18, 2008. “The Star-Spangled Banner”: New York Times, October 2, 2008. FSA announcing temporary ban on short-selling: David Prosser, “Hedge Funds’ Misery as FSA Bans Short-selling on 32 Firms,” Independent, September 20, 2008. “Treasury, Fed Weighing Wider Plan”: Alison Vekshin, “Treasury, Fed Weighing Wider Plan to Ease Crisis, Schumer Says,” Bloomberg, September 18, 2008. Charlie Gasparino of CNBC reported what he was hearing from his sources on Wall Street”: “Treasury Secretary Hank Paulson is working on an RTC-type solution to the financial crisis, reports CNBC’s Charlie Gasparino,” CNBC, September 18, 2008.


Systematic Trading: A Unique New Method for Designing Trading and Investing Systems by Robert Carver

asset allocation, automated trading system, backtesting, barriers to entry, Black Swan, buy and hold, cognitive bias, commodity trading advisor, Credit Default Swap, diversification, diversified portfolio, easy for humans, difficult for computers, Edward Thorp, Elliott wave, fixed income, implied volatility, index fund, interest rate swap, Long Term Capital Management, margin call, merger arbitrage, Nick Leeson, paper trading, performance metric, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, survivorship bias, systematic trading, technology bubble, transaction costs, Y Combinator, yield curve

The rules might be over-fitted, which I will discuss at length in the next chapter. Alternatively they could rely on forward looking data that was published with a delay not present in the back-test. There may be also survivorship bias in the 29 Systematic Trading instruments you are considering.You might have underestimated trading costs or missed out an important element of the market structure at the time, such as constraints on short selling of equities. Finally your history could be too brief and miss out on a crucial period when the strategy would have blown up.23 The world changes You want strategies that worked in the past and will continue to do so. But what if the behaviour or market pattern you are trying to exploit vanishes? For example what if systematic traders, using the same rules, dominate a market? Won’t the relevant strategies all stop working?

Hedge fund manager George Soros bet against the Bank of England and made a billion pounds or so when they capitulated. 36 Chapter Two. Systematic Trading Rules Behavioural effects A classical financial economist would be comfortable with most of the above explanations. But you can also create rules which extract returns from other people’s behavioural weaknesses. These effects persist because of market inefficiencies such as bans on short selling, and the sheer weight of money influenced by these biases. The early loss taker trading rule of chapter one is a simple trend following rule which I believe is profitable because of prospect theory biases. People don’t want to keep recent winners, they prefer hanging on to losers, and they will give up excess returns for the nice warm feeling they get from behaving like this. Prospect theory can also explain preferences people have around return skew and overweighting unlikely events, which I’ve already touched on.

You need a forecast – a prediction of how much prices are expected to go up or down. This chapter is about making forecasts. I’ll return to the rest of Sergei’s wisdom in subsequent chapters. A forecast is a number: a positive value means you want to buy the asset because the price is expected to go up and a negative indicates you want to short the asset. Investors who don’t use derivatives and can’t short sell will only make positive forecasts. A forecast shouldn’t be binary – buy or sell – but should be scaled. Forecasts close to zero indicate a small movement in prices and larger absolute values mean you expect bigger returns. There are three reasons why scaled forecasts make sense. Firstly, if you were to examine the returns made by a trading rule given the size of its forecasts, you’d normally find that forecasts closer to zero aren’t as profitable as those further away.


pages: 153 words: 12,501

Mathematics for Economics and Finance by Michael Harrison, Patrick Waldron

Brownian motion, buy low sell high, capital asset pricing model, compound rate of return, discrete time, incomplete markets, law of one price, market clearing, Myron Scholes, Pareto efficiency, risk tolerance, riskless arbitrage, short selling, stochastic process

Definition 6.2.2 w is said to be a zero cost or hedge portfolio if its weights sum to 0 (w> 1 = 0). The vector of net trades carried out by an investor moving from the portfolio w0 to the portfolio w1 can be thought of as the hedge portfolio w1 − w0 . Definition 6.2.3 Short-selling a security means owning a negative quantity of it. In practice short-selling means promising (credibly) to pay someone the same cash flows as would be paid by a security that one does not own, always being prepared, if required, to pay the current market price of the security to end the arrangement. Thus when short-selling is allowed w can have negative components; if shortselling is not allowed, then the portfolio choice problem will have non-negativity constraints, wi ≥ 0 for i = 1, . . . , N . A number of further comments are in order at this stage. 1.

THE SINGLE-PERIOD PORTFOLIO CHOICE PROBLEM 6.3 The Single-period Portfolio Choice Problem 6.3.1 The canonical portfolio problem Unless otherwise stated, we assume that individuals: 1. have von Neumann-Morgenstern (VNM) utilities: i.e. preferences have the expected utility representation: v(z̃) = E[u(z̃)] Z = u(z)dFz̃ (z) where v is the utility function for random variables (gambles, lotteries) and u is the utility function for sure things. 2. prefer more to less i.e. u is increasing: u 0 (z) > 0 ∀z (6.3.1) u 00 (z) < 0 ∀z (6.3.2) 3. are (strictly) risk-averse i.e. u is strictly concave: Date 0 investment: • wj (pounds) in jth risky asset, j = 1, . . . , N • (W0 − P j wj ) in risk free asset Date 1 payoff: • wj r̃j from jth risky asset • (W0 − P j wj )rf from risk free asset It is assumed here that there are no constraints on short-selling or borrowing (which is the same as short-selling the riskfree security). The solution is found as follows: Choose wj s to maximize expected utility of date 1 wealth, W̃ = (W0 − X wj )rf + j = W0 rf + X j Revised: December 2, 1998 X wj r̃j j wj (r̃j − rf ) CHAPTER 6. PORTFOLIO THEORY 111 i.e. max f (w1 , . . . , wN ) ≡ E[u(W0 rf + {wj } X wj (r̃j − rf ))] j The first order conditions are: E[u0 (W̃ )(r̃j − rf )] = 0 ∀j


pages: 305 words: 69,216

A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

Andrei Shleifer, banking crisis, Bernie Madoff, business cycle, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, Myron Scholes, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

And not all lenders to banks are fully insured, because until recently there were ceilings on federal deposit insurance; and checkable nonbank accounts, such as an account with a money market fund, were not insured at all. (They are now, and the ceiling on deposit insurance has been taken off.) Some investors anticipated the effect of the bursting of the housing bubble on mortgagebacked securities and made billions selling short the securities backed by low-rated mortgages. But there was not enough short selling to alert the market and the government to the weakness of the banks, in part because, as noted earlier, short selling is a risky investment strategy. Premature short sellers lose big, and there were many such because of the duration of the housing bubble. 5 The Government Responds The Government's Response to the crash has moved through four phases, with a fifth that at this writing is wending its way through Congress. The first three phases are collectively the "bailout"; the fourth (running simultaneously with the bailout) I'll call "easy money"; and the fifth will, when executed, be the "stimulus."

They did this by eliminating the limits on federal deposit insurance of bank deposits and by extending that insurance to checkable accounts in money market funds, but more important by bailing out failing firms deemed "too big to fail"—an incentive for corporate giantism and financial irresponsibility (which go hand in hand because the difficulty of controlling subordinates grows with the size of an organization). The government gratuitously disrupted the operations of hedge funds by limiting short selling—at the height of the banking crisis the Securities and Exchange Commission forbade short selling of financial stocks. And by substantially increasing the federal deficit, the government's responses to the crisis are sowing the seeds of a future inflation. But of these criticisms, the main ones — the creation of moral hazard and the planting of the seeds of a future inflation—concern the unavoidable side effects of any effective measures to limit a depression.

Moreover, investors can lower their risk by diversifying their portfolios, so the fact that they own stock in some firms that have a very high ratio of fixed to variable costs and are therefore at risk of bankruptcy needn't worry them. One might think a bubble would collapse before it got too big because investors who realized it was a bubble would sell short—in this case, sell interests in mortgage-backed securities short. But short selling in a bubble is very risky unless the bubble is expected to burst very soon. A short seller typically borrows securities that he thinks will lose value and contracts to sell them at a specified price (presumably close to the current market price) on a specified future date. If the market price has fallen by then, he buys the identical securities at that lower price and returns them to the lender.


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, business cycle, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, John Meriwether, Kickstarter, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, Mitch Kapor, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sam Peltzman, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, survivorship bias, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

“When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don't understand how much risk the institution is running.” This is still a problem, and not just for Buffett. Understanding net risk is genuinely difficult. The companies Buffett owns use derivatives, and Buffett’s Berkshire Hathaway sold Lehman Brothers lots of credit default swaps on municipal-bond debt. 2. See Chincarini (2010). 3. Investors short-sell when they promise to sell a security that they don’t already own. The brokerage house—Lehman Brothers, in this case—handles the logistics of short-selling. Short-selling can bring efficiency to the market. Think of buying and selling as ways to vote on a security’s appropriate price. If no one ever short-sold a security, stock prices might be higher than appropriate, because no investor could vote for them to be lower. 4. See Chapter 4. 5. Of course, if the borrower on a bond defaults, then even this income is variable.

Quantitative funds have a number of common attributes.12 Quantitative equity funds are usually market-neutral or enhanced index hedge funds or mutual funds that use computers to sort stocks by desirable and less desirable factors. They buy stocks with good factors and short sell stocks with bad factors, hoping to create a portfolio that is immune to overall market movements, but outperforms over time as desirable stocks perform better than less-desirable stocks. Many of these funds have a value tilt, believing that it’s better to own stocks that trade at low prices relative to forecast earnings. Thus, a fund might short sell stocks that trade at very high multiples to earnings (conditional on other information), while buying stocks with low prices relative to forecast earnings. Statistical arbitrage funds, on the other hand, use statistical and mathematical models to analyze short-term, sometimes high-frequency price movements, then try to profit from short-term deviations from expected value.

To do that, though, they would have to exercise the warrant in Switzerland, then sell the stock in Japan. It was easier to just sell the warrants in the Swiss market at a price that reflected the hassle of exercising them. As the warrants were trading at less than their intrinsic value, an arbitrage firm might have bought the warrants and short sold the related stocks. The strategy could have worked in the United States, but it was difficult to borrow these small-cap Japanese stocks, and to short sell a stock that it doesn’t own, a firm has to borrow it first. LTCM came up with an exact solution. It bought a basket of small-cap stocks in the JASDAQ (Japanese Association of Securities Dealers Automated Quotations Index) with cheap associated warrants and shorted the JASDAQ futures contract. The hedge wasn’t a perfect one, because LTCM’s short position was on the whole index, and the basket was only a subset of Japanese stocks.


pages: 338 words: 106,936

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall

Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, beat the dealer, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business cycle, butterfly effect, buy and hold, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, Myron Scholes, new economy, Paul Lévy, Paul Samuelson, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, Vilfredo Pareto, volatility smile

The origins of this investment practice, known as short selling, are obscure, but it is at least three hundred years old. We know this because it was banned in England in the seventeenth century. Today, short selling is perfectly standard. But in the 1960s — indeed, for much of the practice’s history — it was viewed as dangerous at best, and perhaps even depraved or unpatriotic. The short seller was perceived as a blatant speculator, gambling on market moves rather than investing capital to spur growth. Worse, he had the nerve to take a financial interest in bad news. This struck many investors as déclassé. Views on short selling changed in the 1970s and 1980s, in part because of Thorp’s and others’ work, and in part because of the rise of the Chicago School of economics. As those economists argued at the time, short selling may seem crude, but it serves a crucial social good: it helps keep markets efficient.

If the only people who can sell a stock are the ones who already own it, people who have information that could be bad for the company often don’t have any way of affecting market prices. This would mean that information could be available that isn’t reflected in the stock price, because the people who have access to the information aren’t able to participate in the market. Short selling prevents this situation. Whatever the social impact, short selling does have real risks attached. When you buy a stock (sometimes called taking a “long” position, in contrast to the “short” position that short sellers take), you know how much money you stand to lose. Stockholders aren’t responsible for a corporation’s debts, so if you put $1,000 into AT&T, and AT&T goes under, you lose at most $1,000. But stocks can go up arbitrarily high.

If you sell $1,000 worth of AT&T short, when it comes time to buy the shares back to repay the person you borrowed them from, you might need to come up with a lot more money than you originally received in the sale in order to get the shares back. Still, Thorp was able to find a broker who was willing to execute the required trades. This solved one problem, of figuring out how to apply Kelly’s results in the first place. But even if Thorp could ignore the social stigma of short selling — and he could — the real dangers of unlimited losses remained. Here, though, Thorp had one of his most creative insights. His analysis of warrant pricing gave him a way of relating warrant prices to stock prices. Using this relationship, he realized that if you sell warrants short, but at the same time you buy some shares of the underlying stock, you can protect yourself against the warrant increasing in value — because if the warrant increases in value, according to Thorp’s calculations the stock price should also increase, limiting your losses on the warrant.


pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

Albert Einstein, Atul Gawande, backtesting, beat the dealer, Bernie Madoff, Black Swan, buy and hold, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, William of Occam, zero-sum game

Positive Outlier Trades as a Percent of Total Trades for the Year 80% 72% 70% 59% 60% 50% 44% 42% 43% 39% 40% 37% 36% 38% 35% 28% 30% 21% 20% 11% 11% 10% 9% 10% 12% 8% 6% 6% 3% 0% % Positive Outlier Trades 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 0% 318 Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets Short Selling For the purposes of this project, we decided against testing short-selling6 strategies. Our reasons for this have to do with the following issues. Forced Buy-Ins A short seller has to borrow shares before they can short sell them. Likewise, the short seller must return (deliver) the shares should the brokerage firm call them back. From the historical data available, there is no way to know when or if a short seller would have been subject to a forced buy-in.7 Borrowing Shares Short selling a security requires borrowing shares from an investor who holds them in a margin account. Not all stocks meet these criteria all the time; some never meet these criteria at all.

Foreword to the First Edition by Charles Faulkner . . . . . . . . . . . . . . . . 247 248 253 265 266 277 278 279 280 281 282 285 285 288 290 294 296 299 Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 Introduction to Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A Trend Following for Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Does Trend Following Work on Stocks? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short Selling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Capitalism Distribution: Observations of Individual Common Stock Returns, 1983–2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305 307 307 318 318 331 338 xii Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets B Performance Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Trend Following Historical Performance Data . . . . . . . . . . . . . . . . . . . . . . . . 347 Abraham Trading Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Campbell & Company, Inc.

Not all stocks meet these criteria all the time; some never meet these criteria at all. There is no reliable method to determine what stocks from the investable universe would have been realistically shortable in the past. Limited Expectancy With respect to long-term trend following, short selling offers a severely limited mathematical expectancy. The price of a stock can decline only by a maximum of 100 percent. However, it can rise by an infinite amount. This is a significant disability to overcome. Tax Efficiency The average hold time for the average trade came in lower than the 12 months necessary to qualify for long-term capital gains treatment. However, due to the nature of trend following systems in general, this statistic is misleading. There was a significant correlation between trade length and profitability, showing that the vast majority of historical profits would have qualified for long-term capital gains treatment. 319 Appendix A • Trend Following for Stocks Average Trade Result Relative To Days in Trade 450% Average Return 350% Very few short term capital gains 250% Majority of profits are long term capital gains 150% 50% -50% - 360 720 1,080 1,440 1,800 2,160 2,520 2,880 3,240 Days in Trade Diversification The following table shows how many positions would have resulted from entering stocks at all time highs and exiting with a 10 ATR stop while honoring all data integrity and realistic universe issues.


pages: 263 words: 75,455

Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, business cycle, butter production in bangladesh, buy and hold, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Edward Thorp, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, intangible asset, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, The Myth of the Rational Market, time value of money, transaction costs

We go bargain hunting in Part Four, looking for the price ratios that best identify undervalued stocks and lead to the best risk-adjusted investment performance. We look at several unusual implementations of price ratios, including long-term average price ratios and price ratios in combination. Part Five sets out a variety of signals sent by other market participants. There we look at the impact of buybacks, insider purchases, short selling, and buying and selling from institutional investment managers like activists and other fund managers. Finally, in Part Six we build and test our quantitative value model. We study the best way to combine the research we've considered into a cohesive strategy, and then back-test the resulting quantitative value model. CHAPTER 1 The Paradox of Dumb Money “As they say in poker, ‘If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy.'”

If we also consider the ease of calculating it, it looks like the strongest candidate. With our examination of quality and price completed, we now move to the final phase of our investment checklist: finding stocks with signals that corroborate our valuation. In the next part, we consider several different signals sent by market participants to find those that forecast market-beating performance. We examine buy-backs, insider buying, activism, institutional investors, and short selling. NOTES 1. Benjamin Graham, and David Dodd, Security Analysis: The Classic 1934 Edition (McGraw-Hill, 1996). 2. J. Y. Campbell and R. J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook.” Journal of Portfolio Management (Winter 1998): 11–26. 3. John Y. Campbell and Robert J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook: An Update (April 2001).” NBER Working Paper Series, Vol. w8221, 2001.

The second potential pitfall is in aggregating institutional investment manager stock purchases to the point that the target stocks are heavily concentrated with institutional investment managers. Some cloning services allow investors to create a portfolio that takes the most popular ideas from a number of institutional investment managers that have historically performed very well. SHORT MONEY IS SMART MONEY Short selling is the practice of selling a stock in anticipation of a decline in its price. The stock sold short is borrowed from another market participant and must eventually be bought back and returned to the lender, which is called covering. If the price declines as anticipated, the short seller covers to realize a profit. If the price advances, the short seller must still cover, but realizes a loss. Short interest (or the change in short interest) is measured by the short interest ratio (SIR), which is a monthly snapshot of the proportion of outstanding shares of any given stock sold short.


pages: 819 words: 181,185

Derivatives Markets by David Goldenberg

Black-Scholes formula, Brownian motion, capital asset pricing model, commodity trading advisor, compound rate of return, conceptual framework, correlation coefficient, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, financial innovation, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, law of one price, locking in a profit, London Interbank Offered Rate, Louis Bachelier, margin call, market microstructure, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, price mechanism, random walk, reserve currency, risk/return, riskless arbitrage, Sharpe ratio, short selling, stochastic process, stochastic volatility, time value of money, transaction costs, volatility smile, Wiener process, yield curve, zero-coupon bond, zero-sum game

However, it is possible for some commodities such as stock indexes and bond indexes. Certain precious metals like gold and silver can be short sold. It also depends who you are and what counterparties will agree to. J. P. Morgan can do a lot more than the private investor can on his own. Sometimes one can short an Exchange Traded Fund (ETF) related to the underlying commodity as a proxy for short selling the actual underlying commodity, because there are short ETFs available in the market. Classical short selling a commodity, like an equity security, means borrowing it from a broker, selling it immediately, and placing the proceeds from that sale (in addition to required margins) in an account. The good news is that interest can be paid on that account, so in effect its opportunity cost is zero. The bad news is that eventually you have to ‘cover’ the short sale by replacing the borrowed stock.

We now have to figure out how to partially replicate the put option’s payoffs. Provided that we accomplish this with payoffs that are no larger than the payoffs to the put option, the dominance principle then will provide a lower bound to the put option’s current price. In order to partially replicate the long European put option position, we have to short sell less than one unit of underlying stock, because the short position in the spot market has to restitute the option seller for the dividends paid out over [t,T]. If we short sell e–ρτ units of underlying stock at time t, everything works out fine because, once again, e–ρτSt grows to , by definition. Table 11.6 indicates the partial replication strategy. Note that Strategy A has payoffs at least as great as the payoffs to Strategy B in all states of the world. The payoff to Strategy B is while the payoff to Strategy A is 0.

The mortgage loan, car loan, or student loan enables people to receive monies today in return for their promise to pay it back plus interest. Each loan creates a financial instrument called a mortgage bond, a student loan (repayment) bond, or a car loan (repayment) bond. The forward (futures) markets permit future borrowing and lending at fixed rates determined today. What position in the bond is taken by the individual who takes out a loan either currently or in the future? The person would be issuing (shorting, selling) the financial instrument created as a result of the loan agreement. Then the individual would typically pay a fixed rate—unless the loan was a variable-rate bond like a variable-rate mortgage. The same reasoning applies to forward loans. Note that ‘selling’ here doesn’t mean selling something you already own. It refers to what a hedger in an implicit long position would want to do in order to protect the anticipated sale of something they do not currently own.


pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

Andy Kessler, asset allocation, backtesting, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Branko Milanovic, break the buck, Bretton Woods, BRICs, business climate, business cycle, capital asset pricing model, commoditize, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, cuban missile crisis, currency manipulation / currency intervention, debt deflation, Elliott wave, en.wikipedia.org, Fall of the Berlin Wall, feminist movement, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, housing crisis, income inequality, index fund, inflation targeting, Joseph Schumpeter, Kickstarter, laissez-faire capitalism, land reform, liquidity trap, Long Term Capital Management, McMansion, mega-rich, money market fund, moral hazard, mortgage tax deduction, naked short selling, negative equity, offshore financial centre, Ponzi scheme, price stability, pushing on a string, quantitative easing, RAND corporation, rent control, reserve currency, riskless arbitrage, Ronald Reagan, school vouchers, seigniorage, short selling, Silicon Valley, six sigma, statistical arbitrage, statistical model, Steve Jobs, stocks for the long run, The Great Moderation, the scientific method, time value of money, too big to fail, upwardly mobile, War on Poverty, Yogi Berra, young professional

Certain of their brokers secured special regulations that unfairly advantaged large customers, many of which manipulated commodity prices. Their use of short selling was heavily directed against the financial sector itself, and by July 2008 Congress looked into the matter, triggering the SEC to ban “naked” short selling of the common stocks of 19 banks and brokers. By generating such a list, the government favored some companies over others, socialistically guiding where dollars may and may not flow, to the detriment of others not privileged enough to 140 ENDLESS MONEY make the list. In September, the list was expanded to cover 799 financial firms for which no short selling would be permitted, even when it would be done with borrowed shares.2 The Congressional hearings are reminiscent of the government’s scrutiny of capital pools in the early 1930s.

One can argue whether the restrictions placed on these activities is adequate or excessive, or for that matter, if they effectively serve the public good. But what is far more relevant is the SEC’s tacit allowance of naked short selling through what became known as the “Madoff Rule,” which exempted market makers from the same requirements to deliver stock after stock sales. This essentially provided broker-dealers with the ability to legally counterfeit securities, and to rent this resource out to hedge fund clients. Patrick Byrne, CEO of Overstock.com, a company victimized by relentless naked short selling, worked with reporter Mark Mitchell to reveal the extent of the naked short-selling problem through his web site www.deepcapture.com. Clearly this activity has been pernicious to the equity of some companies. However, it did not cause the downfall of the global economy or of the stock market.

If economic actors had been relatively debt free, they would have been strong enough to intercede in capital markets and take advantage of economic opportunities presented by illegitimately pummeled stock prices, somewhat akin to the soaking up of stock through corporate repurchases in the aftermath of the 1987 crash. Politicians demonize the hedging of risk with commodities and even the legitimate deployment of short selling, but the quasi-government entities they have chartered—the Fed and the mortgage agencies—have fostered the overexpansion of credit that is debasing the coin of the realm and brought us to the edge of systemic failure. Only a socialist government would single out those seeking to flee and penalize them as perpetrators. Wall Street knows where its bread is buttered. Goldman Sachs has had deep ties to both Democratic and Republican administrations Moral Hazard 141 through figures such as Henry Paulson (Treasury Secretary to George W.


pages: 368 words: 32,950

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile by Alexander Davidson

accounting loophole / creative accounting, algorithmic trading, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Big bang: deregulation of the City of London, buy and hold, capital asset pricing model, central bank independence, corporate governance, Credit Default Swap, dematerialisation, discounted cash flows, diversified portfolio, double entry bookkeeping, Edward Lloyd's coffeehouse, Elliott wave, Exxon Valdez, forensic accounting, global reserve currency, high net worth, index fund, inflation targeting, intangible asset, interest rate derivative, interest rate swap, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Nick Leeson, North Sea oil, Northern Rock, pension reform, Piper Alpha, price stability, purchasing power parity, Real Time Gross Settlement, reserve currency, Right to Buy, shareholder value, short selling, The Wealth of Nations by Adam Smith, transaction costs, value at risk, yield curve, zero-coupon bond

In October 2002, the Financial Services Authority issued a discussion paper on short selling. It considered it a legitimate activity but thought more transparency would be helpful, and, in the years since, it has not changed its position.  32 HOW THE CITY REALLY WORKS __________________________________ If an investment bank has a net short position in a stock, it may borrow from a lender to deliver the securities on the agreed settlement date. From the buyer’s perspective, there is no practical difference between borrowed and owned stock. If the bank has a net long position, it may lend the stock to borrowers for a fee. As a result of short trades, stock lending flourishes in bull markets, and improves market liquidity. Stock lending figures, available from Euroclear UK & Ireland and other sources, provide only a very loose indication of short selling levels as other factors must be considered as well.

Traders who use spread betting firms are almost entirely male, with a leaning towards the 25–35 year old age group, and those who work in information technology. As a trader, you may place a bet based on your belief that a share price, an index, or interest rates will move up or down. Spread betting and CFDs (see under the next heading) make it possible to take a short position, which is a position that will profit if the underlying instrument goes down. Short selling is effectively closed to private investors in conventional share trading, due to the short standard settlement period. Spread bets are geared and, as a trader, you need to put up only an initial margin, perhaps 10–15 per cent of the underlying value, but will need to top up the amount should the trading position move against you, on the same principle as for options or futures. You will gain or lose as a percentage of the underlying

Signatories must meet standards set in price transparency, access, interoperability and service unbundling, among other areas. The Code has set a deadline for each of the standards, with the final one on 1 January 2008. Through the Code, Commissioner McCreevy has given the market an opportunity to find its own solution, which is very much in the style of the UK Financial Services Authority, as when, for example, it investigated short selling and, without being more prescriptive, called for more transparency, a move that led to Euroclear & Ireland, then known as CRESTCo, making stock lending data available on its website. In January 2007, Euroclear chief executive Pierre Francotte said the success of the Code would depend on whether the parties involved implement it, and whether it was extended from only equities to bonds. He said that the Commission would have to stay actively involved to ensure immediate progress.


Commodity Trading Advisors: Risk, Performance Analysis, and Selection by Greg N. Gregoriou, Vassilios Karavas, François-Serge Lhabitant, Fabrice Douglas Rouah

Asian financial crisis, asset allocation, backtesting, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, compound rate of return, constrained optimization, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, discrete time, distributed generation, diversification, diversified portfolio, dividend-yielding stocks, fixed income, high net worth, implied volatility, index arbitrage, index fund, interest rate swap, iterative process, linear programming, London Interbank Offered Rate, Long Term Capital Management, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, p-value, Pareto efficiency, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, stochastic process, survivorship bias, systematic trading, technology bubble, transaction costs, value at risk, zero-sum game

We can calculate the cumulative performance improvement to the stock/bond/hedge fund of funds portfolio from downside risk protection and upside return enhancement by: (−1.90% × 42 months) − (−2.07 × 42 months) + [(0.92% − 0.91%) × 132 months] = 8.46% 225 60/40 US Stocks/ US Bonds 55/35/10 Stocks/ Bonds/FOF 55/35/10 Stocks/ Bonds/Equity L/S 55/35/10 Stocks/Bonds/ Convertible Arb 55/35/10 Stocks/Bonds/ Market Neutral 55/35/10 Stocks/Bonds/ Distressed Debt 55/35/10 Stocks/Bonds/ Event Driven 55/35/10 Stocks/Bonds/ Fixed Income Arb 55/35/10 Stocks/Bonds/ Global Macro 55/35/10 Stocks/Bonds/ Market Timing 55/35/10 Stocks/Bonds/ Merger Arbitrage 55/35/10 Stocks/Bonds/ Short Selling 2.54% 2.42% 2.40% 2.45% 2.49% 2.36% 2.51% 2.50% 2.43% 1.00% 0.93% 0.92% 0.95% 0.95% 0.90% 0.97% 0.95% 0.93% 2.02% 2.45% 0.92% 0.85% 2.60% 0.91% Standard Deviation 0.198 0.196 0.198 0.207 0.189 0.201 0.204 0.195 0.197 0.215 0.191 0.177 Sharpe Ratio 40 41 42 43 42 41 40 40 41 −2.03% −1.88% −1.83% −1.84% −1.91% −1.86% −2.04% −2.03% −1.90% 37 42 −1.90% −1.63% 42 Number of Downside Months −2.07% Average Downside Downside Risk Protection Using Hedge Funds Expected Portfolio Composition Return TABLE 11.2 26.63% 9.04% 5.74% 5.34% 10.68% 6.72% 8.25% 10.08% 9.86% 5.74% 7.14% N/A Cumulative Downside Protection −7.92% 3.57% 7.18% 9.86% −1.32% 5.28% 4.37% 1.32% 3.57% 13.88% 1.32% N/A Cumulative Upside Potential 18.71% 12.61% 12.92% 15.20% 9.36% 12.00% 12.62% 11.40% 13.43% 19.62% 8.46% N/A Cumulative Performance Improvement 226 RISK AND MANAGED FUTURES INVESTING The cumulative performance improvement of 8.46 percent may be split into two parts, the cumulative return earned from downside risk protection (7.14 percent) and the amount earned from upside return potential (1.32 percent).

A 25-year study recently conducted by Goldman Sachs (2003) concluded that a 10 percent allocation of a securities portfolio to managed 235 236 MANAGED FUTURES INVESTING, FEES, AND REGULATION 70 60 50 40 30 20 10 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003* FIGURE 12.1 Growth of Managed Futures, 1988–2002 Source: Barclay Trading Group, Ltd. “Money Under Management in Managed Futures,” www.barclaygrp.com. Copyright © 2002–2004 Barclay Trading Group, Ltd. *First quarter 2003. –23.37% S&P 500 –31.52% NASDAQ –16.75 DJIA Composite Index –1.19% Short Selling Index Emerging Markets Macro Index Fixed Income 25.06% 4.58% 8.28% 6.75% Equity Market Neutral 1.80% Fund of Funds 1.11% Managed Futures –35 –30 –25 –20 –15 –10 –5 0 15.22% 5 10 15 20 25 FIGURE 12.2 Performance Comparison 2002 Source: Equities: International Traders Research (ITR), an affiliate of Altegris Investments; Hedge Funds; Hedge Fund Research, Inc. © HFR, Inc. [15 January 2003], www.hfr.com; Managed Futures; ITR Premier 40 CTA Index.

In addition, the National Association of Securities Dealers (NASD) has expressed concern that its members may not be fulfilling their legal obligations to customers, particularly retail customers, when promot- 259 260 MANAGED FUTURES INVESTING, FEES, AND REGULATION ing hedge funds and funds of hedge funds to them (see NASD 2003). More recently, the Securities and Exchange Commission (SEC) has raised concerns about the increasing retailization of hedge funds, commodity pools, and private equity funds, the unregulated nature of these products and the potential for fund managers to defraud investors, and the market impact of hedge fund investment strategies such as short selling (SEC 2003).1 The SEC’s concerns are usefully summarized in Wider and Scanlan (2003). In Australia, the Australian Prudential Regulation Authority (APRA), the prudential regulator of banks, insurance companies, and pension funds, recently has questioned the increasing allocation of funds by Australian pension funds to hedge funds and other alternative investments. APRA (2003) has explicitly stated that if it “is not satisfied that an investment in hedge funds is to the benefit of [pension] fund members, it will step in to protect their interests.”


pages: 309 words: 54,839

Attack of the 50 Foot Blockchain: Bitcoin, Blockchain, Ethereum & Smart Contracts by David Gerard

altcoin, Amazon Web Services, augmented reality, Bernie Madoff, bitcoin, blockchain, Blythe Masters, Bretton Woods, clean water, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, distributed ledger, Ethereum, ethereum blockchain, Extropian, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, index fund, Internet Archive, Internet of things, Kickstarter, litecoin, M-Pesa, margin call, Network effects, peer-to-peer, Peter Thiel, pets.com, Ponzi scheme, Potemkin village, prediction markets, quantitative easing, RAND corporation, ransomware, Ray Kurzweil, Ross Ulbricht, Ruby on Rails, Satoshi Nakamoto, short selling, Silicon Valley, Silicon Valley ideology, Singularitarianism, slashdot, smart contracts, South Sea Bubble, tulip mania, Turing complete, Turing machine, WikiLeaks

Roger Ver: early Bitcoin advocate and anarcho-capitalist. Satoshi Nakamoto: the pseudonym used by the creator of Bitcoin. Disappeared in 2011; nobody knows who he was. SEC: The U.S. Securities and Exchange Commission, the government agency that enforces securities law and regulates the industry. Its mission statement is: “protect investors; maintain fair, orderly, and efficient markets; facilitate capital formation.” Short selling, shorting: selling a security you don’t own in the hope it will go down and you can buy to cover what you sold. A form of margin trading. Smart contract: a contract implemented as a computer program that triggers given particular conditions. The DAO: a smart contract for a Distributed Autonomous Organization, intended to operate as an automated venture capital firm. The most famous smart contract ever, as the world’s largest crowdfunding at the time, gathering $150 million.

Bitcoin exchanges: keep your money in a sock under someone else’s bed “Be your own bank” is actually very hard – particularly with “no chargebacks”, meaning that in the event of a theft or even a mistake you’re completely out of luck – so almost everyone who uses cryptocurrencies keeps their coins on an exchange. Exchanges also let you trade between different cryptocurrencies, crypto assets and conventional currencies, and some even offer short-selling and other margin trading, which are enormously popular. Bitcoin exchanges were started by amateur enthusiasts. Most were computer programmers whose approach to anything outside their field was “I know PHP, how hard could running an exchange be?” As Dunning and Kruger pointed out in 1999,79 this approach tends not to work out so well. In real securities trading, you can presume the exchanges themselves are not going to mess you around, and indeed that they’re basically competent.

KYC/AML: Know Your Customer/Anti-Money Laundering rules, which any crypto exchange wanting to deal in hard currencies, particularly US dollars, needs to follow. Margin call: when you need to pay back your margin trading loan. Margin trading: taking a loan from your brokerage to buy a security; lets you buy more than the value of the assets you have to hand. Could be hoping for the security to go up or down. Can pay off hugely, but is risky (especially with cryptos). Short selling is a form of margin trading. Mark Karpelès: Owner of Mt. Gox when it collapsed. Did nothing wrong. Mempool: the “memory pool,” in the memory of a computer running a Bitcoin node, where unconfirmed transactions pile up. Merchant: actual shopkeeper selling legal goods or services, who probably doesn’t accept Bitcoin. Merkle tree: an ordered collection of transactions, each hashed against the hash of previous transactions; this makes it very quick to verify the tree of transactions is the one you think it is.


pages: 650 words: 204,878

Reminiscences of a Stock Operator by Edwin Lefèvre, William J. O'Neil

activist fund / activist shareholder / activist investor, bank run, British Empire, business process, buttonwood tree, buy and hold, clean water, Credit Default Swap, Donald Trump, fiat currency, Hernando de Soto, margin call, Monroe Doctrine, new economy, pattern recognition, Ponzi scheme, price stability, refrigerator car, reserve currency, short selling, technology bubble, trade route, transcontinental railway, traveling salesman, Upton Sinclair, yellow journalism

In 1911, the Supreme Court broke the Standard Oil mo nopoly into 34 new companies, which ultimately remerged to become such current giants as ExxonMobil, Chevron, Amoco, and Conoco. Three of Rockefeller’s personal max ims were, “Good leadership consists of showing average people how to do the work of superior people;” “If your only goal is to become rich, you will never achieve it;” and “I always tried to turn every disaster into an opportunity.” 1.14 Short selling at a bucket shop was quite different than short selling at a legitimate brokerage. Legitimate shorting involves the borrowing of shares you don’t own, normally from another of your broker’s clients, and then selling them with the expectation of buying them back at a lower price and pocketing the difference. But since the bucket shops did not buy or sell actual securities, the trans action was not much different from going long.

The market had been going up all that week—this was twenty years ago, remember—and it was a cinch the bank statement on Saturday would show a big decrease in the surplus reserve.That would give the conventional excuse to the big room traders to jump on the market and try to shake out some of the weak commission-house accounts. There would be the usual reactions in the last half hour of the trading, particularly in stocks in which the public had been the most active. Those, of course, also would be the very stocks that Teller’s customers would be most heavily long of, and the shop might be glad to see some short selling in them. There is nothing so nice as catching the suckers both ways; and nothing so easy—with one-point margins. Livermore would have likely seen the initial results of the statement stream over the ticker. Not all the details would have been available, but he would have been able to see the total weekly changes in the various categories. The full statement was later copied by newspapers and financial magazines.15,16 That Saturday morning I chased over to Hoboken to the Teller place.

You are known as a plunger.” “I still don’t get it,” I said. “I’ll be frank with you, Mr. Livingston. We have two or three very wealthy customers who buy and sell stocks in a big way. I don’t want the Street to suspect them of selling long stock every time we sell ten or twenty thousand shares of any stock. If the Street knows that you are trading in our office it will not know whether it is your short selling or the other customers’ long stock that is coming on the market.” I understood at once. He wanted to cover up his brother-in-law’s operations with my reputation as a plunger! It so happened that I had made my biggest killing on the bear side a year and a half before, and, of course, the Street gossips and the stupid rumor mongers had acquired the habit of blaming me for every decline in prices.


pages: 372 words: 107,587

The End of Growth: Adapting to Our New Economic Reality by Richard Heinberg

3D printing, agricultural Revolution, back-to-the-land, banking crisis, banks create money, Bretton Woods, business cycle, carbon footprint, Carmen Reinhart, clean water, cloud computing, collateralized debt obligation, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, David Graeber, David Ricardo: comparative advantage, dematerialisation, demographic dividend, Deng Xiaoping, Elliott wave, en.wikipedia.org, energy transition, falling living standards, financial deregulation, financial innovation, Fractional reserve banking, full employment, Gini coefficient, global village, happiness index / gross national happiness, I think there is a world market for maybe five computers, income inequality, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, Kenneth Rogoff, late fees, liberal capitalism, mega-rich, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, naked short selling, Naomi Klein, Negawatt, new economy, Nixon shock, offshore financial centre, oil shale / tar sands, oil shock, peak oil, Ponzi scheme, price stability, private military company, quantitative easing, reserve currency, ride hailing / ride sharing, Ronald Reagan, short selling, special drawing rights, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, trade liberalization, tulip mania, WikiLeaks, working poor, zero-sum game

But just how does one successfully go about investing to profit on assets whose value is declining? The answer: short selling (also known as shorting or going short), which involves borrowing the assets (usually securities borrowed from a broker, for a fee) and immediately selling them, waiting for the price of those assets to fall, buying them back at the depressed price, then returning them to the lender and pocketing the price difference. Of course, if the price of the assets rises, the short seller loses money. If this sounds dodgy, then consider naked short selling, in which the investor sells a financial instrument without bothering first to buy or borrow it, or even to ensure that it can be borrowed. Naked short selling is illegal in the US, but many knowledgeable commentators assert that the practice is widespread nonetheless.

In the boom years leading up to the 2007–2008 crash, it was often the wealthiest individuals who engaged in the riskiest financial behavior. And the wealthy seemed to flock, like finches around a bird feeder, toward hedge funds: investment funds that are open to a limited range of investors and that undertake a wider range of activities than traditional “long-only” funds invested in stocks and bonds — activities including short selling and entering into derivative contracts. To neutralize the effect of overall market movement, hedge fund managers balance portfolios by buying assets whose price is expected to outpace the market, and by short-selling assets expected to do worse than the market as a whole. Thus, in theory, price movements of particular securities that reflect overall market activity are cancelled out, or “hedged.” Hedge funds promise (and often produce) high returns through extreme leverage. But because of the enormous sums at stake, critics say this poses a systemic risk to the entire economy.

As long as paper notes were redeemable for gold or silver, the amounts of these substances existing in vaults put at least a theoretical restraint on the process of money creation. Paper currencies not backed by metal had sprung up from time to time, starting as early as the 13th century ce in China; by the late 20th century, they were the near-universal norm. Along with more abstract forms of currency, the past century has also seen the appearance and growth of ever more sophisticated investment instruments. Stocks, bonds, options, futures, long- and short-selling, credit default swaps, and more now enable investors to make (or lose) money on the movement of prices of real or imaginary properties and commodities, and to insure their bets — even their bets on other investors’ bets. Probably the most infamous investment scheme of all time was created by Charles Ponzi, an Italian immigrant to the US who, in 1919, began promising investors he could double their money within 90 days.


pages: 455 words: 138,716

The Divide: American Injustice in the Age of the Wealth Gap by Matt Taibbi

banking crisis, Bernie Madoff, butterfly effect, buy and hold, collapse of Lehman Brothers, collateralized debt obligation, Corrections Corporation of America, Credit Default Swap, credit default swaps / collateralized debt obligations, Edward Snowden, ending welfare as we know it, fixed income, forensic accounting, Gordon Gekko, greed is good, illegal immigration, information retrieval, London Interbank Offered Rate, London Whale, naked short selling, offshore financial centre, Ponzi scheme, profit motive, regulatory arbitrage, short selling, telemarketer, too big to fail, War on Poverty

* * * *1 The Fairfax story is often included in with other legendary bear-raid stories involving companies like Overstock.com, Dendreon, Afinsa (a Spanish collectibles company), and Biovail, another Canadian firm, all of which were targeted by some of the same hedge funds described in this story, many of which ended up out of business and/or mired in scandal. Many of those tales revolve around the issue of naked short selling, a type of financial counterfeiting that allows short investors to artificially depress the stock prices of target companies. Whether naked short selling is a serious social contagion or meaningless conspiracy theory is a passionately debated topic on Wall Street, and to even broach the subject inspires strong emotions: right or wrong (and I believe wrong), in some quarters, if you bring it up at all, eyes roll automatically. One of the reasons I originally shied away from the Fairfax story was that it has a naked short-selling angle that makes some serious observers dismiss it out of hand as nutty conspiracy. So even though naked short selling was actually a factor in the Fairfax case, I’ve left it out of this narrative, because it’s the other craziness that went on in this case that’s really interesting

So if you’re putting a big short on, you usually need to see a serious drop to make a buck, not just a tick or two in the right direction. This is why the big short sellers tend to be wired differently from other Wall Street players. These men (and they’re mostly men) live for the thrill of the chase and the high of conquest when the target of their short finally rolls over and dies. Chanos perfectly embodies that spirit. “I’ll always understand the Schadenfreude aspect to short-selling,” he said early in his career. “I get that no one will always like it.” By the early 2000s, just those four men—Loeb, Chanos, Cohen, and Sender—collectively managed tens of billions of dollars and exerted enormous influence on the daily trading flow of the New York Stock Exchange. And here’s what we know. Sometime in 2002 this collection of high-profile, belligerent, letter-writing, art-collecting millionaires and billionaires, along with hotshots from a few other prominent hedge funds, began talking to one another about a new stock they might want to target: Fairfax Financial Holdings.

Though some of the discovery shows the bank cravenly trying to extract business from hedge funds that seemed to relish Gwynn’s conclusions, the bank also would eventually fire Gwynn (years later, it is true) for leaking information to those same funds. “Gwynn was discharged from Morgan Keegan for violation of a firm policy relating to his apparent advance disclosure of his pending research coverage of Fairfax Financial Holdings,” a Morgan Keegan spokeswoman would say a full five years later, amid the chaos of September 2008. Although negative press and analyst reports and high volumes of carefully timed short selling can definitely exert downward pressure on a stock, and can even “waterfall” a company into collapse, a firm with a solid enough foundation can stick it out for a good long time. But the shorts didn’t have time. The game these major hedge funds were playing was a high-stakes, high-risk totaler Krieg where there’s no room for patience, compromise, or pyrrhic victories. When you bet $50 million, $100 million, $200 million against a certain type of company, inflicting minor damage—like moving its stock down a few percentage points here and there—is not sufficient.


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Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith

bank run, banking crisis, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, income inequality, index arbitrage, index fund, joint-stock company, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market clearing, merger arbitrage, money market fund, Myron Scholes, Paul Samuelson, price stability, random walk, Richard Thaler, risk tolerance, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, stocks for the long run, the market place, transaction costs

He profited from the 1837 market collapse through a technique he is credited with inventing—the “short sale” of stock. As practiced by Little, short-selling involved the sale of stock for delivery at a future date, often six to twelve months later. Little would gamble that share prices would fall in the interim, allowing him to buy back at a lower price the stock he would be required to deliver in the future. While this method of short-selling differs mechanically from the way in which short sales are transacted today, the objective is the same—to profit from a decline in the market. Needless to say, in a time of crisis such as the 1837 panic, a short-selling market operator who openly profited from the distress of others could be (and was) quite unpopular. Little was the first professional “bear” in the history of the American stock market.

Security should not rest on any one man.”14 In the years following 1907, muckraking journalism and progressive politics took their toll on the public’s perception of Morgan and Wall Street bankers and brokers. In 1912, Morgan and other leading financiers were summoned to testify before the Pujo Committee of the House of Representatives; the proceedings quickly took on the look of an inquisition. In response to questioning, Morgan said that while he did not approve of short-selling or speculation in the stock market, such practices were unavoidable if an active marketplace for stocks was to be maintained. The committee was much less willing than Morgan to condone the machinations of stock market operators. It concluded in its official report that “the facilities of the New York Stock Exchange are employed largely for transactions producing moral and economic waste and corruption.”

The following day, after the story behind the leak had been confirmed, stock prices fell precipitously. As The Wall Street Journal put it, “Prices melted like the snows of the Pacific Northwest before the Chinook wind.” Among the big losers was Thomas Lawson, a part-time author and unsuccessful speculator. Lawson happened to be heavily invested in stocks when the peace rumor market break occurred; he cried foul, claiming that short-selling market operators had profited from improperly obtained official information. In his customarily lurid style, he declared, “The good old Capitol has been wallowing in Wall Street leak graft for forty years, wallowing hale and hearty.”4 Lawson already bore a grudge against Livermore, resulting from a business dispute a decade earlier. He thus made the most of his opportunity to accuse Livermore of wrongdoing in the leak scandal.


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, fixed income, implied volatility, index fund, intangible asset, interest rate swap, inventory management, London Interbank Offered Rate, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

Investopedia explains Absolute Return Generally, mutual funds seek returns that are better than those of their peers, their fund category, and/or the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. Absolute return funds seek positive returns by employing investment strategies that often are not permitted in traditional mutual funds, such as short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets. Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. Today, the absolute return approach to fund investing has become one of the fastest growing investment products in the world; it’s called a hedge fund. 3 4 The Investopedia Guide to Wall Speak Related Terms: • Mutual Fund • Return on Investment • Yield • Return on Assets • Total Return Accounts Payable (AP) What Does Accounts Payable (AP) Mean?

Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and typically can be purchased or redeemed as needed at the fund’s current net asset value (NAV) per share, which sometimes is expressed as NAVPS. Related Terms: • Closed-End Fund • Net Asset Value—NAV • Style • Diversification • Open-End Fund N naked shorting What Does Naked Shorting Mean? The practice of short selling shares that have not been confirmed to exist. Ordinarily, traders must borrow a stock or determine that it can be borrowed before they sell it short. However, as a result of various loopholes in the rules and discrepancies between paper and electronic trading systems, naked shorting continues to happen. Although no exact system of measurement exists, most point to the level of trades that fail to deliver from the seller to the buyer within the mandatory three-day stock settlement period as evidence of naked shorting.

The Investopedia Guide to Wall Speak 197 Related Terms: • Cost of Goods Sold—COGS • Gross Income • Operating Income • Economic Profit • Income Statement Net Long What Does Net Long Mean? A condition in which an investor has more long positions than short positions in a specific asset class, market sector, portfolio, or trading strategy. Investors who are net long will benefit when the price of the asset increases. Investopedia explains Net Long Many mutual funds are restricted from short selling; this means the funds are usually net long. In fact, most individual investors do not hold large short positions, making the net long portfolio a common and usually expected investing situation. A position that is net long is the opposite of a position that is net short. Related Terms: • Delta • Long (or Long Position) • Short (or Short Position) • Hedge • Overbought Net Operating Income (NOI) What Does Net Operating Income (NOI) Mean?


pages: 224 words: 13,238

Electronic and Algorithmic Trading Technology: The Complete Guide by Kendall Kim

algorithmic trading, automated trading system, backtesting, commoditize, computerized trading, corporate governance, Credit Default Swap, diversification, en.wikipedia.org, family office, financial innovation, fixed income, index arbitrage, index fund, interest rate swap, linked data, market fragmentation, money market fund, natural language processing, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, short selling, statistical arbitrage, Steven Levy, transaction costs, yield curve

Exchange-listed options contracts Short Interest Rule Member organizations of the NYSE, AMEX, and NASD must report listed short sale positions held on a monthly basis, with the exception of AMEX, which must report them twice a month. Every member organization must file with the exchange all short positions on a bimonthly basis. The first is due within two business days after the 15th of each month, and the second is due the next business day after the last day of the month. The types of transactions that must be reported include short sells for equities and exchange traded funds. The key items of information required include 1. for NYSE: Bank Identifier, Symbol, Current Short Position; 2. for NASD: Bank Identifier, NASDAQ Security Symbol, Security Name, Current Short Position; 3. for AMEX: Bank Identifier, NASDAQ Security Symbol, Security Name, Current Short Position. NYSE Rule 123 Members who place exchange orders through a proprietary system are required to report all order and execution details to an exchange-provided database.

The main reason why prime brokers carry out custody activity is to facilitate margin-lending 1 Adam Sussman, Managing Risk in Real-Time Markets, Tabb Group Report, February 2005, http://www.tabbgroup.com/our_reports.php?tabbaction¼4&reportId¼87. 153 154 Electronic and Algorithmic Trading Technology activities and the associated movement of collateral. Prime brokers earn their revenue through cash lending to support leverage and stock lending to facilitate short selling. It is increasingly common for prime broker clients to structure trades, utilizing synthetic products and other different asset classes. In the stock-lending business, prime brokers act as an intermediary between institutional lenders and other hedge fund borrowers. In financing equity role, prime brokers act in the role of an intermediary. 14.2 Prime Broker Services The services that a prime broker provides include the following (see Exhibit 14.1): 1.

Prime brokerage has traditionally been dominated by niche players in the past, but larger banks are increasingly getting Strategy Do Not Use Low (<2.0:1) High (=>2.0:1) Aggressive Growth 20% 60% 20% Emerging Markets 20 50% 30% Equity Market Neutral 15% 50% 35% Event Driven 15% 60% 25% Income 35% 30% 35% Macro 10% 30% 60% Market Neutral Arbitrage 10% 25% 65% Market Timing 55% 35% 10% Multi-Strategy 10% 50% 40% Opportunistic 10% 60% 30% Short Selling 30% 40% 30% Value 20% 60% 20% Exhibit 14.2 Global hedge funds’ use of leverage. Source: Van Hedge Fund Advisors, Aite Group. 2 Sang Lee, ‘‘Shaking Up Prime Brokerage: Unbundling Securities Lending, Financing, and Derivatives Transactions,’’ Aite Group Report 200510171 (October 2005): 9–10. Trading Technology and Prime Brokerage 157 into fund servicing. Large banks figure this is an easy way to gain a foothold in global reach, technology, and personnel capabilities that smaller players cannot. 14.3 The Structure of Hedge Funds Hedge funds today have grown to more than $1.225 trillion in assets under management by the end of the second quarter of 2006 according to the recently released data by Chicago-based Hedge Fund Research Inc.


pages: 549 words: 147,112

The Lost Bank: The Story of Washington Mutual-The Biggest Bank Failure in American History by Kirsten Grind

asset-backed security, bank run, banking crisis, big-box store, call centre, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, fixed income, housing crisis, Maui Hawaii, money market fund, mortgage debt, naked short selling, NetJets, shareholder value, short selling, Shoshana Zuboff, Skype, too big to fail, Y2K

Killinger didn’t want to talk to Paulson just about Cramer’s Mad Money—he also wanted to see if Paulson would help protect WaMu from naked short sellers. Short selling is essentially betting that a company will do badly: investors sell shares of borrowed stock (from a broker, for example) and then buy new shares to replace the old ones. If the new shares were bought for less than the original borrowed stock, the investor makes money. Naked short selling means that original shares aren’t borrowed. Either way, both forms of trading were driving down WaMu’s stock, which was now hovering around $3. Killinger thought Paulson could use his influence at the Securities and Exchange Commission (SEC) to help WaMu get on a list of 19 financial institutions temporarily protected from naked short selling. The SEC had given JPMorgan, Bank of America, and Citigroup this privilege. “What’s interesting about that list,” noted the Seattle Post-Intelligencer at the time, “is one name conspicuous by its absence—Seattle-based Washington Mutual Inc., whose stock has been of more than passing interest to short-sellers.”

., 2, 113, 155, 264, 288, 298 California AIG complaint about WaMu to, 166 banking preferences in, 53 decline in home prices in, 157, 185, 187 impact of WaMu sale in, 331–32 Killinger brand rally in, 92–93 naming of WaMu in, 90n Option ARMs in, 197 real estate market in, 47 subprime lending in, 58, 64, 71 tracking of complex data and customers in, 165 CAMELS ratings, 176, 228, 248, 262, 300 Cantwell, Maria, 275, 293, 293n Capital Markets Group, WaMu, 158, 169 capital raise, WaMu Bair-JPM representatives discussion about, 232 Cathcart and, 201 deadline for, 262 disagreements among regulators and, 234 FDIC/Bair and, 262, 275, 294 Fishman-Frank letter to save WaMu and, 296 Fishman’s attempts at, 270, 294, 296 “Go It Alone” proposal and, 294 Killinger and, 188–90, 191, 199, 201, 202, 205, 234, 237 Moody’s-WaMu meeting and, 265–66 OTS enforcement order and, 258, 267, 270 OTS-FDIC relations and, 244 OTS-Fishman/WaMu meeting about, 273–74 OTS pressures on WaMu for, 228, 229, 234, 237, 244 potential sources for, 235 sale of WaMu and, 279, 301 shareholder relations and, 188–90, 191, 199, 202, 205, 245–46 TPG and, 189, 237, 238, 279 Casey, Tom attempts to sell WaMu and, 232–33, 269, 280, 287, 288, 301 board presentations of, 192, 193 Chapman (Fay) disagreements with, 179–80 concerns about decline in housing market of, 153 definition of subprime loan of, 179 FDIC seizure of WaMu and, 303 JPM negotiations and, 232–33 JPM severance of, 321 Killinger’s hiring of, 98 loan loss forecast of, 192 Moody’s downgrade news and, 261, 264, 265, 266 off-loading of subprime and Option ARMs and, 154 professional background of, 98–99, 107 Rotella’s relationship with, 107 shareholder lawsuits against, 178 “category killers,” 91, 92 Cathcart, Ron, 150–51, 151n, 153, 154, 163, 164, 176, 178, 200–201 Cavanagh, Michael, 232, 234, 266, 272, 316 CBS: IndyMac story on, 242 Centrust Savings and Loan, 28 Cerberus, 235 Chapman, Craig, 61–62, 66, 78, 96, 97, 101, 106, 123, 128 Chapman, Fay appraisal problems and, 178–79, 180–82, 181n financial crisis comment of, 333 hiring of, 19 housing market concerns of, 179–80 Killinger’s “higher-risk lending strategy” and, 123 Killinger’s relationship with, 30, 97, 107, 180, 181–82, 183, 205 Long Beach Mortgage concerns of, 56–58, 60–61, 62, 63, 72, 75–78 NYSE bell ringing and, 54 Pepper and, 19, 310 on Pepper’s leadership style, 20 personal and professional background of, 19, 61, 75 personality and character of, 57, 75 resignation/retirement of, 182–83, 309 Rotella’s relationship with, 180 settlement for, 182 WaMu acquisitions and, 49 WaMu Alumni Fund and, 310 WaMu responsibilities of, 49 at WaMu reunion, 307 Chase Bank. See JPMorgan Chase Chase Home Finance, 104 Chicago, Illinois Jenne’s delinquent homeowner tour and, 171–72 WaMu branches in, 86, 108, 109 chief operating officer (COO), WaMu Pepper’s advice to Killinger about, 103–4 Rotella hired as first, 104–5, 106 Chrysler Financial, 235 Citigroup Dimon at, 230 as largest U.S. bank, 104 naked short selling protection for, 247 near failure of, 314, 314n OTS defense of oversight and, 317, 318 as potential buyer of WaMu, 3, 271, 282, 283, 289, 290, 298 TARP and, 315 Clark, Susie, 224 Clinton, Bill, 64, 113, 155 CNBC, 212, 267 CNN, 267 Coburn, Tom, 135 Cohen, H. Rodgin, 232, 233 Collateralized Debt Obligations (CDOs), 158, 295, 295n commercial real estate loans, 26–27 community banks: closure of, 319–20 Community Fulfillment Centers, WaMu, 142–43, 144–45, 144n, 159, 166 Community Reinvestment Act, 59 compensation Countrywide-WaMu competition and, 160 five emissaries–Killinger discussion about, 204–5 for fixed-rate loans/mortgages, 128, 129, 197 for Goldman Sachs board members, 164 for loan consultants, 117, 128–29, 188, 196, 197 at Long Beach Mortgage, 69–70, 78, 166–67 for Option ARMs sales, 117, 197 Pepper’s advice to Killinger about, 103–4 for real estate agents, 143 for salespeople, 140, 166–67 shareholders concerns about WaMu, 187–88 for subprime loans, 197 for WaMu board members, 164 for WaMu senior executives, 131, 187–88 See also specific person Congress, U.S.

See secondary market; shareholders/investors, WaMu; type of investor irrational money lenders, Killinger’s comment about, 163, 170, 240 Jenne, Kevin, 112–18, 167–68, 170–72 Jiminez (Ramona and Gerardo) family: mortgage loan to, 154–57, 172–73, 331–32 Johnson, Earvin “Magic,” 141–42 JPMorgan Chase assets of, 229 Bair meetings with representatives from, 232–33, 266, 316 Bank One acquisition by, 104–5, 230 Bear Stearns acquisition by, 187, 232, 246, 325, 329 board of, 295 bundling of mortgage-backed securities by, 120 Dimon appointment as president and COO of, 105 FDIC-OTS relationship and, 251 FDIC relationship with, 232, 246, 316 Great Depression and, 212 high-risk mortgages at, 138 home equity loans at, 325 investor conference call at, 301, 304 as largest company in world, 329 lawsuits against, 326 losses at, 325 Morgan Stanley acquisition rumors and, 287, 293 OTS/Reich and, 233–35, 283 philanthropy of, 326–28 political connections of, 231 regulators’ meetings with, 232–34 Rotella hiring of employees from, 107 SEC protection from naked short selling of, 247 shareholders at, 325 subprime mortgages and, 325 TARP and, 315, 328 See also JPMorgan Chase, WaMu and; specific person JPMorgan Chase, WaMu and acquisition of WaMu by, 3, 4, 6, 7, 300, 321–22 bidding for WaMu by, 300, 316–17 Chapman’s (Fay) recommendation to sell WaMu to, 179 closure of WaMu and, 301, 316–17 conversion of WaMu by, 320–24 direct negotiations for JPM acquisition of WaMu and, 189, 195, 229–38, 238n FDIC sale of WaMu and, 274–75, 289–90, 292–93, 298, 300, 316–17 and Fishman attempts to sell WaMu to JPM, 271–72 and funding for WaMu acquisition, 301, 304, 304n hostile takeover of WaMu proposal by, 245–46 Moody’s downgrade of WaMu and, 290 Paulson’s views about WaMu offer from, 248 plans for acquisition of WaMu by, 266, 274–75, 275n, 283–84, 295 press conference of, 4 profits on WaMu purchase by, 328–29 renegotiation of WaMu borrowers with, 332 rumors about WaMu deal with, 267, 268 rumors about WaMu health and, 214 Santander-JPM bid-rigging allegations and, 282n and WaMu as government-assisted deal, 266 WaMu online data room and, 291, 322 and WaMu sale as “government assistance” transaction, 246, 246n WaMu stockholders and, 245–46 junk bonds, 28 Justice Department, U.S., 60, 332 Kashkari, Neel, 315 Kaufman, Ted, 126, 330 Kelly, Edward “Ned,” 289, 298 Keystone Holdings, 42 Kido, Ken, 209–10, 281 Killinger, Brad, 29, 33, 37, 45, 81 Killinger, Bryan, 29, 33, 35, 36, 37, 45, 81 Killinger, Debbie, 29, 30, 33, 34–36, 37, 43, 45, 46, 79, 80–84, 88, 311 Killinger, Karl, 33–34, 35, 37 Killinger, Kerry absence from Seattle office of, 93–94 as Alexander the Great, 88 appearance of, 88, 189 appointment as president and CEO of, 30, 309 Baker e-mail about housing to, 152 as “Banker of the Year,” 87 blame for WaMu problems and, 241, 330 board memberships of, 83 board regulators meeting and, 192–93 caricatures of, 49, 322 compensation for, 45, 94, 104, 174, 205 congressional testimonies of, 329–31 corporate jets and, 88–89, 97, 174, 205 demands for resignation of, 195, 205 dilemma of, 121–22 employee views about, 93–94, 177, 180, 201–2, 241–42 FDIC lawsuit against, 333–34 firing of, 3, 252–53, 254, 263 five emissaries meeting with, 203–6 hiring by, 98–99 Linda thanked by, 196 management style of, 52, 55, 57, 62–63, 87, 96, 123, 174–76, 177 marginalization and isolation of, 201–2 marital problems of, 80–83 McKinsey review and, 241–42 McMurray’s report and, 186–87, 201 media criticisms of, 102, 308 nickname for, 33 NYSE bell ringing and, 54 optimism of, 173–75 organization and structure of WaMu and, 67, 96, 101, 108 OTS pressures to replace, 255 Pepper’s advice to, 102–4, 133–35, 133n Pepper’s CD gift to, 30–31 Pepper’s hiring of, 18, 19 Pepper’s relationship with, 149, 309 as Pepper’s successor, 27–31, 205 Pepper’s views about, 29–30, 87, 102–4 Pepper’s visits to WaMu and, 148 personal life of, 33–38, 45–46, 52–53, 80–84, 94 personality and character of, 28–29, 36–37, 43, 44, 45–46, 47, 53, 87–88, 90–91, 102, 105, 132, 135, 173–75, 199–200 plans/vision for WaMu of, 67, 85, 86, 87, 88, 96, 108, 109, 122–23, 228–29, 240, 241 political connections of, 231 popularity of, 87, 93 potential successors to, 106, 107, 175, 202 professional background of, 18–19, 28, 29, 37, 38 reputation/image of, 43, 44, 88, 99 resignation thoughts of, 175 sale of WaMu and, 179, 330 Seattle office of, 32–33, 95 severance package for, 258 shareholder/investor relations and, 47, 55, 81–82, 102, 173, 188, 189–91, 193–200 shareholder lawsuits against, 102, 178 stress on, 190, 241 surprise birthday party for, 79–80 as WaMu board chairman, 30, 200, 239, 240–41, 309 WaMu board relationship with, 164–65, 170, 186–87, 239 WaMu as “category killer” and, 91 WaMu culture/values and, 94–95, 98, 107, 132–33 WaMu reunions and, 308–9, 311 wealth of, 37–38, 46, 82–83 work ethic of, 35 See also specific person, merger, acquisition, or topic Killinger, Linda Cottington, 83–84, 89–90, 94, 174, 196, 205, 231, 308, 309, 328, 333 Kohn, Donald, 250, 252, 275, 294, 295–96 Korea Development Bank (KDB), 261 Korszner, Randy, 275 Kovacevich, Richard, 297 Ladder Capital, 254 Lannoye, Lee Killinger–five emissaries meeting and, 203–6 Long Beach Mortgage acquisition and, 59–60, 62–63 retirement of, 62 at shareholders 2008 meeting, 197–99 Last Hurrah Party, WaMu, 322 Lehman Brothers as advisor to WaMu, 228 bankruptcy of, 270, 272, 273, 296 capital raise at, 187 concerns about survival of, 260, 261 decision not to bail out, 269 decline in stock price of, 260, 261 Financial Services Conference of, 87 Great Western acquisition and, 41, 44 impact on borrowing at Fed’s discount window of, 285 impact on WaMu of problems at, 268, 272, 273, 296 KDB deal and, 261 losses at, 261, 263 mortgage-backed securities sales at, 120 Lehman Investors Conference, 153, 173 Leonard, Andrew, 128 Leppert, Tom, 163 Lereah, David, 136, 152, 152n Levin, Carl: Senate Committee hearings and, 318, 329–31, 334 Lewis, Kenneth D., 125, 231 Lillis, Charles, 164 liquidity, WaMu Break the Bank model for, 215, 248, 278 Cantwell-Paulson conversation about, 293 closing of banks and ratio for, 215 closure of WaMu and, 299–300, 300n, 304–5 FDIC-OTS-WaMu discussion about, 244 Fishman capital raise plan and, 294 Fishman letter to customers about, 280 Moody’s-WaMu meeting about, 265 OTS press release about, 304–5 OTS report and, 300 regulators’ concerns about, 250 sale of WaMu and, 284, 290 WaMu reports to regulators about, 286, 299 See also bank runs, WaMu; credit lines The Little Prince (children’s book), 49 loan consultants/managers compensation for, 117, 128–29, 188, 196, 197 Countrywide-WaMu competition and, 126–28 fraud among, 145 Jenne’s Option ARMs focus groups and, 116–18 layoffs of, 188 at President’s Club meetings, 142–44 pressures on, 129 underwriting guidelines and, 125–26 See also Ramirez, Tom Long Beach Mortgage AIG report about, 166 Ameriquest loans compared with those of, 154n assets of, 58 audits of, 166, 167 California regulation of, 66 change from thrift to mortgage company of, 64–65 Chapman (Craig) as manager of, 66, 78, 101 Chapman (Craig)-Rotella relationship and, 128 Chapman’s (Fay) concerns about, 56–58, 60–61, 62, 63, 72, 75–78 compensation at, 69–70, 78, 129, 166–67 Countrywide-WaMu competition and, 127 culture at, 63–64 Davis (Craig) as head of, 75–76 defaults and delinquencies at, 137, 153 expansion of, 78, 136–37 founding of, 63 fraud and, 71–73, 76, 93, 154, 166 funding for mortgage brokers and, 129 Goldman Sachs relationship with, 121, 131, 157 “higher-risk lending strategy” and, 122 Home Loans Group and problems at, 167 Justice Department accusation against, 60 Killinger and, 57, 58, 62–63, 75, 76, 78, 137–38 Lannoye opposition to, 197–98 losses at, 66 mortgage-backed securities sales at, 67, 73–75 off-loading of risky loans and, 157 OTS concerns about, 223–24 oversight of, 65, 66, 137 paperwork problems at, 332 privatization of, 66 profits of, 64, 65, 71 proposal to shut down, 76, 78 public offering for, 65 repurchase of mortgage-backed securities by, 137 reputation of, 157, 176 Rotella and, 109–10, 128, 137–38 subprime mortgages at, 63, 69, 71, 75, 167–68 underwriting guidelines for, 56, 65–66, 67, 78, 125, 137–38, 167 WaMu acquisition of, 58, 59–60, 62, 63 WaMu reviews of, 57, 76–78 See also Jiminez (Ramona and Gerardo) family: mortgage loan to Longbrake, Bill end of savings and loan banks comment of, 318 hiring of, 18 housing market warnings of, 161–63 junk bond incident and, 28 Killinger as Pepper successor and, 28 NYSE bell ringing and, 54 Pepper appointment as temporary CEO and, 10–11 personal and professional background of, 28, 98 as potential Pepper successor, 27, 29, 205 WaMu departure of, 98 WaMu responsibilities of, 98 Los Angeles Times, 71, 242–43 Mad Money (TV show), 246–47 Magleby, Alan, 297 Maher, John, 40, 42, 43–44, 45, 60 Market Research Department, WaMu, 192 See also Jenne, Kevin Martinez, Melissa, 126 Matthews, Phillip, 164 McCain, John, 264, 301 McGee, Liam, 255 McKinsey Group, 241–42 McMurray, John, 186–87, 186n, 201–2, 260–61, 264, 266, 269, 270, 288, 301 media bailout reports by, 2 bank runs and, 2, 201, 207–8, 209, 211–12, 214, 215, 243, 279, 282 criticisms of Killinger by, 102, 308–9 Dimon’s Seattle address and, 326–27 end of modern Wall Street proclaimed by, 288 FDIC seizure of WaMu and, 300–301, 302, 303 Fishman appointment announced in, 258 IndyMac failure and, 207–8, 209, 242–43 JPM merger offer to WaMu and, 237–38 Kido interview with, 281 Killinger firing reported in, 254 Lehman problems and, 270 Paulson interview with, 284–85 Pepper and, 309–10 sale of WaMu rumors and, 279, 288, 289, 298–99, 300–301, 302 and WaMu failure as nonevent, 314 WaMu final hours and, 267–68, 272, 276, 279, 281, 282, 288, 289, 292, 298–99, 300–301, 302 WaMu information lockdown and, 281 WaMu layoffs and, 321 WaMu shareholder meetings and, 189 See also specific media organization Meola, Tony, 75, 76, 142, 144, 145 “Merge with Washington Mutual!”


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stocks for the long run, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

In the past decade, disagreement models showed how differences in investor beliefs can influence financial markets through several channels: gradual information flow, limited attention, and heterogeneous views. Disagreement is especially important for explaining the high level of trading volume, but it also can help explain correlation or volatility risk premia as well as some cross-sectional patterns in equity returns. For example, high levels of disagreement and short-selling constraints together predict relatively low equity returns because overvalued stocks cannot be shorted and tend to be held by the most optimistic investors. Asymmetric information refers to situations in which one party is better informed than the other, leading to so-called principal–agent problems (including moral hazard, adverse selection, conflict of interest). Vayanos–Woolley (2010) show that delegated asset management can cause momentum patterns.

It is not surprising, then, that paper profits tend to be most consistent in illiquid assets (e.g., small-cap stocks) or in trading styles that involve high turnover (e.g., short-term reversal). Faced with evidence of profitable trading strategies, it is always reasonable to question whether trading cost estimates (including both direct costs and market impact) have been understated. Fortunately, newer studies increasingly adjust profits for trading costs, financing costs, short-selling constraints, and other market frictions. While the limits-to-arbitrage literature explains why speculative capital is generally scarce, these adjustments explain why certain paper regularities are harder to exploit in practice than others. Only market-makers and other efficient low-cost traders can take advantage of such opportunities, and even then, only on a limited scale. Changing world Past success can prove ephemeral without implying that potential predictable profits never were there in the first place (as other mirage explanations imply).

Rallis–Miffre–Fuertes (2010) systematically review three approaches from the perspective of a long-only investor: overweighting upward-trending commodities, overweighting positive-roll commodities, and extending futures maturity to longer (deferred) contracts from the most liquid front contracts. All approaches appear to boost returns and Sharpe ratios but they also involve higher trading costs (and, likely, fees). 11.4 HEDGE FUNDS 11.4.1 Introduction Hedge funds (HFs) are pools of money run by HF managers, who face less regulation and have much greater flexibility than traditional managers, notably in their use of short selling, leverage, and derivatives. HFs face limited disclosure requirements, although transparency demands are growing both from customers and regulators. HF management contracts typically involve exceptional compensation arrangements with a large performance-related component; a 1.5% to 2% fixed management fee plus an incentive fee consisting of 20% of returns are the norm. Managers are further incentivized by holding significant parts of their wealth in their funds.


pages: 424 words: 119,679

It's Better Than It Looks: Reasons for Optimism in an Age of Fear by Gregg Easterbrook

affirmative action, Affordable Care Act / Obamacare, air freight, autonomous vehicles, basic income, Bernie Madoff, Bernie Sanders, Branko Milanovic, business cycle, Capital in the Twenty-First Century by Thomas Piketty, clean water, coronavirus, David Brooks, David Ricardo: comparative advantage, deindustrialization, Dissolution of the Soviet Union, Donald Trump, Elon Musk, Exxon Valdez, factory automation, failed state, full employment, Gini coefficient, Google Earth, Home mortgage interest deduction, hydraulic fracturing, Hyperloop, illegal immigration, impulse control, income inequality, Indoor air pollution, interchangeable parts, Intergovernmental Panel on Climate Change (IPCC), invisible hand, James Watt: steam engine, labor-force participation, liberal capitalism, longitudinal study, Lyft, mandatory minimum, manufacturing employment, Mikhail Gorbachev, minimum wage unemployment, obamacare, oil shale / tar sands, Paul Samuelson, peak oil, plutocrats, Plutocrats, Ponzi scheme, post scarcity, purchasing power parity, quantitative easing, reserve currency, rising living standards, Robert Gordon, Ronald Reagan, self-driving car, short selling, Silicon Valley, Simon Kuznets, Slavoj Žižek, South China Sea, Steve Wozniak, Steven Pinker, supervolcano, The Chicago School, The Rise and Fall of American Growth, the scientific method, There's no reason for any individual to have a computer in his home - Ken Olsen, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, transaction costs, uber lyft, universal basic income, War on Poverty, Washington Consensus, WikiLeaks, working poor, Works Progress Administration

At this writing, the extent to which Moscow may have influenced the 2016 US presidential election was unclear. Moscow’s desire to do so was not. Wall Street speculators try to short-sell stocks: today Russia and other authoritarian regimes are trying to short-sell democracy. Russia never will beat democracy in a fair fight. But dictatorship can short-sell those governments that protect freedom of speech and civil rights by planting rumors, inveigling citizens to question the legitimacy of free elections, and making democracy seem to be falling apart. Planting rumors to cause firms to appear to be falling apart is the technique of stock market short-selling: if the stock price then tumbles, the short-sellers benefit. Totalitarian governments are hoping the “stock price”—the reputation—of the United States will tumble, allowing them (keeping the metaphor) to snatch up assets at a bargain.

Totalitarian governments are hoping the “stock price”—the reputation—of the United States will tumble, allowing them (keeping the metaphor) to snatch up assets at a bargain. If Russia did assist Trump in gaining the White House, the impact on the United States—a vain, incompetent president who is unprepared and acts befuddled, distracting his nation—was exactly what a short-selling strategy would seek. DURING THE SAME RECENT PERIOD when democracy expanded, two counterweights arose. One is the Internet. Initially, web access was the bane of dictators. George Orwell thought Oceania, his Nineteen Eighty-Four dystopia, would use electronics to prevent citizens from knowing what was really going on; during the initial spread of the Internet, it turned out electronics worked the other way around, allowing average people to know what’s happening. Dictators have begun to respond: for instance, China strengthening the Great Firewall to impede Internet reporting of corruption by local party hacks, Turkey blocking access to Wikipedia to prevent citizens from accessing information about genocide against Armenian Christians.

., crime bill, 110–111 decline of, 109–111, 120, 137–139 global rates of, 106, 111 law enforcement and, 110–115 lead and violent, 111–112 media and, 105, 107 political campaigns and, 105–106 sentencing for, 115–116 violent, 106 See also terrorism crime-boss government, 182 The Culture of Narcissism (Lasch), 84 death air pollution and, 30 capital punishment, 116, 155–156 of law enforcement officers, 115 leading causes in US of, 24 by prescription drugs, 34 self-inflicted, 35 technology and workplace, 155 traffic deaths, 28, 142–143, 145–146 Deaton, Angus, 82 The Decline of the West (Spengler), 197, 198 declinism, 210, 285 academia and, 201 aging and, 203 anecdotes and, 218–220 Big Sort communities and, 222–223 blame and identity groups and, 218 blame-Washington attitude and, 207–209 Brexit referendum and, 204, 209, 217 freedom of association and, 222–223 history of panics of, 200 homogamy and, 223 Kaus on, 223–224 logic of, 92 luck and, 217–218 media and, 202 national bookkeeping switcheroo and, 208 natural selection and, 202 Obama and, 200–201, 221 opinionization of America and, 214–215 Plato and, 202–203 politics and, 84, 200–202, 206–209, 220–222 power and, 221 religious attendance and, 222 Sanders and, 84, 201–202 Sharkey on, 224–225 smartphones and, 212 Sputnik and, 200 victimhood and, 204–205, 217 Western civilization and, 201 See also Facebook and social media; Trump, Donald DeConto, Robert, 233–234 deindustrialization, 29 democracy China and, 170 creativity and, 167 Diamond, L., on, 165–166, 178, 183–184, 185–186 dictatorship and, 164–166 economy and, 167–168, 170, 173–174, 193 education and, 169–170 ethics and, 174 freedom of thought and, 168–169 internet and, 175–176 inventions and inventiveness in, 172–173 recession of, 165 short-selling strategy for, 175 slavery and oppression and, 174–175 Trump lying and, 184–185 World War I and, 170–171 World War II and, 171–173 See also corruption developing world positive change in, 17, 18 poverty in, 20, 280 sanitation infrastructure in, 30 traffic deaths in, 142–143 Diamond, Larry, 165–166, 178, 183–184 two-party duopoly for, 185–186 dictatorship, 193 Carnation Revolution and, 165 coup d’état and, 166 democracy and, 164–166 education and, 169 internet and, 175–176 World War II and, 171–173 dietary habits, of West, 25, 116 disability, 249, 257 education and, 37 veterans and, 36–37, 258 disease in Africa, 25, 39 avian and swine flu, 22 chemical and biological weapons and, 26–27 Ebola, 23, 25 films and, 28 influenza pandemic, 27–28 malaria, 39 media negativity and, 24–25 MERS, 23 mosquitoes and, 39 news coverage and, 24–25 obesity as, 5, 26, 35 smoking and, 24 unstoppable contagion, 27, 28 vaccinations and, 25, 39–40 weight gain and metabolic syndrome, 25–26 See also public health Dodd-Frank Act, 92–93 Dust Bowl, 5 dynamism catastrophism and, 20–21, 221, 283 food production and, 21 East of Eden (Steinbeck), 17–18, 58, 134 Easy Rider (movie), 198, 199 Ebola, 23, 25 echo chamber, 215–216 economy, 209–210 bulk transportation and, 80–81 buying power and, 85–86, 87, 246, 249 Clinton, H., on, 67 coal mining and, 61, 76–77, 233 collapse anxiety and, 68 communism and, 174 comparative advantage and, 79–80 control and, 65–66 currency and, 69 democracy and, 167–168, 170, 173–174, 193 Dodd-Frank Act and, 92–93 education and, 169 fascism and, 66 Feldstein on, 91 globalization and, 82 golden age of, 69–70 Great Recession and, 64, 68, 97 inequality and, 84–85 inflation and, 87 infrastructure and, 93–95 Keynes on, 98–99 marriage and, 267, 268 media negativity and, 77, 79, 87–88 modern monetary theory and, 96 Panasonic and, 68–69 paper mills and, 78–79 Piketty on, 84–85 predictions and, 64 pretax income and, 84–85, 91 regulations of, 92–93 retirement economics, 31, 273–274 slow growth and, 90–92 Soviet and American, 167 state pension accounts and, 97–98 trade boosting, 79, 245–246 Trump and, 70–71 US domestic production and, 77–78 US GDP and, 84, 90–91 war and, 93, 132–134 Washington Consensus and, 66–67 Western living standards and, 88 See also market economy; middle class, US; national debt, US education, 280 book reading and, 271 in China, 170 college as, 269–271 democracy and, 169–170 disability and, 37 economy and, 169 immigrants and, 269–270 jobs and, 89–90 longevity and, 37–38 marriage and, 267 public school system and, 38, 269 skilled trades and, 270 wage and, 89–90 The Education of Henry Adams (Adams), 197, 198 Ehrlich, Paul, 5 elections.


The Handbook of Personal Wealth Management by Reuvid, Jonathan.

asset allocation, banking crisis, BRICs, business cycle, buy and hold, collapse of Lehman Brothers, correlation coefficient, credit crunch, cross-subsidies, diversification, diversified portfolio, estate planning, financial deregulation, fixed income, high net worth, income per capita, index fund, interest rate swap, laissez-faire capitalism, land tenure, market bubble, merger arbitrage, negative equity, new economy, Northern Rock, pattern recognition, Ponzi scheme, prediction markets, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, short selling, side project, sovereign wealth fund, statistical arbitrage, systematic trading, transaction costs, yield curve

Strategies that require leverage to perform, or that make investments based on fundamentals, have under-performed during this period. Long/short equity The major drag on performance has been aggressive sector rotations between financials and commodities. Long/short funds tend to invest in positions based on fundamentals, which have succumbed to indiscriminate selling. During 2008 many governments introduced temporary restrictions on the short selling of financial stocks. At the time the cost of borrowing such stocks to short sell had increased dramatically, in many cases making the trade prohibitive. Later on in the year, managers began to see shorting opportunities in consumer-related stocks. Due to the volatile environment, managers reduced their trade sizes, believing that this would not have a negative impact on returns as dispersion was so high. Indiscriminate selling is not conducive to this approach.

During 2008, managers took profits from longer-term themes, such as the rise in commodity prices and allocated more capital to shorter-term trends. Convertible bond arbitrage Poor performance has been the result of credit spreads widening and considerable distressed sell off as investors took flight to quality assets. The strategy involves purchasing the convertible bond and short selling the underlying equity. The restrictions on short selling in financials also impeded this strategy. Event driven The number and size of global mergers and acquisitions were significantly down during 2008 compared with the preceding years. This has meant that the opportunity set for this strategy was reduced. Deal spreads remained high, to compensate for the risk of deals failing to complete. The outlook for strategic M&A deals remains positive but the potential for leveraged buy-outs has reduced significantly.


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, break the buck, buy and hold, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, Kenneth Rogoff, Kickstarter, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

A former Treasury minister, Kitty Ussher, recalls a briefing in July outlining bailout plans for banks whose names were replaced with animals or planets to preserve secrecy. They knew what was coming. Regulators in the United States were now playing a desperate game of catch-up, scrambling to do what little they could, even if that meant keeping investors in the dark. Lehman Brothers’s chief executive, Dick Fuld, panicked by David Einhorn’s famous short-selling campaign against his firm, persuaded the SEC to restrict short selling of large financial firms. A couple of months after Fannie Mae and Freddie Mac raised shareholder capital, Congress gave the Treasury Department new powers to take over the imploding mortgage behemoths. Those powers came not a moment too soon: Fannie and Freddie were placed in conservatorship by the Treasury Department in early September, stripping away once and for all the private sector fig leaf of what had always been a massive government housing subsidy scheme.

At Goldman, a key figure was Fabrice Tourre, a young French derivatives marketing wizard who had been posted to New York from Europe to work with Jonathan Egol. With Viniar’s orders to “get closer to home” ringing in his ears, Sparks had to find a mechanism to stop his growing short positions from getting too big. “Fab,” as everyone called him, had a marketing pitch: he proposed “renting” the Abacus platform to hedge funds like Paulson & Co. After overcoming opposition from Sparks’s traders, who wanted to earmark the Abacus platform for their own short-selling, in March 2007 Tourre arranged a synthetic CDO called Abacus 2007 AC-1 for the purpose of allowing Paulson to short a billion dollars worth of subprime. The detail that landed Goldman and Tourre in the SEC’s gunsights was a minor tweak to the static Abacus template: Tourre brought in a monoline insurance company called ACA to select the specific subprime bonds in the CDO while allowing Paulson extensive influence over the selection.

This department found it could earn extra money for shareholders by providing a service to Wall Street called securities lending. Traders at banks and hedge funds like to borrow stocks and bonds (for a fee) in order to sell them short. In other words, they speculate against falls in price, then buy the securities back again and return them to their rightful owners. Some pension funds and insurers object to short selling and refuse to lend their securities out, but most were happy to comply in return for a few points in fees.17 In the mid-2000s, Win Neuger, who ran the global investment group for AIG, had the bright idea of taking this notion further. Normally, securities lenders park the cash collateral received for lent securities in the safest possible Treasury bills or government bonds so that they can redeem the loans quickly, if necessary.


pages: 1,335 words: 336,772

The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance by Ron Chernow

always be closing, bank run, banking crisis, Big bang: deregulation of the City of London, Bolshevik threat, Boycotts of Israel, Bretton Woods, British Empire, buy and hold, California gold rush, capital controls, Charles Lindbergh, collective bargaining, corporate raider, Etonian, financial deregulation, fixed income, German hyperinflation, index arbitrage, interest rate swap, margin call, money market fund, Monroe Doctrine, North Sea oil, oil shale / tar sands, old-boy network, paper trading, plutocrats, Plutocrats, Robert Gordon, Ronald Reagan, short selling, strikebreaker, the market place, the payments system, too big to fail, transcontinental railway, undersea cable, Yom Kippur War, young professional

He said short sellers were preventing an economic rebound and warned that unless Whitney curbed them, he would ask Congress to investigate the Exchange and possibly impose Federal regulation. Whitney refused to admit any danger in short selling. Privately Morgan partners mocked Hoover’s obsession as absurd and fantastic, but they couldn’t dissuade him from his vendetta. Although fearing that public hearings would dredge up “discouraging filth” and sabotage recovery efforts, in 1932 Hoover asked the Senate Banking and Currency Committee to start an inquiry into short selling. Wall Street bankers were so upset that Lamont lunched at the White House with Hoover and Secretary of State Stimson, trying to spike the inquiry. Hoover said destructive short sellers had offset his beneficial measures, a remark that led to a heated exchange about the hearings.

Treasury Secretary Andrew Mellon wanted higher interest rates to stop the flow of gold to Europe. Many at the Fed saw austerity as a bitter but necessary medicine. “The consequences of such an economic debauch are inevitable,” said the Philadelphia Fed governor. “Can they be corrected and removed by cheap money? We do not believe that they can.”9 By the second half of 1930, the postcrash calm was gone. That fall, Hoover complained to Lamont about bear raids, short selling, and other unpatriotic assaults against national pride. The following year would be the worst in stock market history. While the Fed had assumed responsibility for the health of the entire financial system after the 1929 crash, the House of Morgan still played a part in specific, smaller crises. The Fed had no obligation to rescue individuals, banks, or companies; its concerns were more general.

Maybe they have settled German reparations but they did it the worst damned way they could.”14 He wouldn’t extend his one-year debt moratorium and rejected French and British proposals for deferring upcoming payments; he forced France to default. So on the eve of Hitler’s advent, the Allies were squabbling over moldy financial issues that had bedeviled them for years. The Morgan-Hoover feud over debt was mild compared with their debate over short selling on Wall Street. Moody and isolated, taciturn and stony-faced, Hoover now shared the average American’s view of Wall Street as a giant casino rigged by professionals. He saw the stock market as a report card on his performance, and it showed consistently failing grades. He came to believe in a Democratic conspiracy to drive down stocks by selling them short—that is, by selling borrowed shares in the hope of buying them back later at a cheaper price.


Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi

addicted to oil, affirmative action, Affordable Care Act / Obamacare, Bernie Sanders, Bretton Woods, buy and hold, carried interest, clean water, collateralized debt obligation, collective bargaining, computerized trading, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, money market fund, moral hazard, mortgage debt, obamacare, passive investing, Ponzi scheme, prediction markets, quantitative easing, reserve currency, Ronald Reagan, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War

In that same period, in late September 2008, both Goldman CEO Lloyd Blankfein and Morgan Stanley CEO John Mack lobby the government to impose restrictions on short sellers who were attacking their companies—and they get them, thanks to a decision by the SEC on September 21 to ban bets against some eight hundred financial stocks. Goldman’s share price rises some 30 percent in the first week of the ban. The short-selling ban was galling for obvious reasons: the same bank that just a year before had bragged about the fortune it had made shorting others in the housing market was now getting its buddies in the government to protect it from short sellers in a time of need. The collective message of all of this—the AIG bailout, the swift approval for its conversion to bank holding company status, the TARP funds, and the short-selling ban—was that when it came to Goldman Sachs, there wasn’t a free market at all. The government might let other players on the market die, but it simply would not allow Goldman Sachs to fail under any circumstances.

In his Neuger Notes back in December 2005, Neuger wrote, “There are still some people who do not believe in our mission … If you do not want to be on this bus it is time to get off … Your colleagues are tired of carrying you along.” How was he going to make that money? Again, just like Cassano, he was going to take a business that should have and could have been easy, almost risk-free money and turn it into a raging drunken casino. Neuger’s unit was involved in securities lending. In order to understand how this business makes money, one first needs to understand some basic Wall Street practices, in particular short selling—the practice of betting against a stock. Here’s how shorting works. Say you’re a hedge fund and you think the stock of a certain company—let’s call it International Pimple—is going to decline in value. How do you make money off that knowledge? First, you call up a securities lender, someone like, say, Win Neuger, and ask if he has any stock in International Pimple. He says he does, as much as you want.

So let’s say a month later, International Pimple is now trading not at 10 but at 7½. You then go out and buy a thousand shares in the company for $7,500. Then you go back to Win Neuger and return his borrowed shares to him; he returns your $10,000 and takes the stock back. You’ve now made $2,500 on the decline in value of International Pimple, less the $200 fee that Neuger keeps. That’s how short selling works, although there are endless nuances. It’s a pretty simple business model from the short seller’s end. You identify securities you think will fall in value, you borrow big chunks of those securities and sell them, then you buy the same stock back after the value has plummeted. But how does a securities lender like Neuger make money? Theoretically, with tremendous ease. The first step to being a successful securities lender is having lots and lots of securities.


Ugly Americans: The True Story of the Ivy League Cowboys Who Raided the Asian Markets for Millions by Ben Mezrich

index arbitrage, index card, invisible hand, Nick Leeson, profit motive, short selling, white picket fence

“Although organs might be an interesting way to go,” Winters said. “At the moment, most hedge funds focus on arbitrage and shorting opportunities.” “Picking out losers,” Carney expounded. “Finding companies that are on their way down, betting against them, then helping them along. It can get fairly rough, as you expose faults to help the process along.” It sounded malicious, but Malcolm guessed it was more complicated than Carney made it sound. Short selling was most likely a trading technique like any other. Instead of betting that a company’s stock would go up, you were betting that it would go down. The idea that you actively tried to expose faults to make the company’s stock go down seemed a bit malevolent, but was it really different from putting out press releases lauding a company’s positive features to get the price up? The slender hostess with the triangular face returned from the bar with a wooden carafe held delicately between two cloth wraps.

Sometimes Carney started the meeting with news from the financial markets and sometimes he let his boys run the show. At first, the meetings tended more toward chaos than order, with everyone throwing out ideas at once. As Carney had explained during their short, two-day orientation before ASC first opened its doors, at a hedge fund, there was only one bottom line: profit. No deal was out of bounds, no position too crazy. ASC could buy or short-sell simple equities such as stocks and bonds, trade index futures, trade commodities such as the yen, precious metals, pork bellies, even orange juice. Or they could go after more exotic positions: real estate, rare art, IPOs. There was no one to answer to, no forms to file or permission to be granted. The only real constraints were the 350-milliondollar bankroll and the first Rule of Carney: you never get into something you can’t get out of by the closing bell.

And though it was unspoken, every one of Carney’s Boys knew that the prop trader who came up with the biggest deal would reap the biggest benefits—financially in the short term and politically in the long term. So far, the most dominant among them in terms of profit-making ideas had been Steve Townsend. Of the dozen ideas he’d put forward over the past six months, Carney and Bill had okayed three of them: an arbitrage scheme involving Indonesian municipal bonds that had already earned ASC three million dollars; a short-selling position in a Singapore-based textile firm that Townsend had rightly determined was hugely overvalued, a position that had made ASC another million; and a quick “in and out” trade involving a South Korean hardware chain, which was expanding its outfit into Vietnam. Townsend had been riding high on his success, and since he’d sold the South Korean position for a four-million-dollar gain, he’d taken to sitting at the seat right next to Carney, tanned arms crossed against his chest, a superior look flashing from his bright green eyes.


pages: 294 words: 89,406

Lying for Money: How Fraud Makes the World Go Round by Daniel Davies

bank run, banking crisis, Bernie Madoff, bitcoin, Black Swan, Bretton Woods, business cycle, business process, collapse of Lehman Brothers, compound rate of return, cryptocurrency, financial deregulation, fixed income, Frederick Winslow Taylor, Gordon Gekko, high net worth, illegal immigration, index arbitrage, Nick Leeson, offshore financial centre, Peter Thiel, Ponzi scheme, price mechanism, principal–agent problem, railway mania, Ronald Coase, Ronald Reagan, short selling, social web, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, time value of money, web of trust

When you make a deal on the stock exchange,* the buyer has a few days to deliver the cash and the seller has a few days to deliver the shares. This arrangement is quite like trade credit, isn’t it? And trade credit is both a necessary administrative convenience, and an opportunity for all kinds of misbehaviour, as readers will have noticed. In the case of the stock market, buying a share that you don’t have enough money to pay for is called ‘trading on margin’, and selling a share that you don’t own is called ‘short selling’. In both cases, the expectation is that you will be able to scrounge up either the cash or the share before the ‘settlement date’. You scrounge up cash by borrowing it or selling something else, of course, but how do you scrounge up a Piggly Wiggly share? The answer, and the source of Clarence Saunders’ misfortunes, is that the brokerage community maintain a pool of shares available to be borrowed,* and make them available to scrounge up by people who have made short sales.

It’s got a bit of the appeal of Robin Hood, with less danger of an arrow in the vitals. Leslie Payne once said* that, if you have no convictions or bankruptcies on your record, that ‘everyone gets one free shot at a long firm’, and I’d be lying if I said I’d never daydreamed. I have two friends who spend a lot more time than me looking at the subject, though, and they don’t share this outlook at all. One is a hedge fund manager who augments his returns by short-selling the shares of fraudulent stock promotions, and the other is a computer expert who writes programs to trawl through email archives and to catch online poker cheats. Both of them independently confirm something which you can check up yourself by randomly choosing a first-person account from the bibliography; the more time you spend trying to get inside a criminal’s head, the less attractive you find them.

A. 201–3,205 Henry VIII 216 high-net worth investors tendency to have time on hands 109 tax strategies of a proportion of 266–8 Hippocratic Oath 134 hire purchase scam (Leslie Payne) 36, 39–40 homomorphism 209, 212 Hooley, Ernest ‘The Millionaire’ 230 hotel bills 37 House of Commons 1 Howe, Sarah 90, 116–19, 222 HSBC 188, 189, 280 Hudson Oil 249, 251 Humphery, John Stanley 228 I IBM 64–8 Iceland 218–22 Inca Empire 226–7 Incentives 13, 22, 62, 74, 115, 135, 159, 165, 174, 185–6, 205, 210 incidental fraud vs entrepreneurial 213, 215, 287, 288 Infinity Game 92–9 information 24, 71, 199–208, 211–15, 238 control of by fraudsters 41, 65, 71, 115, 173 insider, securities fraud 23, 239–42, 260 inheritance 117, 217, 218–22, 235, 266 insider dealing 23, 106, 129, 241–43, 260 insurance 36, 39–40, 65, 163–4, 171, 225, 228 medical 74–7, 84 Payment Protection Insurance (PPI) 187–97 insurance scam (Leslie Payne) 40–41 International Reply Coupons see Ponzi, Charles investors 1, 16 in OPM leases 65–7, 69–71 Charles Ponzi’s 86–9 hedge fund 96, 104–9, 113 in pigeons 100, 103 institutional 104 nineteenth century female 118–20 mining 126–30 reliance on accounts 142–54 expectations of UK banks 188 Victorian 228, 231 Retail 240–43 in Piggly Wiggly 256–61 IRS vs UBS 263–4 Israel, Sam see Bayou Capital drug habit of as potential indicator something was wrong 116 J Jehoash (high priest) 217 John Bull 230 K Keating Five 182 Keating, Charles 177–83, 214 Kennedy, John Fitzgerald 61 Kerviel, Jerome 165 King, Don 163 Knights of Industry 234, 237 Kolnische Volkszeitung 232, 234, 236, 237 KPMG 150 Kray, Ronnie and Reggie 26–7, 31, 36, 39, 41 Kutz Method 152–3 KYC (know your customer) 281 L Lab fraud anaemia 74 Ladies’ Deposit Bank (Boston) 116–19 lawyers 19, 27, 33–4, 39, 45, 71, 115, 117, 161, 180, 182, 194, 196, 225, 267, 271, 272, 281 (they’re usually in the background even when not specifically mentioned) professional qualifications of 114 extreme expensiveness of 234 leasing tax advantages of 64 see also OPM Leasing importance of residual value 66 accountancy issues 152 Leeson, Nick 17, 165–73, 285 Lehman Brothers collapse 13 relationship with OPM Leasing 65, 71 Lehnert, Lothar 235–7 Lernout & Hauspie 150 Let’s Gowex see Gowex letterhead 31, 70, 80, 122 Levi, Michael 81, 216, 283 Levy, Jonathan 224 libel 77, 236–8 LIBOR 1–4, 12–16, 193, 205, 215, 244 Liman & Co 235–6 limited liability 34, 225, 231 Lincoln Savings & Loan 177–8, 180, 182–3 livestock 100 Livingstone, Jesse 259 Lloyd’s of London 164, 225 Lomuscio, Joe 59 Long firms 21, 23, 27, 29, 35, 41–2, 43–50, 61, 63, 72, 73–5, 77, 79–82, 96, 141, 142, 163, 164, 212, 224, 283, 284 ‘sledge-drivers’ 232–4 against government 271–4 Lucifer’s Banker 263 M MacGregor, Gregor 5, 8, 9, 17, 77, 78, 214 dubious knighthood of 7, 162 military career 7 previous frauds 18 Madden, Steve 147 Madoff, Bernard 96, 104–5, 113 Mafia 41, 253 Mahler, Russ 249–53 management scientific 19, 200, 206–12, 215 risk management 212–13, 287 strategic 248 public sector 264 marginal cost pricing 248 Marino, Dan (fraudster) 107–9, 113, 115 Marino, Dan (quarterback) 107 maritime capitalism 34, 224–6 market corner 259 market crimes 23, 24, 58, 194, 239–62, 271, 282, 289 markets general characteristics of 23, 197, 201–4, 208, 278, 289 financial 3, 4, 8, 13, 26, 58–60, 99, 100, 107–8, 129, 132, 142–5, 147–8, 149, 150–56, 161, 163, 166, 171–2, 176, 195, 230–31, 239–40, 242–4, 256–61 pharmaceutical, ‘grey’ 136–7 drugs, illegal 43–50 prime bank securities 110–11, 184 real estate 179–80 supermarkets 213, 255 Marx, Groucho 66 Marx, Karl 84, 232, 247 McGregor, Ewan 165, 173 McVitie, Jack ‘The Hat’ 26, 41 Medicare 73–6,134–5, 199, 289 Merchant of Venice 34 Merck Pharmaceuticals 138–40 Michaela, Maria 215, 222 military planning 204, 207, 211 Milken, Michael 177, 183 Miller, Norman 52 mis-selling 194–6 money laundering 278–82 Monopolies Commission (UK) 247 mortgages 38, 77, 101, 175–9, 188, 191, 194, 215, 238 multi-level marketing 94–5 N New England Journal of Medicine 139 New Zealand 9, 172, 241 newspapers 9, 125, 152, 230, 237, 252, 262 Nichols, Robert Booth 110–12 Nikkei index 170–71, 173 nobility Scottish 7 phony scottish 5–9, see Gregor MacGregor phony 223 North Wales Railway Company 229 notaries 114, 125, 133 indiscriminate stamping of documents by in 1920s Portugal 121–2 O ODL Securities 112–13 OECD 268 oil recycling 249–54 OODA loop 208 operations research 204, 208–10, 289 OPM Leasing 63–72 snowball effect of interest expense 98 accounting trick 152–3 options markets 163–4, 171–2 Optitz, Gustav 235–7 Opus Dei 53, 57 Original Dinner Party 92 Other People’s Money 63, 285 P Paddington Buys A Share 20, 43 Parmalat 155 Patsies see fronts Payment Protection Insurance (PPI) 187–97 Payne, Leslie 26–8, 30, 33–6, 39–42, 67, 73, 98, 163, 237, 283 petrol stations 190, 247–8 pharmaceutical industry 133–41 track and trace 136 Philadelphia Savings Fund 70–71 Pigeon King International see Galbraith, Arlan pigeons, racing 100–103 Piggly Wiggly 255–61 Ponzi, Charles 84–90, 96, 109, 116 trial of 90 takeover of Hanover Trust 88–9 launch of scheme 86 Portuguese Banknote Affair 120–25 Powers, Austin 263 Poyais 5–9, 15, 78, 121, 162, 215, 219, 287, 297 prime bank securities 110–13, 122, 184 Prince 135 Prince Albert 228 Princess Caraboo see Baker, Mary Princesses 6, 223 Principles of Scientific Management 206 Prison 18, 61, 112, 119, 125, 173, 208, 252, 270 debtor’s 34, 225 private equity 144 psychology 17, 87 public choice theory 210–11 pump and dump 147 pyramid schemes 91–5, 116, 184, 222 Q Quakers 118 quality control 184, 207, 213–15, 287 Quanta Resources 251–2 Quarterly Review 162 Queen Victoria 228 Queenan, Joe 10 Qwest 150 R Rabelais, Francois 120 Railway Mania 176, 231 Ranbaxy Laboratories 137 Reagan, Ronald 174–5, 251 real estate 89, 177–81, 214, 281 Reddit 48 regulators financial 2, 4, 14, 18, 99, 165, 177–83, 194–5, 240, 260–61, 280–81, 289 softness of in 1960s London 40 environmental 250–51 pharmaceutical 136, 137, 140 Reuschel, Rollo (Stanislaus Reu) 232–8 libel case 237 Richmond-Fairfield 107 Robb, George 228 Rockwell Industries 66–71 Rogers, Will 283 rogue traders 98, 165–73, 215 Royal Canadian Mounted Police 129 S salting (mining fraud technique) 127 Sarbanes-Oxley 194, 202 Saunders, Clarence 255–61 Savings and Loans 174–84, 185, 196, 285, 289 economic theories of failure 174 business model 175 settlement, securities 60, 107, 108, 112, 163, 257, 261 Sherman Antitrust Act 246 shipowners 10, 116, 117, 164, 224–6 ships 164, 207, 221, 224–6 US Navy 89, 249 short firm 73–5, 93 short selling 147, 258–9, 261, 283 shotgun/rifle technique 76–7, 134 signatures, forged 67, 123 Silk Road (online market) 44, 47–8, 50 simplified summary which hopefully captures the important structural features see homomorphism Sketch of the Mosquito Shore 8, 162 Skilling, Jeff 17, 142, 153 slaves 34, 219–21, 225 ‘sledge-drivers’ 232–8 SLK Securities 108, 115 Smith, Adam 11, 213 on cartels 246 snowball effect see compound interest societies, high and low trust 10, 16, 62, 125, 166–7, 264, 287 Soviet planning 204, 208, 227 Sparrow, Malcolm 74, 76 St Joseph (fictitious city) 5 stock exchanges Alberta 11, 129 Toronto 129 Vancouver 11, 126 London 9, 117 New York 59–60,147, 228–31, 256–61 Chicago 59–60, 256 Singapore 170–72 Osaka 170 Tokyo in general 142–5, 147, 163–4,241–2 NASDAQ 240 Strangeways, Thomas 162, see also Gregor MacGregor Strathclyde Genetics see Galbraith, Arlan Stratton Oakmont 145–8 Sufficient Variety, Law of 209 Sullivan, Scott 154 Susquehanna River 251, 252 T tacit knowledge 202–3 Tarantino, Quentin 105 tax 32, 64, 69, 98, 155, 159, 177, 191, 263–71 value added see VAT Taylor, F.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

"Robert Solow", Albert Einstein, Bayesian statistics, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, Thales and the olive presses, Thales of Miletus, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

In the ensuing modeling, Black and Scholes neglected taxation and transactions costs, and assumed an investor has perfect access to borrowing at the risk-free interest rate. One strategy they proposed and analyzed was what they called the zero-beta portfolio. Their idea was to The Black-Scholes Options Pricing Theory 111 hold low beta stocks long that they predicted would perform better than the market. The short selling of high beta stocks should then allow the purchase of the low beta stocks, with some profit left over and with very little or, ideally, zero risk. This higher risk-free return could then be used to buy and sell along a Markowitz security line with a higher risk-free return intercept. An investor could then earn a superior risk-return trade-off for any level of desired risk through leverage purchases of the market portfolio.

As early as 1963, at the age of 19, he gambled that a corporate merger would go through and calculated the optimal rate to buy one stock and sell the other in order to profit from the merger. His risk arbitrage strategy was successful, and his early successes induced him soon after his arrival at graduate school at the California Institute of Technology in the West Coast university town of Pasadena to hang out in the early morning at brokerage houses in anticipation of the market opening in New York. His trades, first in buying stocks, then in buying and shorting (selling stocks borrowed by the trader) stocks, and then in the increasingly sophisticated instruments of warrants (stock options issued by the corporations themselves), options, and bonds, taught him about the market and helped put himself through school. Merton also engaged in the somewhat risky practice of investing on margin. This strategy allows the investor to move further out on the Markowitz efficient securities market line to a point of higher reward but also magnified risk.

However, both the new and the very slightly aged bond would both be aged within a short time and would still have a very similar and long horizon. These differences in liquidity may be slightly more pronounced even between two trading centers located in different time zones and thousands of miles apart. Long Term Capital Management developed a strategy to capitalize on these differences. It could even do so with almost no invested capital, by buying the thinly traded slightly aged bonds and at the same time short selling the new issue bonds to raise the funds. This way, it could afford to trade very The Nobel Prize, Life, and Legacy 169 large volumes of each, and make perhaps only pennies per bond, but over millions of bond contracts. These strategies were wildly successful at first. Because Long Term Capital Management had to front little money on these covered transactions, its equity grew to almost $5 billion within four years and it had borrowed to purchase contracts worth almost $130 billion.


pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, business cycle, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Jones Act, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, NetJets, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, plutocrats, Plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Thaler, Right to Buy, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, survivorship bias, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

In reality, I, not Mailer, had analysed the proposed investment strategy, the script by which a trader or fund manager attempts to make money. Nonprofessionals are astonished as to how banal all investment strategies are when stripped of the marketing gloss that is used to sell them. A long-short strategy is where the investor buys something they expect to go up and short sells something that they expect to go down. It is called market neutral or relative value. Long-short is differentiated from long only where the investor can buy things that presumably they think will go up. Short selling involves selling something that you don’t own but hope to buy back at a lower price when the price goes down. You can sell tickets to a sought-after concert by the latest hot band for $200 for delivery in 1 week. You don’t own the tickets but you think that ticket prices will fall before you have to deliver them.

Black and Scholes built upon Kassouf and Thorp’s idea of hedging options using the underlying stock. The value of the option must be determined by the value of the stock. As the stock price changes, so should the price of the option. If a stock price moves from $10 to $11, then the price of the call option should also increase. The relationship allows the setting up of risk-free portfolios where you buy a call option and at the same time short sell a share. If the stock price goes up then the value of the call option increases but you suffer a loss on the shares, as you have to buy them back at the higher price. By adjusting the ratio of options to the shares, you can construct a portfolio where the changes in the value of the options and shares exactly offset, at least, for small movements in the stock price. Working as research assistant to Paul Samuelson, Robert Merton was also working on option pricing.

In contrast, hedge funds focused on absolute returns, trying to make money under all market conditions. In the early 1990s and again in the early 2000s, equity markets were moribund and interest rates were at record lows. Forced to look elsewhere, investors increased investment in hedge funds. Suspicious of new products, traditional institutions reluctantly entered new markets to boost declining returns. Not allowed to buy structured securities, short sell, leverage or use derivatives, conservative funds gave money to hedge funds that could. The new mantra was “hedge funds for everybody.” Style Gurus Hedge fund managers argued that only they knew what they do, reminiscent of a prospectus from the 1920s: “the credit and status of the company are so well known that it is scarcely necessary to make any public statement.”6 At a 2009 Congressional Inquiry, Citadel’s Ken Griffin argued against disclosure by comparing it to “asking Coca-Cola to disclose their secret formula to the world.”7 One manager explained his investment strategy as throwing light on “fragmented information” and “opaque” track records.


pages: 782 words: 187,875

Big Debt Crises by Ray Dalio

Asian financial crisis, asset-backed security, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, break the buck, Bretton Woods, British Empire, business cycle, capital controls, central bank independence, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, declining real wages, European colonialism, fiat currency, financial innovation, German hyperinflation, housing crisis, implied volatility, intangible asset, Kickstarter, large denomination, manufacturing employment, margin call, market bubble, market fundamentalism, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Northern Rock, Ponzi scheme, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, refrigerator car, reserve currency, short selling, sovereign wealth fund, too big to fail, transaction costs, universal basic income, value at risk, yield curve

–New York Times July 15, 2008 Stocks Fall Back After Early Gains on Rescue Plan “The United States treasury secretary, Henry Paulson Jr., and the Federal Reserve chairman, Ben Bernanke, acted after the shares of Freddie Mac and Fannie Mae came under enormous selling pressure last week.” –New York Times July 16, 2008 S.E.C. Unveils Measures to Limit Short-Selling “The Securities and Exchange Commission, under pressure to respond to the tumult in the financial industry, announced emergency measures on Tuesday to curb certain kinds of short-selling that aims at Fannie Mae and Freddie Mac, as well as Wall Street banks.” –New York Times July 19, 2008 Freddie Mac Takes Step Toward Raising Capital “The nation’s two beleaguered mortgage finance giants continued to win back investors on Friday, as Freddie Mac, the smaller of the two companies, took a crucial step toward raising capital.

That raised interest rates and tightened liquidity, bringing on the most painful period of the depression, lasting until FDR took the US off the gold standard eighteen months later to devalue the dollar and print money. Stocks had sold off during the run on sterling. The Dow finished September down 30.7 percent, its largest monthly loss since the crisis began. On October 5, the market fell 10.7 percent in a single day. Amid the chaos, the NYSE once again banned short selling in a classic attempt to slow the sell-off.126 While previously “safe” treasury bonds had rallied as stocks crashed in 1929 and 1930, they were now selling off along with stocks, reflecting the US balance of payments crisis. The yield on long-term US treasuries rose to 4 percent, nearly 1 percent above their midyear lows. Due to the US’s stock of debts and their rising debt service, there were concerns about the US Treasury’s ability to roll bonds that would come due in the following two years.127 The fear of devaluation led to particularly acute runs on US banks, so banks needed to sell bonds to raise cash, which contributed to rising yields.128 In September 1931, the dollar ceased to be a safe haven for the first time since the global debt crisis began.

For eight days there have been no national bank failures, a new record for many months, while there has been an appreciable decline in failures of other member and State banks for ten days.” –New York Times February 27, 1932 Credit Bill Voted; Hoover Signs Today; Not a Dissenting Voice Is Heard In Congress Against Passage of Bank Aid Measure –New York Times March 2, 1932 Senate Body Acts for Broad Inquiry on Short Selling; Banking Committee Will Go Beyond Hoover Idea in Stock Exchange Investigation “An investigation of the New York Stock Exchange was recommended today by the Senate Banking and Currency Committee. A subcommittee, headed by Senator Walcott, Republican, of Connecticut, immediately began drafting a resolution requesting authority for such an investigation from the Senate.” –New York Times March 10, 1932 Hoarding by Banks Put Before Hoover “A charge that some banks were hoarding money and that their restrictive credit policies crippled industrial activities was laid before President Hoover today by the Institute of Scrap Iron and Steel through its director general, Benjamin Schwartz.”


pages: 733 words: 179,391

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

"Robert Solow", Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, Sam Peltzman, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, survivorship bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

After all, individuals buy and sell shares of Koffee Meister every day, and for many reasons. But if you happen to be a big shareholder of Koffee Meister stock (which may explain why you spent so much time and effort testing the ’Cino Bambino), your decision to sell may well hurt the share price. In fact, even if you didn’t own any shares of Koffee Meister, you might still want to bet on the information you’ve acquired. You can do this by short-selling Koffee Meister. Short sales are a little more complicated than the typical stock trade, but not much more. You borrow shares of Koffee Meister in order to sell them at a higher price, buy the shares back at a lower price (you hope) when you’re proven right, return the borrowed shares to the lender, and pocket the difference between the price you received for selling them and the price you paid to buy them back.

On the other hand, if the Apricard turns out to be a flop, and Apricot goes down by 10 percent, the fund loses a million dollars. Most people understand how mutual funds work. Now, let’s suppose a hedge fund has $10 million of capital. Thanks to the magic of leverage—which is just a fancy term for borrowing—the hedge fund can purchase $30 million of Apricot stock at a three-to-one leverage ratio. This will greatly boost the fund’s return if the Apricard is a success. But the hedge fund can also simultaneously short-sell $30 million of stock in BlueBerry Devices, Apricot’s main competitor, and the producer of the BlueBerry, a leather wallet the size of a clutch purse that physically stores up to 25 credit cards, but has an excellent keyboard. The hedge fund is betting that the Apricard will make the BlueBerry obsolete, causing its stock price to decline. If this bet works out, and BlueBerry Devices declines by 10 percent, the hedge fund will earn another $3 million in addition to the $3 million it earned on its leveraged position in Apricot, for a total of $6 million in profits.

That’s the good news. Now here’s the bad news. If the hedge fund’s bet goes wrong—maybe the Apricard technology has a flaw that allows hackers to steal millions of credit card numbers—and Apricot suffers a 10 percent loss while BlueBerry benefits from its competitor’s woes and enjoys a 10 percent gain, the hedge fund will lose $6 million, wiping out 60 percent of the fund. The power of leverage and short selling cuts both ways. There are currently over nine thousand hedge funds worldwide, managing more than $2 trillion in assets, and an unknown number of hedge fund–like entities at proprietary trading desks and the like. In fact, the hedge fund industry is more like twenty to thirty cottage industries, each with its own particular specialty. The mix of this industry clearly is adaptive to market conditions: new funds are started to take advantage of emerging opportunities from one strategy, while other funds close down after experiencing losses from another strategy.


pages: 586 words: 159,901

Wall Street: How It Works And for Whom by Doug Henwood

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, business cycle, capital asset pricing model, capital controls, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, plutocrats, Plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

A sale made by someone who doesn't own the underlying asset — and this applies to bonds and stocks as well as wheat — is selling it "short," on the anticipation of buying it back at a lower price, or, in a pinch, buying it in the open WALL STREET market at whatever price prevails and delivering the goods.'"* Short-selling exposes the practitioner to enormous risks: w^hen you buy something — go long, in the jargon — your loss is limited to what you paid for it; when you go short, however, your losses are potentially without limit. In theory, brokers are supposed to be sure their clients have the credit rating to justify short-selling, though things don't always work out by the book. Options are similar. On April 18, 1995, the July wheat contract closed at $3.5175 per bushel for a contract covering 5,000 bushels, or $17,587.50 per contract. The typical player would have to put up 5% margin — a good faith cash deposit with the broker, who treats the other 95% as a loan, on which interest is charged — or $880.

But only in part, because the derivatives were a fancy-dress version of a classic strategy, borrowing lots of money to make bad investments. You don't need instruments WALL STREET jointly concocted by MBAs and theoretical physicists to lose at that game. 13. Anyone who thinks an option on a future is too abstract to exist is obviously not schooled in the higher financial consciousness. 14. An old Wall Street rhyme says of short-selling: "He who sells what isn't his'n/Buys it back or goes to prison." 15. What follows describes futures markets, but options markets are very similar. 16. Long before stock options were traded on exchanges, stock warrants were traded on the NYSE and other exchanges.Warrants are essentially long-term options to buy a stock, with maturities typically measured in years rather than months; they're frequently attached to new bond issues to make them more attractive. 17.

See debt deflation (Fisher) Delaney, Kevin, 265 Democratic Party, 87 deposit insurance, 88 Depository Intermediary Deregulation and Monetary Control Act of 1980, 87 depreciation, 140 Depression, 1930s financial mechanisms, 155-158 Friedman and Schwartz on, 200 derivatives, 28-41 custom, 34-37 defined, 28 early, 29 economic logic, 37-41 market-traded standardization and centralization, 32-33 technical details, 29 more complex strategies, 31 motives for, 31 and risk, individual and systemic, 40-41 short selling, 29-30 trading prowess, 32 winners, long-term, 32 development, 322 protectionism and, 300 Dickens, Edwin, 219 DiNapoli, Tom, 180 direct investment vs. portfolio investment, 109 Third World, 110-111 in U.S., dismal returns, 117 disclosure requirements, corporate, 91 discounting, interest rates and, 119-120 distribution Gini index, 115 income CEO vs. worker pay, 239 Manhattan's inequality, 79 polarization in 1920s, 200 wealth, 4, 64-68 dividends, 73, 135 changes in, and excess volatility, 175 payout ratios, and investment, 154 retention ratio, 75 unexpected changes in, 169 yields, 125 dollar, U.S.


pages: 433 words: 53,078

Be Your Own Financial Adviser: The Comprehensive Guide to Wealth and Financial Planning by Jonquil Lowe

AltaVista, asset allocation, banking crisis, BRICs, buy and hold, correlation coefficient, cross-subsidies, diversification, diversified portfolio, estate planning, fixed income, high net worth, money market fund, mortgage debt, mortgage tax deduction, negative equity, offshore financial centre, Own Your Own Home, passive investing, place-making, Right to Buy, risk/return, short selling, zero-coupon bond

A big advantage of introducing options into an investment strategy is the opportunity to make money from falling as well as rising prices and markets, whereas conventional strategies rely on markets rising. Complex investment funds While most investment funds tend largely to use conventional buy-andhold strategies, there is a growing tendency to use derivatives and other techniques, such as short selling, to boost returns. Short selling means selling shares you do not own with the hope of buying them back later at a lower price. Private investors are barred from short selling, but professional investors can borrow shares from other large investors (in return for a fee) in order to sell and buy back later. You need to be aware when these strategies are being employed because they have implications for the risks you are taking on when you invest. Guaranteed and protected products Guaranteed and protected products are examples of structured products.

The residue buys, say, a call index option with an exercise price significantly higher than the current level of the market. As long as the stock market increases by a target amount, your capital is returned in full. If it rises by less, only part of your capital is returned and, in effect, the extra income you have received will have been funded out of your capital. Hedge funds Hedge funds use gearing, derivatives, short-selling and a wide range of other techniques to pursue a variety of strategies. Types of hedge fund include: OO Absolute return funds. These funds aim to produce either a target level of return or to beat the return on savings accounts, whether stock markets are rising or falling. A variety of techniques may be employed, for example, the fund may invest in corporate bonds and use put options to protect against a fall in their prices.

Absolute return funds will provide a medium-risk core for long-term investors in the same way that with-profits funds aimed to do in the past. Others question the ability of absolute return funds to deliver the promised returns. Most funds do not claim to meet their target month by month, but over an average period of a year or more. OO 130/30 funds. These funds are using something similar to leverage in order to magnify the gains from successful buy-and-hold investments. However, rather than borrowing to invest, the fund short sells investments to the value of 30 per cent of the fund. It then uses the proceeds of these sales to buy more of its buy-and-hold investments. The success of the strategy relies on the fund manager being able to stock pick successfully. OO Covered call funds. The aim of these funds is to provide a high level of income. The fund is invested in shares with a record of paying good dividends – in much the same way as a conventional equity income fund.


pages: 452 words: 150,785

Business Adventures: Twelve Classic Tales From the World of Wall Street by John Brooks

banking crisis, Bretton Woods, business climate, cuban missile crisis, Ford paid five dollars a day, Gunnar Myrdal, invention of the wheel, large denomination, lateral thinking, margin call, Marshall McLuhan, plutocrats, Plutocrats, short selling, special drawing rights, tulip mania, upwardly mobile, very high income

And in the days when corners were possible, the short seller’s sleep was further disturbed by the fact that he was operating behind blank walls; dealing only with agents, he never knew either the identity of the purchaser of his stock (a prospective cornerer?) or the identity of the owner of the stock he had borrowed (the same prospective cornerer, attacking from the rear?). Although it is sometimes condemned as being the tool of the speculator, short selling is still sanctioned, in a severely restricted form, on all of the nation’s exchanges. In its unfettered state, it was the standard gambit in the game of Corner. The situation would be set up when a group of bears would go on a well-organized spree of short selling, and would often help their cause along by spreading rumors that the company back of the stock in question was on its last legs. This operation was called a bear raid. The bulls’ most formidable—but, of course, riskiest—counter-move was to try for a corner. Only a stock that many traders were selling short could be cornered; a stock that was in the throes of a real bear raid was ideal.

Ryan achieved his corner and the Stock Exchange short sellers were duly squeezed. But Ryan, it turned out, had a bearcat by the tail. The Stock Exchange suspended Stutz dealings, lengthy litigation followed, and Ryan came out of the affair financially ruined. Then, as at other times, the game of Corner suffered from a difficulty that plagues other games—post-mortem disputes about the rules. The reform legislation of the nineteen-thirties, by outlawing any short selling that is specifically intended to demoralize a stock, as well as other manipulations leading toward corners, virtually ruled the game out of existence. Wall Streeters who speak of the Corner these days are referring to the intersection of Broad and Wall. In U.S. stock markets, only an accidental corner (or near-corner, like the Bruce one) is now possible; Clarence Saunders was the last intentional player of the game.

London opens an hour after the Continent (or did until February 1968, when Britain adopted Continental time), New York five (now six) hours after that, San Francisco three hours after that, and then Tokyo gets under way about the time San Francisco closes. Only a need for sleep or a lack of money need halt the operations of a really hopelessly addicted plunger anywhere. “It was not the gnomes of Zurich who were beating down the pound,” a leading Zurich banker subsequently maintained—stopping short of claiming that there were no gnomes there. Nonetheless, organized short selling—what traders call a bear raid—was certainly in progress, and the defenders of the pound in London and their sympathizers in New York would have given plenty to catch a glimpse of the invisible enemy. IT was in this atmosphere, then, that on the weekend beginning November 7th the leading central bankers of the world held their regular monthly gathering in Basel, Switzerland. The occasion for such gatherings, which have been held regularly since the nineteen-thirties except during the Second World War, is the monthly meeting of the board of directors of the Bank for International Settlements, which was established in Basel in 1930 primarily as a clearing house for the handling of reparations payments arising out of the First World War but has come to serve as an agency of international monetary coöperation and, incidentally, a kind of central bankers’ club.


pages: 514 words: 153,092

The Forgotten Man by Amity Shlaes

anti-communist, bank run, banking crisis, Charles Lindbergh, collective bargaining, currency manipulation / currency intervention, Frederick Winslow Taylor, invisible hand, jobless men, Mahatma Gandhi, plutocrats, Plutocrats, short selling, Upton Sinclair, wage slave, Works Progress Administration

He would eventually do prison time for covering up illegal loans with the aid of his loyal brother George. To have a Wiggin or a Whitney as their spokesman hurt defenders of the market at a time when their argument was crucial. For it was not wrong that a restriction on short selling would scare the market by depriving it of a vehicle for hedging its risks. That fear alone might even trigger big drops in stock prices. And there would no longer be the countervailing pressure of the short buyer. Mellon’s “liquidate” phrase sounded harsh but was far less constraining than the president’s restrictions on short selling. When a man marked your stocks to the market price and sold, everyone knew what everything was worth. The dread uncertainty of a further decline would diminish, and stocks might begin to move up again. Whitney’s colleagues outdid one another in their efforts to demonstrate to Hoover that they could handle matters without Washington.

This was what everyone expected in any case, for at that time Washington did not regulate the stock market; the exchange was a New York corporation. Still, Hoover could scold, and he did. In his first annual message to Congress, delivered in December 1929, Hoover railed against the “wave of uncontrolled speculation” that he saw as a cause of the crash. Over the course of the winter and the next year he would speak out, too, against short selling. In a short sale, a trader borrows a stock and sells it at a certain price, in the hopes that by the time he must deliver the stock, he can buy it himself even more cheaply. Hoover believed that this was not logic but roulette at its worst. The game was dangerous because it moved away from the value of the underlying asset—shares in a company—and into the racy world of betting. Without short contracts, he reckoned, the stock market would not experience such violence ructions.

Wall Street in the 1920s had felt like a gamble, and some of the players had been irresponsible or worse. One was Richard Whitney, the new president of the New York Stock Exchange. Whitney, a patrician, could make the free-market argument as well as any. At a meeting in October 1930 at the Stevens Hotel in Chicago, Whitney criticized the idea of blanket legislation to restrict short sales and other forms of speculation: “The Exchange is convinced that normal short selling is an essential part of a free market in securities.” How could a market exist if it was not allowed to place such bearish contracts? “Such a contract to deliver something in the future which a person does not own is common to many types of business. When a builder contracts to build a skyscraper he is literally short of every bit of material.” Yet no one, Whitney pointed out, considered that builder a criminal for signing the contract.


pages: 479 words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, asset-backed security, bank run, barriers to entry, Basel III, Bernie Sanders, break the buck, Bretton Woods, business cycle, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, greed is good, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, liquidity trap, London Whale, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, negative equity, new economy, Northern Rock, obamacare, price stability, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

Though initially creative and entrepreneurial, Enron resorted to deceiving regulators and its own shareholders. Short sellers legitimately bet against its stock, taking out a dirty operator to the betterment of the industry. Sometimes short sellers prey upon companies that are vulnerable due to poor management, risk intoxication, or plain bad luck. That described Bear Stearns to a tee. By mid-March, it was apparent that short-selling wolves were determined to cull Bear from the herd. Beginning on March 10, rumors and the memory of the previous year’s hedge funds debacle prompted skittish investors to pull $17 billion from Bear in two days. The price of its stock fell 60 percent as word got out. Early on March 12, the company issued a press release denying that Bear was in trouble. Later that morning, a few minutes after 9 A.M., CNBC reporter David Faber interviewed Bear CEO Alan Schwartz on camera.

With the blessing of President Bush, on Friday before markets opened, Paulson issued a statement outlining his proposed “troubled-asset relief program” (TARP) to remove “illiquid assets that are weighing down our financial institutions and threatening our economy.” Wall Street breathed a sigh of relief. The stock market rallied. The calm didn’t last. Short sellers had turned their attention away from Lehman to the walking wounded like Morgan Stanley, even Goldman Sachs. They drove down stock prices and kept the fear alive. At the urging of the Fed and Treasury, the SEC board on September 19 voted unanimously to impose a temporary ban on the short selling of 799 stocks. Those who legitimately used short positions to hedge risk were outraged. This wasn’t China, after all. On September 21, Goldman Sachs and Morgan Stanley converted to bank holding companies to gain access to government rescue funds. In the meantime, the run on Washington Mutual continued. In the week ending September 23, depositors withdrew $17 billion. WAMU was sold the next day to JPMC for $1.9 billion.

See also District Banks; Federal Open Market Committee (FOMC) auditing of, calls for, 253–54 author’s hiring by and early experience at, 30–42, 46 DiMartino Booth’s recommendations for, 263–66 chairman of, 42–43 (See also specific Chairman) creation of, 2 economists of, 46–50, 62–64 financial crisis of 2008 and (See financial crisis of 2008) hubris and myopia of, 46–50, 236 Keynesian wealth effect model of, 6–7 lack of diversity at, 63–64 liquidity trap created by, 209–11 organization of, 42–45 politics and, 42–44 potential consequences of policies of, 252–53 profits and expenses of, 35–36 purpose of, 2, 41–42 shadow banking system and, 167–69 stress tests and, 170–71 fed funds interest rate, 3, 42, 212 September 2007 rate cut, 91 2008 decisions regarding, 102–3, 118, 119, 154–55, 157–63 Yellen raises, December 2015, 262 zero-interest-rate policy, 3, 8, 159–63, 175, 176, 218–21 Feldstein, Martin, 82 Ferguson, Niall, 56, 198 financial crisis of 2008, 2–10 AIG bailout and, 138–39 Bear Stearns’ collapse and, 105–16 Bear Stearns hedge fund bankruptcies and, 89–90 discount window opened to bond dealers in, 118 fed funds rate decisions in response to, 102–3, 118, 119, 154–55, 157–63 FOMC meetings during, 152–63 housing bubble and (See housing bubble) Lehman Brothers collapse and, 130–37, 145–47 losses from credit crunch reported during, 120–21 money market fund’s breaking the buck and, 140–42 PWG recommendations, 104–5 quantitative easing, adoption of, 160 Rajan’s paper warning of banking risks and, 93–96 shadow banking system and, 121–29, 167–69 short selling, temporary ban on, 143 TARP and, 142–43 Washington Mutual sale to JP Morgan & Chase, 143 yen carry trade, unwinding of, 90–91 zero-interest-rate policy, adoption of, 159–63 Financial Times, 108–9, 121 Fischer, Stanley, 234, 246–47 Fisher, Leslie, 67–68 Fisher, Richard, 19–20, 23–24, 61–62, 67–73, 76–77, 90, 147, 173, 212–13, 228–30, 234, 248–49, 254, 260 DiMartino Booth’s daily briefings for, 100–101 calls for end to QE2, 214–15 campaigns to dismantle too-big-to-fail banks, 186–87 defends Fed lending facilities, 169 education of, 68–69 extension of ZIRP to 2013, dissent to, 219–21 Fed bull market, consequences of, 238–39 at FOMC meetings, 76–78, 81–84 housing bubble and, 89 Operation Twist, dissent to, 224 opposition to QE and ZIRP of, 169, 175, 179–81 pre-briefings for, 164–67 QE2 and, 195, 197 on Texas economy’s outperformance, 226–27 2008 fed funds rate decisions and, 103, 118, 119, 154–55, 157–60, 161–63 Fitch Ratings, 27 flash crash, 189–90 Foreign Exchange (FX), 168 Foroohar, Rana, 7 Fortune, 112 forward guidance, 81 Frank, Barney, 120, 139, 220 Freddie Mac, 22, 120 Free to Choose (Friedman & Friedman), 59 Free to Choose (TV series), 59 Friedman, Milton, 48, 59–60, 87, 101 Friedman, Rose, 59 Friedman, Stephen, 148 Fuld, Dick, 29, 131–37, 146–47 Fundamental REO, 232 Galbraith, John Kenneth, 46 Geithner, Timothy, 51–55, 89–90, 113, 143–44, 147, 200 AIG bailout and, 138–39 appointed Treasury Secretary, 170 Bear Stearns rescue and, 109–12, 114 failure to see housing bubble, 55 Lehman collapse and, 135–36 money market fund’s breaking the buck and, 140–42 General Electric, 47, 169 General Motors, 46 Gingrich, Newt, 223 Globalization and Monetary Policy Institute, 82 Glucksman, Lew, 132 GMAC, 169 Goldman Sachs, 14, 115, 133, 143–45, 147–48, 168, 232, 257–60 Goldsborough, Alan, 119 Goncalves, George, 31 González, Henry B., 36 Gorton, Gary, 125–27, 128 government shutdown, 234 Grant, James, 198 Great Depression, 177 Great Moderation, 65, 87 Greece, bailout of, 188–89 Greenburg, Alan, 105 Greenspan, Alan, 6, 13, 16–17, 19, 26, 47, 60, 77, 78, 91, 153, 220 Black Friday and, 64–65 education of, 48–49 financial crisis and, 167 housing bubble and, 8, 20–21, 23, 27, 50 inflation targeting and, 195–96 irrational exuberance comment of, 11, 12 Long-Term Capital Management crisis and, 14, 15 on too-big-to-fail banks, 187 Greenspan Put, 64–65 Gregory, Joe, 131 groupthink, 9, 50, 166, 197 Gunther, Jeffrey, 207, 208 Hackett, Jim, 71 Haines, Mark, 216 Harker, Patrick, 259 Hartnett, Michael, 1 Hatzius, Jan, 29 Hayes, Samuel L., 144 Hayman Capital Management, 115 high-frequency trading, 190 Hilsenrath, Jon, 80, 195, 223, 228, 233, 237, 245, 260, 262 Hoenig, Thomas, 181, 197, 210, 213 household formation, 211 housing bubble, 6, 20–29 adjustable rate mortgages (ARMs) and, 22 author’s warnings regarding, 23–26 Bernanke and, 23, 74 Fisher on, 89 FOMC conclusions regarding lack of, 78–79 Geithner’s failure to anticipate, 55 Greenspan and, 8, 20–21, 23, 27, 50 lowered mortgage standards and, 21–22 reinflating of, in 2012, 232 subprime mortgages and, 21, 22, 27, 28, 74–75 systemic risk and, 26, 28 Yellen’s failure to see, 86–87, 88–89 housing market, 4–5, 215.


Trading Risk: Enhanced Profitability Through Risk Control by Kenneth L. Grant

backtesting, business cycle, buy and hold, commodity trading advisor, correlation coefficient, correlation does not imply causation, delta neutral, diversification, diversified portfolio, fixed income, frictionless, frictionless market, George Santayana, implied volatility, interest rate swap, invisible hand, Isaac Newton, John Meriwether, Long Term Capital Management, market design, Myron Scholes, performance metric, price mechanism, price stability, risk tolerance, risk-adjusted returns, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, the scientific method, The Wealth of Nations by Adam Smith, transaction costs, two-sided market, value at risk, volatility arbitrage, yield curve, zero-coupon bond

For example, it was plainly easier to trade the long side of the stock market in the last half of the 1990s, first, because the market enjoyed a sustained rally for the entire period; second, because the equity markets are structurally organized under all market conditions to favor long bets through such mechanisms as the “uptick rule” for short sales, the rather complicated “borrowing-based” mechanics of short selling, the rules that compel large institutional portfolios to operate exclusively on the long side of the market, and other factors. We 136 TRADING RISK must bear in mind that short-selling in the equities markets represents, when results are characterized in terms of their extremes, an asymmetric bet under which gains are limited by the fact that a stock cannot price itself at a value less than zero, while potential losses are, at least in theory, unlimited in nature, as there is no upper bound to the value at which a security can trade.

From these perspectives, we can reasonably conclude that the calculation of a leverage factor for short options portfolios is a complex and ambiguous process that is probably viewed most rationally as a function of both the margin collateral required to fund them and the amount of risk capital rationally allocated to them. Absent the necessary precautions, the naked short sale of options is in most cases irresponsible and almost always a losing strategy over the long term. However, if incorporated into a sound risk-control program that features some of the components we’ve mentioned, short selling of options can have more attractive risk-control features than long options programs, which often generate large losses while providing false comfort as to their actual levels of exposure. To reiterate: Options are mathematically complex and extremely idiosyncratic. Options markets are notorious for packaging certain types of economic attributes on the surface while imposing subtle costs in hidden ways.

See Exposure range determination Risk-free rate, exposure ranges, 112 Index Risk-free return, 65–66 Risk Management Investment, 1–5, 9–18 Risk mitigation, 136, 152 Risk models, 28–29 Risk of ruin, 245–246, 250–251 Risk profile, 12 Risk-taking capacity, 115–117, 233 Risk tolerance, 26–27, 63 Risk transference, 241 Scenario analysis, 84, 104–106 Scientific method, 5–6 Self-directed traders, 123 Self-funded traders, 110 Serial correlation, 76–78 Sharpe Ratio, 65–68 equation, 65 Inverted, 111–114, 248–250 limitations, 67–68 Sustainable, 112, 249 Short put options, 153 Short selling, 148–149, 152–154, 207 Short-side P/L, 166–168 /P/L, 62, 95, 116, 118 Size of position, significance of, 134–135, 159, 231 Skewness, 64–65, 70, 201 Slippage, 198 South Sea Bubble, 54–55 Spreadsheet programs, 61 Standard deviation, 57–65 confidence intervals and, 59–62 equation, 61 of returns, 66 sigma, 62 VaR parameters, 99–100 Static parameters, 87 Statistical significance, 40–42 Statistics: average P/L, 56–57, 69 confidence intervals, 59–62, 100 consolidated statistical profile, 79–80 correlations, 73–79 drawdown, 70–73 historical perspective, 53–56 257 median P/L, 68 percentage (%) of winning days, 68–69 performance ratio, 68–69 Sharpe Ratio, 64–68, 100 standard deviation, 57–66 winning days vs. losing days, 69–70 Stock index, benchmark, 73–74 Stock market crashes, impact of, 14–15, 43, 136, 173, 227 Stop-loss orders, 9, 207–208 Stop-out level, 20–21, 26–32, 118–119, 122–124, 190, 193, 227, 233–234 Strike price, 149–150 Support level, 107–108 Sustainable Sharpe Ratio, 112, 249–250 Target return(s): nominal, 20, 24–26 optimal, 20–24 Technical analysis, 77, 106–108 10% Rule, 116, 122–123, 249, 251 Time horizon, 53, 56, 142–144 Time series, generally: analysis/construction of, 6–7, 39 charts, 107 Time spans, 39–40, 43–48 Time units, 39–42, 46–48 Time unit/time span matrix, 39, 48 Timing, significance of, 220–221 Total long/short capital utilized, 161 Trade level P/L, 162 Trade selection, 187 Trading capital, risk exposure determination, 114–126 Trading Capital Equation, 122–123, 125 Trading efficiency, 223–224 Trading environment, assessment of, 22–23 Trading frequency, 203–204 Trading psychology, 208 Trading styles, 200 Trading with an edge, 219–225 Transaction, defined, 158–160 Transaction flow, 221–222 258 Transactions-level analysis: benefits of, 79 core statistics, 161–168 database, overview, 156–158 position snapshot statistics, 160–161 transaction defined, 158–160 Two-sided market, 135–137, 140 Underlying markets, 117 Underlying price, 149–150 Unit impact ratio, 187 Value at Risk (VaR) calculation: accuracy testing, 98–99, 103 and correlation analysis, 178–179 implications of, generally, 84, 91–92 justification of, 92–94 parameter setting, 99–100 in portfolio management, 102–104 purpose of, 178 types of, 94–98 Variance/covariance approach, VaR, 94–97, 99 Vince, Ralph, 246 Volatility: -adjusted exposure, 83–84 correlation analysis, 177–179 INDEX exposure range determination, 111–126 historical, 84–88, 96–97 impact of, generally, 40, 49–51, 65, 67, 74, 79 implied, 86–87, 89, 150 options implied, 86–89 position level, 141–142 risk management, as trading capital percentage, 114–126 size of position and, 134–135 skew/smile, 88 trading capital, impact on, 124 Volume-Weighted Average Price (VWAP), 159, 186 Wealth-management program, 30 Weekly P/L, 41, 43 Weighted average P/L, 164 Win/loss ratio, 184–186 Winning days, percentage (%) of, 68–70 Winning trades, 186–188, 191, 193 Working capital, 29, 122 Zero/low correlation, 172–173


pages: 354 words: 118,970

Transaction Man: The Rise of the Deal and the Decline of the American Dream by Nicholas Lemann

Affordable Care Act / Obamacare, Airbnb, airline deregulation, Albert Einstein, augmented reality, basic income, Bernie Sanders, Black-Scholes formula, buy and hold, capital controls, computerized trading, corporate governance, cryptocurrency, Daniel Kahneman / Amos Tversky, dematerialisation, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, fixed income, future of work, George Akerlof, gig economy, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, index fund, information asymmetry, invisible hand, Irwin Jacobs, Joi Ito, Joseph Schumpeter, Kenneth Arrow, Kickstarter, life extension, Long Term Capital Management, Mark Zuckerberg, mass immigration, means of production, Metcalfe’s law, money market fund, Mont Pelerin Society, moral hazard, Myron Scholes, new economy, Norman Mailer, obamacare, Paul Samuelson, Peter Thiel, price mechanism, principal–agent problem, profit maximization, quantitative trading / quantitative finance, Ralph Nader, Richard Thaler, road to serfdom, Robert Bork, Robert Metcalfe, rolodex, Ronald Coase, Ronald Reagan, Sand Hill Road, shareholder value, short selling, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, TaskRabbit, The Nature of the Firm, the payments system, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, too big to fail, transaction costs, universal basic income, War on Poverty, white flight, working poor

Rita of Cascia Salomon Brothers; former staff of Samuelson, Paul Sanders, Bernie Sarnoff’s law savings and loans: in Chicago Lawn; deregulation of; failures of; federal insurance on; Whitewater and Schmidt, Eric Scholes, Myron School in the Home, The (Berle) Schumer, Chuck Schumpeter, Joseph Schwarzman, Stephen Scientology Sears seasteading Second Bank of the United States Securities and Exchange Commission; creation of; derivatives and; fixed commissions and; risk monitored by; Rule 415 of; short selling halted by Security Analysis (Graham and Dodd) September 11, 2001 Settlers of Catan shareholders: on boards; empowerment of; executives removed by; executives selected by; in hostile takeover; lack of accountability to; typical behavior of; war bonds as gateway to; see also principal-agent problem Sharpe, William Sherman Act Shockley, William short selling Silicon Valley (show) Silicon Valley; big corporations in; founding of; globalization of; Hollywood vs.; lobbying by; Morgan Stanley and; online networks and, see networks; political vision of; start-up culture of; Transaction Man in; venture capital in; workers’ rights in simulation hypothesis Sinai Health System singularity Sisters of St.

Berle knew what he believed: that the government should directly control the economic life of the corporation to the greatest possible extent. In those early years of the New Deal, Berle found himself in constant battle with other liberals who did not share his view. He had hoped, for example, that when the new agency regulating stocks, the Securities and Exchange Commission, was created, it would not only require public information but also regulate financial behavior—for example, banning margin trading, short selling, and the practice of banks trading stocks for their own accounts rather than those of their customers. Instead, his rivals holed up in a suite at the Mayflower Hotel to draft the SEC’s charter without informing Berle, and none of that happened. Berle enthusiastically supported the National Industrial Recovery Act, a law passed during the early days of Roosevelt’s presidency that gave the federal government the power to regulate specific companies’ prices, wages, and basic economic decisions, as another aspect of its new role as an economic power fully equal to the corporation.

The government’s idea was that a larger and more stable bank should take over Morgan Stanley quickly, and through the week, officials lined up a succession of possible partners: J.P. Morgan Chase, Citicorp, Wachovia (which was itself failing), Goldman Sachs, a big Chinese investment fund. Mack, for his part, with the help of New York’s two senators, Schumer and Hillary Clinton, lobbied the government to call a temporary halt to short selling of financial company stocks; short sellers were swarming all over Morgan Stanley that week, trying to drive its stock ever lower so they could make more money. Despite the obvious irony in Mack’s request—most of the short sellers were Morgan Stanley clients, and the firm itself regularly shorted stocks for its own account—the Securities and Exchange Commission did impose a ban on Wednesday, September 17.


pages: 374 words: 114,600

The Quants by Scott Patterson

Albert Einstein, asset allocation, automated trading system, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Blythe Masters, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Meriwether, John Nash: game theory, Kickstarter, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Robert Mercer, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

The entire global credit market suffered a massive panic attack, threatening to bring down trading powerhouses such as Saba and Citadel in its wake. Another blow came from the federal government’s ban on short selling in the weeks following the Lehman-AIG debacle. Shares of financial firms across the board—even stalwarts such as Goldman Sachs and Morgan Stanley—were collapsing. To keep the situation from spiraling out of control, the Securities and Exchange Commission in September instituted a temporary ban on shorting about eight hundred financial stocks. Citadel, it turned out, had short positions in some of those companies as part of its convertible bond arbitrage strategy. Just as Ed Thorp had done in the 1960s, Citadel would buy corporate bonds and hedge the position by shorting the stock. With the short-selling ban, those shares surged dramatically in a vicious short squeeze that inflicted huge losses on hedge funds.

Over the next fifteen minutes before trading began on the NYSE, massive pressure built up on index futures, almost entirely from portfolio insurance firms. The big drop by index futures triggered a signal for another new breed of trader: index arbitrageurs, investors taking advantage of small discrepancies between indexes and underlying stocks. When trading opened in New York, a brick wall of short selling slammed the market. As stocks tumbled, pressure increased on portfolio insurers to sell futures, racing to keep up with the widely gapping market in a devastating feedback loop. The arbs scrambled to put on their trades but were overwhelmed: futures and stocks were falling in unison. Chaos ruled. Fischer Black watched the disaster with fascination from his perch at Goldman Sachs in New York, where he’d taken a job managing quantitative trading strategies.

Adams arranged a meeting in New York between Griffin and Frank Meyer, an investor in Triple I as well as Princeton/Newport. Meyer too was floored by Griffin’s broad understanding of technical aspects of investing, as well as his computer expertise, an important skill as trading became more mechanized and electronic. But it was his market savvy that impressed Meyer most. “If you’re a kid managing a few hundred thousand, it’s very hard to borrow stock for short selling,” Meyer recalled. “He went around to every major stock loan company and ingratiated himself, and because he was so unusual they gave him good rates.” Griffin set up shop in Chicago in late 1989 with his $1 million in play dough, and was quickly making money hand over fist trading convertibles with his handcrafted software program. In his first year of trading, Griffin posted a whopping 70 percent return.


A Primer for the Mathematics of Financial Engineering by Dan Stefanica

asset allocation, Black-Scholes formula, capital asset pricing model, constrained optimization, delta neutral, discrete time, Emanuel Derman, implied volatility, law of one price, margin call, quantitative trading / quantitative finance, Sharpe ratio, short selling, time value of money, transaction costs, volatility smile, yield curve, zero-coupon bond

The change in the value of the portfolio is II(B + dB) - II(B) O(B + dB) - ~. (B + dB) - (O(B) O(B + dB) - O(B) - ~ dB. ~. B) (3.98) We look for ~ such that the value of the portfolio is insensitive to small changes in the price of the underlying asset, i.e., such that II(B + dB) - II(B) ~ O. From (3.98) and (3.99), and solving for ~ ~ 0 (B ~, we find that + dB) dB (3.99) 0 (B) . 7To explain short selling, consider the case of equity options, i.e., options where the underlying asset is stock. Selling short one share of stock is done by borrowing the share (through a broker), and then selling the share on the market. Part of the cash is deposited with the broker in a margin account as collateral (usually, 50% of the sale price), while the rest is deposited in a brokerage account. The margin account must be settled when a margin call is issued, which happens when the price of the shorted asset appreciates beyond a certain level.

The cash from the brokerage account can be invested freely, while the cash from the margin account earns interest at a fixed rate, but cannot be invested otherwise. The short is closed by buying the share (at a later time) on the market and returning it to the original owner (via the broker; the owner rarely knows that the asset was borrowed and sold short). We will not consider here these or other issues, such as margin calls, the liquidity of the market and the availability of shares for short selling, transaction costs, and the impossibility of taking the exact position required for the "correct" hedge. 106 CHAPTER 3. PROBABILITY. BLACK-SCHOLES FORMULA. By letting dS -+ 0, we find that the appropriate position .6. in the underlying asset in order to hedge a call option is ac .6. = as' which is the same as .6.(C), the Delta of a call option defined in (3.61) as the rate of change of the value of the call with respect to changes in the price of the underlying asset.

Assume that the return of one of the assets is independent of the returns of the other three assets. Also, assume that not all assets have the same expected rate of return. i=l We assume it is possible to take arbitrarily large short positions in any of the assets. Therefore, the weights Wi are not required to be positive 7 . Let ~ be the rate of return (over a fixed period of time) of asset i, and let jLi = E[~] and eJ'f = var(Ri) be the expected value and variance of ~, 7If short selling is not allowed, then all assets must have positive weights, i.e., Wi ::::: 0, i = 1 : n. These inequality constraints make the portfolio optimization problem a quadratic programming problem which cannot be solved using Lagrange multipliers. For notation purposes, assume that asset 4 is the asset with uncorrelated return, i.e., Pi,4 = 0, for i = 1 : 3. Let Wi be the weight of asset i in the BFinding efficient portfolios is one of the fundamental problems answered by the modern portfolio theory of Markowitz and Sharpe; see Markowitz [17] and Sharpe [25] for seminal ~apers.


pages: 482 words: 121,672

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

It is clear that arbitrage trades to correct a perceived price bubble are inherently risky. And there are also times when short selling is not possible or at least severely constrained. Typically in selling short, the security that is shorted is borrowed in order to deliver it to the buyer. If, for example, I sell short 100 shares of IBM, I must borrow the securities to be able to deliver them to the buyer. (I must also pay the buyer any dividends that are declared on the stock during the period I hold the short position.) In some cases it may be impossible to find stock to borrow, and thus it is technically impossible even to execute a short sale. In some of the most glaring examples of inefficient pricing, technical constraints on short selling prevented arbitrageurs from correcting the mispricing. Arbitrages may also be hard to establish if a close substitute for the overpriced security is hard to find.

If Royal Dutch sells at a 10 percent premium to Shell, the appropriate arbitrage is to sell the overpriced Royal Dutch shares short and buy the cheap Shell shares. The arbitrage is risky, however. An overpriced security can always become more overpriced, causing losses for the short seller. Bargains today can become better bargains tomorrow. It is clear that one cannot rely completely on arbitrage to smooth out any deviations of market prices from fundamental value. Constraints on short selling undoubtedly played a role in the propagation of the housing bubble during the end of the first decade of the 2000s. When it is virtually impossible to short housing in specific areas of the country, only the votes of the optimists get counted. When the optimists are able to leverage themselves easily with mortgage loans, it is easy to see why a housing bubble is unlikely to be constrained by arbitrage.

., 118 securities: collateralized, 99 fixed-interest, 126 Securities and Exchange Commission (SEC), 59, 65, 89, 167, 173, 185, 259 beta approved by, 218 Regulation FD (Fair Disclosure) of, 183 Security Analysis (Graham and Dodd), 32, 105 security analysts, 159–85 advice and, 172 conflict of interest with investment banking, 164, 170–73 equity research stars and, 159 fads and, 75 forecasting difficulties of, 164–74 forecasting future earnings as raison d’être of, 160–63 Internet bubble fostered by, 88–89 loss of best of, 164, 170 metamorphosis of, 159 occasional incompetence of, 162–63, 164, 168–70, 173 selection penalty, 243, 254 self-employment, 304 sell vs. buy recommendations, ratio of, 171–72 Seybun, H. Negat, 157 Shakespeare, William, 219 Sharpe, William, 209 Shell Transport, 251 Shields, Brooke, 70 Shiller, Robert, 35, 80, 242, 253, 267, 285, 347 short selling, 51, 250–51 Shoven, John, 390 Siegel, Jeremy, 292 similarity, 237 single-family homes, 313–14 six-month certificates, risk of, 308 Skilling, Jeff, 95 small-firm effect, 266 “smart beta” funds, 27, 223, 260–88 DFA and, 270–71, 272, 273, 277–78 EMH and, 284–87 equally weighted portfolios and, 271, 280 ETFs and, 264, 266, 268, 271, 273, 274, 275, 276, 278, 280, 281, 282–83, 421 excess returns and, 279–80, 281, 283 failures of, 260, 271–73, 278 Fama-French model and, 270–71, 272, 274, 280 implications of, 282–87 low-volatility strategies and, 268–70, 281, 282 management expenses and, 273 momentum strategies and, 266–68, 281–82 mutual funds and, 270–71, 273, 274, 421 RAFI and, 271, 272, 277, 278–80 rebalancing and, 272–73 returns and, 268–70, 272 reversion to mean and, 266–68, 273, 276 risk and, 260–61, 271–73, 279, 280, 283 “small-cap” vs.


pages: 349 words: 134,041

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy and hold, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Meriwether, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, Right to Buy, risk-adjusted returns, risk/return, Satyajit Das, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

In currency markets, actual trade and investment flows make up a tiny portion of trading volume – around 3%. The rest is ‘capital flow’. This is just double-speak for speculative capital zooming around the globe at the speed of light along fibre-optic cables in search of profits. All this is aided and abetted by the turbo-charged power of cash settled derivatives. Derivatives also allow traders to short sell. You could sell something you don’t own. Confused? Well, if you don’t own something generally it is difficult to sell it. Even the most clueless buyer wouldn’t pay good boodle for something you can’t give him. Why can’t you deliver it to him? Well, you don’t own it – otherwise it would not be a short sale. Catch-22. The beauty of derivatives is that you sell forward. You don’t have to deliver it today.

Hedge funds charge a fee of 1% on AUM plus around 20% of profits, sometimes above an agreed benchmark; sought-after funds charge more. One ‘hot’ hedge fund charges more – 5% and 35% of profits. Most hedge funds are small and fund managers are owner managers – Performance-related fees mean that they get paid more than they ever would on the sell side. Hedge funds are not actually hedged. They can do certain things that traditional investors can’t, short sell to take advantage of falling prices and leverage to increase profits. The benefits of derivatives – access, customized risk-reward profiles, ability to short and leverage – mean they are essential to hedge funds. Hedge funds also trade a lot; dealers love it. Special desks to sell exclusively to hedge funds are now common. The money just keeps rolling in. These funds have many investment styles, the favourite being ‘market neutral’.

The weird nature of shares affects equity derivatives – there are many more moving parts. You have to watch the risk of dilution (changes in the number of shares on issue) and you especially have to watch out for dividends (how much, when and how they are taxed). Then there are all the DAS_C04.QXP 8/7/06 242 4:51 PM Page 242 Tr a d e r s , G u n s & M o n e y quaint rules of stock exchanges that apply to trading shares (when you could short sell). This is a world of new unknowns but for those in the know, it presents endless opportunities. Many of these opportunities are presented by the uninitiated as they blunder around in equityland. Recently I saw an interesting trade between two reputable and highlyregarded banks on a five year option on a stock. Both dealers booked a large profit on the deal, which in the zero sum world of derivative trading is not possible.


pages: 457 words: 143,967

The Bank That Lived a Little: Barclays in the Age of the Very Free Market by Philip Augar

activist fund / activist shareholder / activist investor, Asian financial crisis, asset-backed security, bank run, banking crisis, Big bang: deregulation of the City of London, Bonfire of the Vanities, bonus culture, break the buck, call centre, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, family office, financial deregulation, financial innovation, fixed income, high net worth, hiring and firing, index card, index fund, interest rate derivative, light touch regulation, loadsamoney, Long Term Capital Management, Martin Wolf, money market fund, moral hazard, Nick Leeson, Northern Rock, offshore financial centre, old-boy network, out of africa, prediction markets, quantitative easing, Ronald Reagan, shareholder value, short selling, Sloane Ranger, Social Responsibility of Business Is to Increase Its Profits, sovereign wealth fund, too big to fail, wikimedia commons, yield curve

Jenkins decided that the very brief encounter had been some sort of job offer, but it was one that he had no intention of taking up. Although Seegers was well in with Weill, he had a fearsome reputation inside Citigroup. TAKING IT TO THE NEXT LEVEL Beneath Varley’s bookish demeanour lay a committed capitalist. This punctilious lawyer had learned banking as a corporate financier, trading and risk management at BZW and modern financial techniques at Odey Asset Management. He knew all about shorting (selling shares you didn’t own in the hope that the price would fall and you could buy them back more cheaply before any money changed hands); leverage (borrowing money at low interest rates to invest in the markets); derivatives; and hedging risk. As Barclays’ finance director, his interactions with investors showed him that shareholders of all kinds were demanding in their expectations. He knew that quick results were expected and he had no time to waste.

The Bank of England was covertly providing it with funds but customers were withdrawing deposits at an alarming rate, and the British government had to facilitate its rescue by Lloyds on 17 September. There were similar bank runs and rescues across Europe: Glitnir bank in Iceland, Fortis Group in Belgium, Luxembourg and Holland, and Dexia in Belgium. In a futile attempt to stabilize markets, the British, American, Canadian and French authorities banned the short selling of bank shares. Brown led other world leaders in thinking through the crisis, and he was the first to see where it might lead. In the last week of September he used the annual meeting of the UN General Assembly in New York to sound out other government heads, senior figures on Wall Street and the Fed’s Geithner. Following these meetings, on Friday 26 he flew to Washington with Vadera to meet President Bush at the White House.

While this was going on, the fund’s technical experts were working out how to put on a sizeable short position, which would involve borrowing – in effect renting – Barclays shares from other institutions to settle the trade. Meanwhile, the fund’s derivatives specialists worked out how to hedge some of the risk involved. It had been a painstaking process but in the end the hedge fund had gone short in Barclays for a full year as the share price fell from 700 pence to 300 pence and had made record returns for its investors and partners. They closed out the position just before the FSA ban on short selling in September 2008 and banked all the profits. William was the originator of the idea, and although they didn’t do praise or formal year-end appraisals, he knew that he was now being listened to every time he spoke. William had learned a lot from watching the trade being put on and taken off. He had a restless mind and he was now thinking about Barclays again. The news was dreadful. The British and American economies were shrinking, interest rates were being cut, governments were trying everything they could to stimulate business and consumer spending but investors were convinced a recession was imminent.


pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, buy low sell high, capital controls, central bank independence, commoditize, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, diversification, diversified portfolio, family office, fixed income, glass ceiling, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, John Meriwether, Long Term Capital Management, margin call, market bubble, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shale / tar sands, oil shock, out of africa, paper trading, Paul Samuelson, Peter Thiel, price anchoring, purchasing power parity, reserve currency, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond, zero-sum game

I couldn’t believe how calm they were, considering the amount of money we lost. It was an out-of-control hit but because of the spare capital, we weren’t backed into a corner and were never forced sellers.They were able to be rational about it and actually bought more shares. It turned out to be a great buying opportunity. What was your next job? I went to work with Jim Chanos, who just did short selling. It was interesting going to work with him after the family, who were always optimistic and incredibly bullish. Jim was always trying to go against the crowd. He constantly picked things apart and looked for what “the market” had wrong. One thing Jim was never great at was figuring out why it would end. He never really looked for the catalyst that would change the market’s focus. He was usually right, but what I’ve learned since is that it’s more important to be there when a mania ends, than spotting it early.

He was usually right, but what I’ve learned since is that it’s more important to be there when a mania ends, than spotting it early. What I came away with from my time with Chanos was that you don’t have to be skeptical about everything. Maybe the guys at Starbucks really are good managers and it really is one of the greatest concepts ever. Maybe eBay is the perfect business model. Short sellers can’t think that way. Short selling is a unique and specific mind-set. According to them, every Internet stock had to go bankrupt. Jim’s always betting against the house but, working with him, I learned that the house usually wins.That’s part of the short seller’s problem. Another problem is that it’s harder now because there are a lot more people doing it. There are also other inherent problems with shorting.There is a difference between investing or buying stocks and shorting.

Also, when a short goes against you, it becomes a bigger percentage of your portfolio, but when it’s working, it becomes a smaller percentage. So with a short, your risk increases as its goes against you. What distinguishes Jim Chanos as a short seller? Jim has been very successful and has caught some great shorts, like Enron recently. The great thing about Jim is that he is the presentable, educated face of short selling. He’d gone to Yale and is very articulate and thoughtful. He wasn’t one of these guys from a strange religion who crawled out from under a rock.We weren’t squeezing little trades and constantly fighting with the Vancouver Stock Exchange to borrow stocks. A lot of what he did was to catch the big shorts. He actually sat there and did a lot of homework. When I was there, the firm went from $20 million in assets under management to $500 million.


pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low cost airline, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, stocks for the long run, survivorship bias, the market place, transaction costs, Y2K, yield curve, zero-sum game

Long-Short Equity strategies invest mainly in equities and derivative instruments. The manager uses short selling, but maintains a position in the neutral stock. Equity Market Neutral strategies attempt to exploit inefficiencies in the market through balanced overvalued securities buying and selling so that either a neutral-beta (that is, risk) or a neutral-dollar (that is, amounts invested) approach is obtained. Merger Arbitrage funds invest in companies involved in the mergersand-acquisitions process. Typically, they go long on targeted companies and sell short the acquiring companies. Relative Value strategies look to take advantage of the relative price differentials between related instruments. Short Selling strategies maintain a net or simple short exposure relative to the market. Chapter 12 Keeping the Wheels on the Hedge-Fund ATV 227 The potential downside of hedge-fund strategies is, if misapplied, they can bring disastrous results.

Alpha Strategies 1997 1998 1999 2000 2001 2002 Convertible Arbitrage 14.81% 3.11% CTA Global 12.27% 14.30% 1.82% Distressed Securities 16.70% –2.26% 19.75% 4.81% 14.65% 5.86% 27.34% Emerging Markets 22.57% –26.66% 44.62% –3.82% 12.52% 5.76% Equity Market Neutral 15.43% 10.58% 13.15% 15.35% 8.18% 4.71% Event Driven 20.98% 1.00% 22.72% 9.04% 9.32% –1.08% 20.48% Fixed-Income Arbitrage 12.43% –8.04% 12.63% 5.70% 7.81% 7.56% Long/Short Equity 21.35% 14.59% 31.40% 12.01% –1.20% –6.38% 19.31% 16.08% 17.77% 13.78% 8.60% 7.32% 3.52% 2003 2004 Average Return Standard Deviation Sharpe Ratio 10.61% 6.09% 1.08 8.73% 5.01% 0.94 17.89% 12.73% 9.58% 0.91 31.27% 14.30% 10.56% 21.82% 0.30 6.29% 4.71% 4.49% 1.27 12.43% 11.54% 9.07% 0.83 6.26% 6.41% 6.45% 0.37 8.62% 11.87% 12.22% 0.64 10.80% 1.10% 14.57% 11.64% 8.35% 5.17% 9.72% Alpha Strategies 1997 1998 1999 2000 2001 Merger Arbitrage 17.44% 7.77% 17.97% 18.10% 2.87% Relative Value 16.51% 5.27% 17.15% 13.35% 8.63% Short Selling 3.07% 2002 2003 2004 Average Return Standard Deviation Sharpe Ratio –0.90% 8.34% 4.83% 9.33% 7.44% 0.72 2.77% 5.71% 10.08% 5.40% 1.13 20.76% –0.05 12.15% 27.07% –22.55% 22.80% 10.20% 27.27% –23.87% –4.66% 3.01% Chapter 14 Every Strategy Has Its Day Average Return 15.78% 4.25% 15.88% 11.13% 8.21% 6.25% 12.01% 6.94% 9.98% 4.36% 1.37 Funds of Funds 17.39% 4.20% 28.50% 7.84% 3.52% 1.26% 11.45% 7.08% 9.85% 8.98% 0.65 Hurdle Rate* 9.30% 10.44% 7.72% 5.76% 5.20% 5.54% 7.88% 9.67% 9.55% * The hurdle rate is defined as the average of one month LIBOR plus 400 basis points.


pages: 306 words: 97,211

Value Investing: From Graham to Buffett and Beyond by Bruce C. N. Greenwald, Judd Kahn, Paul D. Sonkin, Michael van Biema

Andrei Shleifer, barriers to entry, Berlin Wall, business cycle, capital asset pricing model, corporate raider, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index fund, intangible asset, Long Term Capital Management, naked short selling, new economy, place-making, price mechanism, quantitative trading / quantitative finance, Richard Thaler, shareholder value, short selling, Silicon Valley, stocks for the long run, Telecommunications Act of 1996, time value of money, tulip mania, Y2K, zero-sum game

There is another approach to risk management that most value investors avoid. There are short sellers in the money management business, and there are more hedge fund managers who run portfolios composed of long and short positions. At the extreme is a strategy called market neutral, in which a balance between long and short is maintained to immunize the portfolio from whatever the market does. The assumption behind all short selling is that the current price of a security is not sustainable, and that as the price falls, the investors will buy back the shares they have sold and make a profit. Short sellers and hedgers use technical, fundamental, and event-oriented analyses to make their selections. One might think that orthodox value investors, armed with their valuation methods, would be well equipped to spot overpriced securities and benefit as reality sets in.

Even the more contemporary and supposedly scientific version of hedging-the idea that certain positions can be counted upon to converge in price over time and that money can be made by pairing long and short positions as a bet on that convergence-has proved vulnerable to the point of a Federal Reserve intervention. Klarman, recognizing how much rides on those kinds of bets, especially when leverage is employed, steers clear of that kind of hedging. He does not employ naked short selling as a strategy, fearing the skewed risk of unlimited loss on a short position that moves higher. He will commit a portion of his funds to buying put options on a stock index, to hedge against a broad decline in the market. But that strategy is genuinely buying an insurance policy, a cost that will slightly reduce returns if everything works as intended but will offer some protection should the market drop.

That includes all the investors we have profiled in this book and a host of other individuals: Bill Ackman, Barbara Dodd Anderson, David Berkowitz, Chris Browne, Bob Bruce, Chuck Brunie, Hirsch Cohen, Pat Duff, the late Tom Ebright, Geraldine Fabrikant, Bill Falloon, Meyer Feldberg, Bob Gottesman, David Greenspan, Larry Hilibrand, Irving Kahn, Thomas Graham Kahn, Marilyn Kohn, Helene and Sid Lerner, Carol Loomis, Ronald Meyer, Catherine Murray, Joe Reich, Chuck Royce, Mina Samuels, Lew Sanders, Jace Schinderman, Andy Weiss, and Marty Whitman. As value investors know, families are invaluable. We thank ours: Diana Greenwald, Gabriel Kahn, Lavinia Lorch, Anne, Katie, Frank and Sally Rogin, Ava Seave, Stacy and Zev Sonkin, Fiamma and Tristan van Biema. 'We are going to confine our discussion throughout this book to the `long' position side of investing and ignore those investors who `short' (sell without owning) securities that they think are priced at more than their fundamental value. At certain points in his career, Graham used short sales to hedge other positions he had taken, and there may be bona fide value investors today who make active use of shorting securities. In the main, however, value investing is identified with uncovering fundamental value and buying it at bargain price.


Mathematical Finance: Core Theory, Problems and Statistical Algorithms by Nikolai Dokuchaev

Black-Scholes formula, Brownian motion, buy and hold, buy low sell high, discrete time, fixed income, implied volatility, incomplete markets, martingale, random walk, short selling, stochastic process, stochastic volatility, transaction costs, volatility smile, Wiener process, zero-coupon bond

Definition 5.43 The fair price at time t=0 of the European option with payoff ψ is the minimal wealth X(0) such that there exists an admissible self-financing strategy (β(·), γ(·)) such that X(T)≥ψ a.s. for the corresponding wealth X(·). 5.9.2 The fair price is arbitrage-free Starting from now and up to the end of this section, we assume that a continuous time market is complete with constant r and σ. Let us extend the definition of the strategy by assuming that a strategy may include buying and selling bonds, stock and options. Short selling is allowed but all transactions must be self-financing; they represent redistribution of the wealth between different assets. There are no outputs or inputs of wealth. For instance, a trader may borrow an amount of money x to buy k options with payoff ψ at time t=0, then his/her total wealth at time T will be kψ−erTx. Assume that Definition 5.29 is extended for these strategies. Proposition 5.44 Assume that an option seller sells at time t=0 an option with payoff ψ for a price c+ higher than the fair price cF of the option.

We assume that F(x) is a given function such that F(x)≥0. If the option holder has to fulfil the option obligations at time τ, we say that he or she exercises the option, and τ is called the exercise time. Sub (super) martingale properties for non-arbitrage prices Similarly to Section 5.9, we shall use the extended definition of the strategy assuming that a strategy may include buying and selling bonds, stock, and options. Short selling is allowed for stocks and bonds and not allowed for options. All transactions must be selffinancing; they represent redistribution of the wealth between different assets. For instance, a trader may borrow an amount of money x to buy k American options at time t with payoff then his/her total wealth at exercise time s is kF(S(s))−er(s−t) x. We assume that Definition 5.29 is extended for these strategies.


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

"Robert Solow", Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

The financial crisis gave hedge funds a bad name, probably a worse name than they deserved. They were depicted as predators for their short selling; as excessively leveraged, and therefore a source of financial fragility; and as facilitating herding behavior, both in the bubble and in the panic after the music stopped. Maybe even as unsavory gambling dens. Nobody, it seemed, loved hedge funds—except, of course, the people who ran them, many of whom had amassed, in the apt words of a popular book on hedge funds, “more money than God.” Surely anyone who had gained such an obscenely large fortune so fast must be guilty of something. But the facts did not support those harsh judgments, other than the charge of obscene rewards. First, short selling probably kept the housing and bond bubbles from blowing up even bigger than they did. Why?

The new Wall Street model looked shaky, and in the market’s view, Lehman was probably the next to go. On Bear Stearns Day, Lehman’s CEO Richard “Dick” Fuld knew that his company was in the crosshairs, and when the stock market opened on the next Monday, Lehman’s stock was, indeed, pummeled. As he later lamented to the FCIC, “Bear went down on rumors and a liquidity crisis of confidence. Immediately thereafter, the rumors and the naked short-selling came after us.” It certainly did. But Lehman managed to hold things together for another six months. Lehman’s primary regulator was the same as Bear’s: the somnolent SEC. After the Bear Stearns bailout, however, and especially after the Fed began lending to broker-dealers, the central bank started watching over Lehman Brothers and the other three Wall Street giants—with supervision, stress tests, requests for data, and the like.

“[as] fundamentally flawed”: FCIC Report, 323. “central to the financial crisis”: FCIC Report, 323. “‘save their ass’”: Paulson, On the Brink, 144. “you may not have to take it out”: Paulson, On the Brink, 151. “hardest thing I had ever done”: Paulson, On the Brink, 170. $200 billion worth of repos outstanding: FCIC Report, 326. “what we learned scared us”: Paulson, On the Brink, 121. “naked short-selling came after us”: FCIC Report, 326–27. better than they actually were: See Latman, “New York Accuses Ernst & Young of Fraud in Lehman Collapse,” New York Times. longer-term debt by June: FCIC Report, 326. rejected the idea as “gimmicky”: FCIC Report, 328. $55 billion loan from the Fed: FCIC Report, 328. Fannie and Freddie were taken over: Sorkin, Too Big to Fail, chapter 11. Paulson refused: Paulson, On the Brink, 190.


The Concepts and Practice of Mathematical Finance by Mark S. Joshi

Black-Scholes formula, Brownian motion, correlation coefficient, Credit Default Swap, delta neutral, discrete time, Emanuel Derman, fixed income, implied volatility, incomplete markets, interest rate derivative, interest rate swap, London Interbank Offered Rate, martingale, millennium bug, quantitative trading / quantitative finance, short selling, stochastic process, stochastic volatility, the market place, time value of money, transaction costs, value at risk, volatility smile, yield curve, zero-coupon bond

Note that the speculators and traders in the banks are actually providing a public service - their frenetic buying and selling increases the liquidity of markets thus ensuring that the ordinary investor can buy or sell at anytime he wishes, rather than being forced to wait until a counteiparty can be found. 2.4.3 Shorting The third is the assumption that one can go `short' at will. That is, one can have negative amounts of an asset by selling assets one does not hold. Whilst there are some restrictions on short-selling assets in the market, it is allowed. The opposite of going `short,' holding an asset, is sometimes called being `long' in it. Similarly, buying an asset is called `going long.' 2.4.4 Fractional quantities The fourth assumption is the ability to purchase fractional quantities of assets. Whilst one can clearly not do this in the markets, when one is dealing in quantities of millions, which trading banks generally do, this is not so unreasonable the smallest unit one can hold is a millionth of the typical amount held, so any error is pretty small in comparison. 2.4.5 No transaction costs The fifth assumption is that there are no transaction costs.

For example, at the time of writing, NatWest made an offer for Legal and General shares at an offer price of 210p a share. The share price for Legal and General reacted to this information by immediately jumping to about 200p. So there was an `arbitrage opportunity' to purchase Legal and General shares for 200p and sell them for 210p to NatWest. Many `arbitrage houses' therefore bought lots of Legal and General shares and financed the purchase by short-selling NatWest. However there was a good reason for the market's pricing the shares at 200p - there was a still a possibility that the deal would fall through. Indeed, Bank of Scotland launched a bid for NatWest and urged the shareholders to reject the Legal and General merger. The NatWest share price jumped up, the Legal and General one fell and the arbitrage houses had their fingers badly burnt. (The final outcome was that the Royal Bank of Scotland launched a second bid, and took over NatWest.)

Indeed, it can be perfectly hedged in a static model-independent fashion. In this section, we define and price swaps. In general, 13.2 The simplest instruments 303 the best way to analyze an interest rate derivative is in terms of the cashflows involved, and we illustrate this here. All pricing of interest rate derivatives assumes the existence of a continuum of zero-coupon bonds which can be freely bought and sold, including short-selling as necessary. We will return to why it makes sense to make this assumption later but for now note that the bonds in question do not exist. The zero-coupon bonds will always have notional one. They will almost always be worth less than their face value as a bigger value is equivalent to negative interest rates, and so their values will be less than 1. In fact, as a function of maturity we will obtain a function which is monotone decreasing and ranges from 1 at T = 0 to 0 as T becomes infinite.


pages: 670 words: 194,502

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

3Com Palm IPO, accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, George Santayana, hiring and firing, index fund, intangible asset, Isaac Newton, Long Term Capital Management, market bubble, merger arbitrage, money market fund, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, stocks for the long run, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

This usually means buying stocks when the market has been advancing and selling them after it has turned downward. The stocks selected are likely to be among those which have been “behaving” better than the market average. A small number of professionals frequently engage in short selling. Here they will sell issues they do not own but borrow through the established mechanism of the stock exchanges. Their object is to benefit from a subsequent decline in the price of these issues, by buying them back at a price lower than they sold them for. (As our quotation from the Wall Street Journal on p. 19 indicates, even “small investors”—perish the term!—sometimes try their unskilled hand at short selling.) 2. SHORT-TERM SELECTIVITY. This means buying stocks of companies which are reporting or expected to report increased earnings, or for which some other favorable development is anticipated. 3.

See also dividends; interest; performance; return on invested capital (ROIC); yield; specific company or type of security return on invested capital (ROIC) revenue bonds Riley, Pat risk: and advice; and aggressive investors; Buffett’s comments about; and defensive investors; and factors that characterize good decisions; foolish; and formula trading; and Graham’s business principles; and history and forecasting of stock market; and inflation; and investment vs. speculation; managing of; and margin of safety; and market fluctuations; and price; and return/reward; and security analysis; and short selling; and speculation; and value; what is; Zweig’s comments about. See also specific company or type of security Risk Management Association Ritter, Jay Roche Pharmaceutical Co. Rockefeller family Rodriguez, Robert Rogers, Will Rohm & Haas Rosen, Jan M. Ross, Robert M. DEL Roth, John Rothschild, Nathan Mayer Rothschild family roulette Rouse Corp. Rowan Companies Royce, Charles Ruane, Bill Ruettgers, Michael “Rule of 72,” “rule of opposites,” “safety of principle,” safety tests: for bonds San Francisco Real Estate Investors Sanford C.

Market” (see Chapter 8) send prices wildly out of whack. † Graham launched Graham-Newman Corp. in January 1936, and dissolved it when he retired from active money management in 1956; it was the successor to a partnership called the Benjamin Graham Joint Account, which he ran from January 1926, through December 1935. * An “unrelated” hedge involves buying a stock or bond issued by one company and short-selling (or betting on a decline in) a security issued by a different company. A “related” hedge involves buying and selling different stocks or bonds issued by the same company. The “new group” of hedge funds described by Graham were widely available around 1968, but later regulation by the U.S. Securities and Exchange Commission restricted access to hedge funds for the general public. * In 2003, an intelligent investor following Graham’s train of thought would be searching for opportunities in the technology, telecommunications, and electric-utility industries.


pages: 1,164 words: 309,327

Trading and Exchanges: Market Microstructure for Practitioners by Larry Harris

active measures, Andrei Shleifer, asset allocation, automated trading system, barriers to entry, Bernie Madoff, business cycle, buttonwood tree, buy and hold, compound rate of return, computerized trading, corporate governance, correlation coefficient, data acquisition, diversified portfolio, fault tolerance, financial innovation, financial intermediation, fixed income, floating exchange rates, High speed trading, index arbitrage, index fund, information asymmetry, information retrieval, interest rate swap, invention of the telegraph, job automation, law of one price, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market clearing, market design, market fragmentation, market friction, market microstructure, money market fund, Myron Scholes, Nick Leeson, open economy, passive investing, pattern recognition, Ponzi scheme, post-materialism, price discovery process, price discrimination, principal–agent problem, profit motive, race to the bottom, random walk, rent-seeking, risk tolerance, risk-adjusted returns, selection bias, shareholder value, short selling, Small Order Execution System, speech recognition, statistical arbitrage, statistical model, survivorship bias, the market place, transaction costs, two-sided market, winner-take-all economy, yield curve, zero-coupon bond, zero-sum game

. ◀ * * * 7.2.3.1 Cash Management and Stock Lending and Borrowing Brokerage firms that hold client assets generally invest the cash and often lend the securities. The cash managers of the firm try to keep all cash balances fully invested. Brokers usually house their cash management operations in the Cashier’s Department under the supervision of the firm’s cashier. The employees responsible for security lending operations are often those responsible for borrowing securities for short selling. They are often housed in the Margin Department or in the Stock Loan Department. 7.2.3.2 Risk Management The risk manager of the firm monitors all activities of the firm to ensure that the firm does not lose control over the risks it assumes. The risk manager must ensure that large losses never surprise the firm’s managers. In particular, the risk manager must make certain of the following: • The firm’s management is aware of all significant financial and legal risks to which the firm is exposed

Susan is a U.S. investor who has already realized substantial short-term capital gains from her trading this year. It is now October. If she does not plan her finances carefully, she will pay substantial taxes at the end of the year. Susan needs short-term capital losses to offset her capital gains. Unfortunately—actually fortunately—she does not have any positions with losses that she can sell. To solve her problem, Susan decides to buy the Mexico Fund (MXF) and short sell the Mexico Equity and Income Fund (MXE). These two funds are unrelated closed-end funds that own diversified portfolios of Mexican stocks. Although Mexican stocks are often quite volatile, the combined position is not very risky because the returns to these two funds are very closely correlated. If the Mexican stock market rises before the end of the year, Susan will realize her loss on her short MXE position and carry her gain in MXF over into the next year.

Bluffers therefore may target securities for which little fundamental information is available to the market. Finally, value traders generally cannot sell securities that they cannot borrow. Bluffs therefore are more likely in securities that are hard to borrow. These securities are often small stocks for which the bluffer controls a substantial fraction of the shares outstanding. Because value traders generally can buy securities more easily than they can short sell them, long-side bluffs probably are more common than sell-side bluffs. 12.2.3 Prosecuting Market Manipulation Prosecuting market manipulators is very difficult because bluffers always claim to be well-informed speculators. The best bluffers probably are often well informed, though not necessarily about the objects of their bluffs. Since prosecutors, judges, and juries cannot easily determine whether an opinion is well founded or not, they cannot distinguish between informed speculation and bluffing.


pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy and hold, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

Part of the notebook is devoted to the roulette device and part to a wildly disconnected set of stock market musings. Shannon wondered about the statistical structure of the market’s random walk and whether information theory could provide useful insights. He mentions such diverse names as Bachelier, (Benjamin) Graham and (David) Dodd, (John) Magee, A. W. Jones, (Oskar) Morgenstern, and (Benoit) Mandelbrot. He considered margin trading and short-selling; stop-loss orders and the effects of market panics; capital gains taxes and transaction costs. Shannon graphs short interest in Litton Industries (shorted shares vs. price: the values jump all over with no evident pattern). He notes such success stories as Bernard Baruch, the Lone Wolf, who ran about $10,000 into a million in about ten years, and Hetty Green, the Witch of Wall Street, who ran a million into a hundred million in thirty years.

By buying the stock and selling the option, you create a “horse race” where one side of the trade has to win and the other side has to lose. And if you know the “true” odds better than everyone else and use your beliefs to adjust your bets, you can expect a profit. It can be shown that these long-short trades are Kelly-optimal. They were in use in the stock market long before Kelly, though. Thorp’s innovation was to calculate exactly how much of the stock he had to buy to offset the risk of short-selling the warrant. This technique is now called “delta hedging,” after the Greek letter used to symbolize change in a quantity. In delta hedging, the paper profit (or loss) of any small change in the price of the stock is offset by the change in the price of the warrant. You make money when the “irrational” price of the warrant moves into line with the price of the stock. John Maynard Keynes is famous for remarking that the market can remain irrational longer than you can remain solvent.

That term goes back to 1949. Alfred Winslow Jones, a sociologist and former Fortune magazine writer, started a “hedged fund.” The final d in hedged was later dropped. When Jones liked a stock, he would borrow money to buy more of it. The leverage increased his profits and risk. To counter the risk, Jones sold short stocks that he felt were overpriced. This was “hedging” the fund’s bets. Jones called the leverage and short-selling “speculative tools used for conservative ends.” By 1968 there were about two hundred hedge funds competing for the finite pool of wealthy investors. Many who became well-known managers had started hedge funds, among them George Soros, Warren Buffett, and Michael Steinhardt. In the process, the term “hedge fund” drifted from its original meaning. Not all hedge funds hedge. The distinction between a hedge fund and a plain old mutual fund is now partly regulatory and partly socioeconomic.


pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, computerized trading, diversification, equity premium, fault tolerance, financial intermediation, fixed income, high net worth, implied volatility, index arbitrage, information asymmetry, interest rate swap, inventory management, law of one price, Long Term Capital Management, Louis Bachelier, margin call, market friction, market microstructure, martingale, Myron Scholes, New Journalism, p-value, paper trading, performance metric, profit motive, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, trade route, transaction costs, value at risk, yield curve, zero-sum game

(9.3) Diamond and Verrecchia (1987) and Easley and O’Hara (1992) were the first to suggest that the duration between subsequent data arrivals carries information. The models posit that in the presence of short-sale constraints, inter-trade duration can indicate the presence of good news; in markets of securities where short selling is disallowed, the shorter the inter-trade duration, the higher is the likelihood of unobserved good news. 122 HIGH-FREQUENCY TRADING The reverse also holds: in markets with limited short selling and normal liquidity levels, the longer the duration between subsequent trade arrivals, the higher the probability of yet-unobserved bad news. A complete absence of trades, however, indicates a lack of news. Easley and O’Hara (1992) further point out that trades that are separated by a time interval have a much different information content than trades occurring in close proximity.

Naik and Robert Radcliffe, 1998. “Liquidity and Asset Returns: An Alternative Test.” Journal of Financial Markets 1, 203–219. References 309 Demsetz, Harold, 1968. “The Cost of Transacting,” Quarterly Journal of Economics, 33–53. Dennis, Patrick J. and James P. Weston, 2001. “Who’s Informed? An Analysis of Stock Ownership and Informed Trading.” Working paper. Diamond, D.W. and R.E. Verrecchia, 1987. “Constraints on Short-Selling and Asset Price Adjustment to Private Information.” Journal of Financial Economics 18, 277–311. Dickenson, J.P., 1979. “The Reliability of Estimation Procedures in Portfolio Analysis.” Journal of Financial and Quantitative Analysis 9, 447–462. Dickey, D.A. and W.A. Fuller, 1979. “Distribution of the Estimators for Autoregressive Time Series with a Unit Root.” Journal of the American Statistical Association 74, 427–431.


pages: 218 words: 62,889

Sabotage: The Financial System's Nasty Business by Anastasia Nesvetailova, Ronen Palan

algorithmic trading, bank run, banking crisis, barriers to entry, Basel III, Bernie Sanders, big-box store, bitcoin, Black-Scholes formula, blockchain, Blythe Masters, bonus culture, Bretton Woods, business process, collateralized debt obligation, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, distributed ledger, diversification, Double Irish / Dutch Sandwich, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, financial repression, fixed income, gig economy, Gordon Gekko, high net worth, Hyman Minsky, information asymmetry, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Arrow, litecoin, London Interbank Offered Rate, London Whale, Long Term Capital Management, margin call, market fundamentalism, mortgage debt, new economy, Northern Rock, offshore financial centre, Paul Samuelson, peer-to-peer lending, plutocrats, Plutocrats, Ponzi scheme, price mechanism, regulatory arbitrage, rent-seeking, reserve currency, Ross Ulbricht, shareholder value, short selling, smart contracts, sovereign wealth fund, Thorstein Veblen, too big to fail

I’m not going to use the word “conspiracy”, but it’s part of it,’ said Cayne in his testimony.38 Alan Schwartz, CEO in charge during the collapse, did not mince his words either, singling out Goldman Sachs for the concerted attack that led to Bear’s demise. Schwartz confronted Goldman’s CEO, Lloyd Blankfein, about it.39 Bear Stearns’s executives believed that Goldman collaborated with several hedge funds to short-sell Bear Stearns stocks, in order to subsequently make a huge profit from its collapse.40 They handed over documents to the Securities and Exchange Commission for an investigation into insider trading and market manipulation, but the investigation did not find anything substantial. The data speaks for itself. In the three weeks preceding Bear’s collapse, Goldman and the hedge funds Citadel Investment and Paulson & Co. exited about 400 trades with Bear Stearns – more than with any other firm.41 Inside Bear, rumours had been circulating all week that Deutsche Bank was shorting (that means betting against) Bear, and that Goldman and Citadel were determined to bring Bear down.42 A vice-chairman of an unnamed major investment bank is quoted as saying: I don’t know of any firm, no matter the capital, that could have withstood that kind of bombardment by the shorts.

ABN accounted for 75–144 per cent (depending on different estimates) of the combined group’s operating losses in the same period.29 So did Barclays put RBS on the path to collapse? It may be that Barclays played a very clever game. Or perhaps it was sheer good luck. Barclays certainly appears to have tried to compete with RBS. Barclays Capital, for instance, sought to rally several hedge funds to weaken the consortium partner Fortis by short-selling its shares ‘and kill its planned €13.5bn rights issue’.30 This could have destroyed the position of the consortium, but the strategy failed because most hedge funds were betting in favour of ABN shares and preferred that the RBS consortium keep their price high. In any case, by August 2007 Barclays’ own share price fell, reducing the value of its share-based offer even more. The British lender required the Bank of England stand-by facility to borrow an unusually high amount of £1.6bn at a penal rate of 6.75 per cent.31 Although Barclays blamed the liquidity injection on a technical breakdown in the clearing system, it was the second time in two weeks that Barclays had to rely on the mechanism.


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stocks for the long run, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

It is clear that arbitrage trades to correct a perceived price bubble are inherently risky. And there are also times when short selling is not possible or at least severely constrained. Typically in selling short, the security that is shorted is borrowed in order to deliver it to the buyer. If, for example, I sell short 100 shares of IBM, I must borrow the securities to be able to deliver them to the buyer. (I must also pay the buyer any dividends that are declared on the stock during the period I hold the short position.) In some cases it may be impossible to find stock to borrow, and thus it is technically impossible even to execute a short sale. In some of the most glaring examples of inefficient pricing, technical constraints on short selling prevented arbitrageurs from correcting the mispricing. Arbitrages may also be hard to establish if a close substitute for the overpriced security is hard to fund.

If Royal Dutch sells at a 10 percent premium to Shell, the appropriate arbitrage is to sell the overpriced Royal Dutch shares short and buy the cheap Shell shares. The arbitrage is risky, however. An overpriced security can always become more overpriced, causing losses for the short seller. Bargains today can become better bargains tomorrow. It is clear that one cannot rely completely on arbitrage to smooth out any deviations of market prices from fundamental value. Constraints on short selling undoubtedly played a role in the propagation of the housing bubble during the end of the first decade of the 2000s. When it is virtually impossible to short housing in specific areas of the country, only the votes of the optimists get counted. When the optimists are able to leverage themselves easily with mortgage loans, it is easy to see why a housing bubble is unlikely to be constrained by arbitrage.


pages: 459 words: 118,959

Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff by Christine S. Richard

activist fund / activist shareholder / activist investor, Asian financial crisis, asset-backed security, banking crisis, Bernie Madoff, Blythe Masters, buy and hold, cognitive dissonance, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, family office, financial innovation, fixed income, forensic accounting, glass ceiling, Long Term Capital Management, market bubble, money market fund, moral hazard, old-boy network, Ponzi scheme, profit motive, short selling, statistical model, white flight, zero-sum game

During a Barclay’s Capital conference call on the financial guarantors earlier in the month, one caller prefaced his question by stating that he believed those writing and speaking negatively about the bond insurers were “financial terrorists.” For years Ackman had asked regulators, reporters, and just about everyone he spoke to about MBIA to see no contradiction in shorting a company and being a decent person. It is an idea that many people simply can’t accept. When Ackman had testified at the Securities and Exchange Commission in 2003, this issue of doing good by short selling had come up. Ackman had said it was one reason he decided to short Farmer Mac. “I prefer investments where I’m not fighting against the country. You know, where there’s public policy on my side instead of against me,” Ackman had told the investigators. But the SEC attorneys had been skeptical. Wasn’t he really interested in Farmer Mac because he was seeking to profit from the company’s collapse?

Chapter Nineteen Ratings Revisited To keep the music playing required increasingly egregious excesses—ever greater quantities of increasingly risky loans, structures and leveraging —DOUG NOLAND, DAVID TICE & ASSOCIATES, DECEMBER 2007 IN DECEMBER 2007, Bill Ackman went door to door with his presentation on the bond insurers, launching perhaps the most aggressive “short” campaign in the history of Wall Street. Activist investors typically buy a stake in a company and then pressure management to make changes that will drive up the stock price. Short selling and activism are a much more complex pairing. An activist can’t exactly advocate for changes that will cause the company’s share price to collapse or cause it to file for bankruptcy. At least not very often. Ackman, however, saw his short position in MBIA as a cause. He believed his interests were aligned with those of MBIA’s policyholders because both would benefit if MBIA’s publicly traded holding company had less cash.

ON JANUARY 30—the day Gasparino at CNBC broadcast Ackman’s loss estimates—the Federal Open Market Committee announced another rate cut, taking its benchmark rate to 3 percent from 3.5 percent. The magic worked but only briefly. Fears about bond insurance were weighing on stocks and on corporate bonds. Ackman’s startling high loss numbers were not helping matters. Some people thought Ackman had gone too far. Critics of short selling coined a phrase to describe the very public and unsettling analysis issued by some money managers during the credit crisis: “Short and distort.” The charge was leveled at Ackman and later at David Einhorn, who had begun to point to problems at Lehman Brothers. As Madame de Villefort, one of the nobles caught up in the Count of Monte Cristo’s acts of revenge, tells her friends, “It’s quite simple.


pages: 289 words: 113,211

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

"Robert Solow", affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, intangible asset, Jeff Bezos, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, William Langewiesche, yield curve, zero-coupon bond, zero-sum game

There were no rusting plants, no fire sales of equipment, no tumbleweed rolling past abandoned warehouses; this was a bubble with no soapy residue. Besides isolating the most optimistic investors and setting a market price that reflects their views, the small float sets secondary forces in motion that accentuate the price appreciation. With a small float, investor demand for shares ends up being accommodated in a costly manner: through short selling and through high turnover. Short selling accommodates demand by creating virtual float. This requires a concession in price. Shorting a stock, especially a stock that has seen such price appreciation 172 ccc_demon_165-206_ch09.qxd 7/13/07 2:44 PM Page 173 T H E B R AV E N E W W O R L D OF HEDGE FUNDS and that is subject to widely differing views of valuation, requires sophistication, capital, and a risk appetite beyond that required from the buyers.

They put in orders to sell at the market price at the open, under the assumption that the open would be close enough to the Friday close to still make the discount in the futures contracts a profitable trade. That was a big bet and a far cry from the relatively low-risk enterprise of the usual cash-futures trade. And in this environment, it was even more risky because when the stock market did open, it was almost certain to open down. The execution of the program trade would then be complicated by the downtick rule, which proscribes short-selling a falling stock. The arbitrageurs wanted to buy the futures and sell the stocks short against them. If the market is in free fall, upticks are few and far between, and there are many short sellers trying to squeeze in their execution. It can take a long time to get a trade off. In the meantime, the long futures position is being held unhedged. If the market drops, the trader loses. The portfolio insurance hedgers found the other side of the market for their trades in the cash-futures traders and market makers.


pages: 434 words: 114,583

Faster, Higher, Farther: How One of the World's Largest Automakers Committed a Massive and Stunning Fraud by Jack Ewing

1960s counterculture, Asilomar, asset-backed security, Berlin Wall, cognitive dissonance, collapse of Lehman Brothers, corporate governance, crossover SUV, Fall of the Berlin Wall, full employment, hiring and firing, McMansion, self-driving car, short selling, Silicon Valley, sovereign wealth fund, Steve Jobs

The more Volkswagen shares fell, the more Porsche had to pay. Initially, Volkswagen shares rose in the weeks after Lehman filed for bankruptcy, nearly doubling, to more than four hundred euros, by October 16, 2008. But then they began to follow other German shares downward. Hedge funds swooped in and started to bet that VW’s price would fall further. The hedge funds, most based in the United States, used a risky short-selling strategy in which they sold borrowed shares in anticipation of buying them back later, at a lower price, and pocketing the difference. Compounding the risk, some sold shares that they hadn’t actually borrowed—a “naked” short that makes it even tougher to cover the bet later. As Volkswagen shares plummeted, Porsche’s obligations to Maple Bank began piling up on an almost hourly basis. At 8:14 a.m. on October 21, for example, Maple Bank confirmed in an e-mail to executives in Porsche’s finance department that it had received €300 million ($420 million) in security.

But a federal appeals court ruled that the U.S. courts had no jurisdiction, in part because Porsche and Volkswagen shares were not listed on U.S. stock exchanges. (Some funds also sued in Germany. The cases were still pending as of late 2016.) To be sure, it was hard to shed many tears for the hedge funds. They were operating in a rough neighborhood. As Richard W. Painter, a professor at the University of Minnesota Law School who studied the case, has pointed out, short selling is an inherently risky strategy frowned on, if not banned, in many jurisdictions. It was cheeky of hedge funds to summon protection from U.S. securities laws on shares traded in Germany. That was the equivalent of sitting in New York and betting on a horse race in Stuttgart, then complaining to the New York Gaming Commission that the jockey was corrupt. But it wasn’t just speculators who were unhappy with Porsche’s financial sleight of hand.

., 229 Schröder, Gerhard, 95, 101, 163 Schuster, Helmuth, 102–4, 106 SCR (selective catalytic reduction) systems; See also BlueMotion emissions technology; BlueTec emissions technology Audi’s undermining of, 127 and CARB tests, 173, 176, 177 and defeat device, 227, 246 and EA 288 engine, 180 falling price of, 209 ICCT test, 167 and urea tank, 167 SEAT, 97, 158 self-driving cars, 204, 222 self-expression, cars as form of, 146 sex scandal, 102–7 shared platform, See platform strategy shareholders, VW, 26, 58–59, 244 share prices declines (2015), 189 declines (early 2000s), 130–31 following EPA charges against VW, 212 under Pischetsrieder, 110 Porsche, 96 Porsche-VW takeover battle, 138–40 short-selling, 138–41 short squeeze, 139–40, 142 Siemens bribery scandal, 257–58 Silicon Valley, 222 Skoda, 6, 48, 102–4, 158 Skoda Octavia, 53 slave labor, 12–14 smog, NOx and, 2, 160, 168–69 Snap-On, 70 Social Democratic Party, 26, 49, 164 software, 120, 226–28; See also defeat device software updates, 182–84, 224, 244 soot particles, 43–44, 115, 159 Sorrell, William, 248 South Korea, 245 sovereign wealth funds, 143 Soviet Union, 17 special settlement master, 233 Speer, Albert, 17 sport utility vehicles (SUVs), 94–96 Stadler, Rupert, 257, 272, 273 Stalin, Joseph, 6 Standard & Poor’s, 219 “Statement of Facts,” 269 Steiner, Rudolf, 129 Steinkühler, Franz, 49 stock market, 96 stock options, 133, 136, 137 Strategy 2018, 150–51, 188 stretch goals, 151 Stumpf, John, 262 subprime mortgage crisis, 136 Sudetenland, 6 Sullivan & Cromwell, 229–30, 235 Super Bowl, 145 supervisory board (Audi), 45–46 supervisory board (VW) executive committee awareness of emissions problem, 271 failure to sanction managers for emissions cheating, 256–57 and internal investigation, 216 Piëch as member after retirement, 97, 157 Piëch’s attempt to oust Winterkorn, 187 Piëch’s elevation to VW CEO, 49 Porsche-Piëch family’s influence on, 264 Porsche’s attempted VW acquisition, 135–36 Porsche’s position on VW board, 133 VW’s acquisition of Porsche, 143–44 worker participation in, 57 supply chain, as VW weakness, 50–51 synthetic shares, 137 Tatra, 9 tax credits, 147 TDI (turbocharged direct injection), 44–45, 55, 116, 128, 146, 181 “Think Small” ad campaign, 34–35 Thiruvengadam, Arvind, 1, 167, 169, 171, 172 Thomas, Sven, 239 Thompson, Greg, 79–80, 166, 167, 172, 174 three-liter diesel engine and “acoustic function,” 123, 128, 246 defeat device in, 152, 158 EPA/CARB questions about, 183–84 EPA’s second notice of violation, 217 exclusion from first US settlement, 238 notice of violation for cars with, 217 SCR technology, 180 settlement for US and Canada, 266 US charges against designer of, 246–47 Tiercelet, France, iron mine, 15 Tiger Tank, 10–11 Time magazine, 265 Tolischus, Otto D., 9 Toyota as competitor in early 1990s, 50–51 EA 189 engine as part of VW’s strategy against, 107 European market share, 161 former employees at Porsche, 52 hybrid technology, 2–3, 116, 146; See also Toyota Prius surpassed by VW as world’s largest carmaker, 187–88, 206 VW’s efficiency gap with, 50–51, 58, 94, 110, 188, 219 VW’s sales competition with, 156 Toyota Prius, 107, 116, 146, 207, 208 Transport Select Committee, House of Commons, 231 truck engine emissions cheating scandal, 72–74, 76, 78, 125, 163 trust fund, 236 Tuch, Frank, 223 turbochargers, 44 Type 166 Schwimmwagen, 10 Umweltbundesamt, 162–64 unemployment benefits, 101 unemployment rate, German, 101, 102 United States Audi defeat device revelations, 267–68 Clean Air Act Amendments (1990), 67 EA 189 as key to VW market in, 116–17, 119 EA 189 development, 107–8, 119–20 environmental rule enforcement, 165 fleet average fuel economy milestones, 131 legal ramifications of emissions violations, 225–31 NOx regulations, 165 penalties for emissions violations, 122, 155, 156, 163 state lawsuits, 245–47 TDI Club, 45 truck engine defeat device scandal, 163 VW plant in, 148–49 VW sales (early 1970s), 36 VW sales (early 1990s), 47 VW sales (late 1990s), 55 VW sales (2014), 206 VW sales after cheating revelations, 217–18 VW’s “clean diesel” campaign, 145–58 VW’s declining fortunes in early 1990s, 47, 48, 50 VW’s early success in, 34–35 VW’s missteps in, 115–16 VW’s responsibility for diesel pollution, 253 and Winterkorn’s sales ambitions for VW, 112–13 unit injector (Pumpe Düse), 116–17 University of Virginia Center for Alternative Fuels, Engines, and Emissions, See Center for Alternative Fuels, Engines, and Emissions (CAFEE) urea solution, 177, 180–81, 192; See also BlueTec emissions technology urea tank, 113, 127–28, 152–53, 183 U.S.


pages: 358 words: 119,272

Anatomy of the Bear: Lessons From Wall Street's Four Great Bottoms by Russell Napier

Albert Einstein, asset allocation, banking crisis, Bretton Woods, business cycle, buy and hold, collective bargaining, Columbine, cuban missile crisis, desegregation, diversified portfolio, floating exchange rates, Fractional reserve banking, full employment, hindsight bias, Kickstarter, Long Term Capital Management, market bubble, mortgage tax deduction, Myron Scholes, new economy, oil shock, price stability, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, short selling, stocks for the long run, yield curve, Yogi Berra

The evidence of support in the railroad list and the ability of the average to hold only slightly under the resistance point are significant to the student of the averages. 8 July: [DJIA bottoms] 11 July: While Wall Street generally continues to pay more attention to fears of possible adverse news than to concrete actions which have tremendous potentialities for long-term improvement, there has been investment buying, both here and abroad. 11 July: Several leading stocks broke through their previous low levels late in the week, including American Telephone, Coca Cola, Eastman Kodak, Union Pacific, Public Service of N.J., International Shoe and International Business Machine. 11 July: Common stock of Coca Cola has been subject to considerable short selling… this selling, which has been by traders who believe that the return of beer of a higher alcoholic content than ½ of 1% is rapidly becoming a probability. Robert W. Woodruff, President of Coca Cola pointed out that in Montreal, where the sale of alcoholic beverages has been permitted for some time, sales of Coca Cola are more then double the per capita sales of the United States. 12 July: Shareholders of RCA numbered 103,851 on December 31, 1931.

[List shows 67 stocks 50% or more above their 1932 lows the day the market bottomed on 8 July.] 14 July: The Anglo-French accord agreeing to a united front on political and financial matters affecting the welfare of Europe, was the chief matter of interest. Foreign buying of American stocks has been in somewhat larger volume in the past few days according to some sources…For a period of months, from early March until late June, foreign trading in the market, except for occasional short selling, was relatively negligible. 15 July: The action of stocks in the face of quite a number of unfavourable developments, was particularly encouraging. Unquestionably, the hope of nearby adjournment of Congress, which might provide a stimulus for a rally, remained the prime factor in the upswing. [Congress adjourned next day]. 20 July: Interims coming to hand.The Street is resigning itself to the fact that most of them will not offer pleasant reading but on the other hand it is obvious that the securities of most of the companies reporting have long since discounted this fact. 22 July: At Thursday’s closing price Aluminium Co.

These positions for the most part were never closed in expectations of further unfavourable developments in this country…Previously convinced that the United States was headed for economic chaos, the sight of rising security prices brought conviction that the United States after all furnished the best opportunity for capital investment and appreciation. 5 August: In spite of evidence that many in the Street continued to fight the advance and that both short selling and profit-taking were in the market throughout the session, prices in most instances attained new highs in the most active market since October, 1931. 6 August: While prices eased during the afternoon, it was apparent that substantial resistance was being encountered on the decline, and there was no evidence of any major extension of the reaction. 8 August: The Street believes the short position in many stocks is still as large as it was a month ago a belief which the Exchange’s figures on the short interest as of August tends to bear out. 9 August: All capitals of Europe have probably done more trading in our securities in the past week than in over a year and certainly more buying that at any time since the 1929 crash. 12 August: In the face of the largest month’s percentage advance in the aggregate security values since the depression started, total known security loans declined $112,000,000 in July to the lowest level on record.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, business cycle, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, negative equity, Nelson Mandela, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, stocks for the long run, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, undersea cable, value at risk, Washington Consensus, Yom Kippur War

The next step was for banks to lend money so that shares might be purchased with credit. Company, bourse and bank provided the triangular foundation for a new kind of economy. For a time it seemed as if the VOC’s critics, led by the disgruntled ex-director le Maire, might exploit this new market to put pressure on the Company’s directors. A concerted effort to drive down the price of VOC shares by short selling on the nascent futures market was checked by the 1611 dividend payment, ruining le Maire and his associates.22 Further cash dividends were paid in 1612, 1613 and 1618.23 The Company’s critics (the ‘dissenting investors’ or Doleanten) remained dissatisfied, however. In a tract entitled The Necessary Discourse (Nootwendich Discours), published in 1622, an anonymous author lamented the lack of transparency which characterized the ‘self-serving governance of certain of the directors’, who were ensuring that ‘all remained darkness’: ‘The account book, we can only surmise, must have been rubbed with bacon and fed to the dogs.’24 Directorships should be for fixed terms, the dissenters argued, and all major shareholders should have the right to appoint a director.

securitization 4 of debt 10 federal government and 260 perils of 261 private bond insurers and 260 segregation 250-51 Self, Beanie 268 Senegal Company 141 Serbia 2 sexual language 351 shadow banking see banks Shakespeare, William, The Merchant of Venice 33-4 Shanghai 303 shanty towns 274 shares (or stocks or equities): as collateral 132 displacement 143-4 features of 120-26 Law’s System and 143 shareholders’ meetings 120 and First World War 302 see also options; stock markets Sharpe, William 323 Shaw-Stewart, Patrick 302 shells 30 Shettleston 38-40 Shiller, Robert 281 Shining Path 276 ships/shipping 127-8. see also marine insurance short positions 316 short selling 137 Shylock 33-5 sidecars 227 Siena 69 Silicon Valley see dot.com silver 19-26 and Mississippi Bubble 149-50 Spanish and 1 Simons, James 330 Singapore 337n. SIVs see structured investment vehicles Skilling, Jeffrey K. 169 slavery: and home ownership 267 Rothschilds and 93 slave trading 25 Sloan, Alfred 160 Slovenia 2 Smith, Adam 53 socialists: and bond markets 89-90 and liberalization 312 and welfare state 200-202 Socialist Standard 17-18 Song Hongbing 86 Soros, George 314-19 income 2 on ‘market fundamentalism’ 337 Sourrouille, Juan 112 South America 18-26 gas pipelines 119 property law 274-6 see also Latin America Southern Rhodesia 295 South Korea 233 South Sea Bubble see bubbles sovereign wealth funds 9 Soviet-style economics 213 Soviet Union see Russia/USSR Spain 36 declining empire 26 and gold and silver 1 property price boom 10 royal funding 52 Spanish Succession, War of the 156 special-purpose entitities (SPEs) 172-3 speciation 53 speculators 122. see also futures contracts Spencer, Herbert 351 spices 127 spreads 241 squatters 276-7 squirrel skins 25 Sri Lanka 134 stagflation 211 Standard and Poor’s (S&P) 268 Standard and Poor’s 500: 124n.

bd Since the term was first used, in 1966, to describe the long-short fund set up by Alfred Winslow Jones in 1949 (which took both long and short positions on the US stock market), most hedge funds have been limited liability partnerships. As such they have been exempted from the provisions of the 1933 Securities Act and the 1940 Investment Company Act, which restrict the operations of mutual funds and investment banks with respect to leverage and short selling. be Technically, according to the US Securities and Exchange Commission, a short sale is ‘any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller’. bf A swap is a kind of derivative: a contractual arrangement in which one party agrees to pay another a fixed interest rate, in exchange for a floating rate (usually the London interbank offered rate, or Libor), applied to a notional amount.


pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, break the buck, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Doomsday Book, eurozone crisis, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, housing crisis, Hyman Minsky, illegal immigration, implied volatility, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, Nate Silver, negative equity, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, savings glut, selection bias, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

Its liquidity pool had shrunk from $130 billion to $55 billion in a week; it was borrowing nearly $70 billion from the Fed to make up the difference. Its stock price fell 60 percent before word of the short-selling ban leaked. One New York Fed bank examiner reported in an email that a Citi executive had told her: “Morgan is the deer in the headlights.… It’s looking like Lehman did a few weeks ago.” And everyone on Wall Street knew that if Morgan went the way of Lehman, Goldman would be next. That would be more stress than the system could handle. WE WERE under no illusions that the short-selling ban or even the prospect of broad congressional relief would magically stop the run on the investment banks. Morgan and Goldman needed immediate solutions. As Blankfein put it later, this would be their “existential weekend.”

In May, the hedge fund manager David Einhorn, who had bet heavily against Lehman, publicly accused the firm of overly optimistic accounting, and in June, Lehman announced a $2.8 billion second-quarter loss, prompting Dick Fuld to oust his longtime deputy and demote his chief financial officer. Lehman’s stock price dropped nearly 75 percent below its peak. Fuld urged Hank and me to push the SEC to ban short selling, but that seemed like a shoot-the-messenger solution. The markets could see that Lehman was carrying assets at 80 or 90 cents on the dollar that other firms had written way down. And they were justifiably worried about what they couldn’t see. One thing we saw when our monitors dug into Lehman and the other investment banks was that their internal stress tests had not been very stressful. Most of them had never imagined that their repo funding could be vulnerable to a run, obviously a faulty assumption after Bear.

In fact, Hank’s guarantees were so powerful that FDIC chair Sheila Bair called him to say they could trigger a run on the banking system and threaten her agency’s insurance fund, by encouraging bank depositors with more than $100,000 in their accounts to shift their uninsured cash into money market funds. She was right—and to her credit, she had an alternative plan. She suggested Treasury should guarantee only investments that were in money funds before September 19, removing the incentive to shift cash out of FDIC-insured banks. Hank agreed. In yet another announcement that busy Friday, the SEC temporarily banned the short selling of 799 financial stocks, a heavy-handed effort to stop the stampede of speculation and rumor mongering. We all had reservations about this. It seemed to signal a debilitating lack of confidence in those 799 firms. I thought there was some risk that preventing investors from hedging their exposures would actually accelerate the flight to safety through other mechanisms. It felt like trying to ban risk aversion, or the expression of negative opinions about firms that often deserved them.


Global Governance and Financial Crises by Meghnad Desai, Yahia Said

Asian financial crisis, bank run, banking crisis, Bretton Woods, business cycle, capital controls, central bank independence, corporate governance, creative destruction, credit crunch, crony capitalism, currency peg, deglobalization, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, floating exchange rates, frictionless, frictionless market, German hyperinflation, information asymmetry, knowledge economy, liberal capitalism, liberal world order, Long Term Capital Management, market bubble, Mexican peso crisis / tequila crisis, moral hazard, Nick Leeson, oil shock, open economy, price mechanism, price stability, Real Time Gross Settlement, rent-seeking, short selling, special drawing rights, structural adjustment programs, Tobin tax, transaction costs, Washington Consensus

There is initially a financial liberalization of some sort and this leads to a significant expansion in credit. Bank lending increases by a significant amount. Some of this lending finances new investment but much of it is used to buy assets in fixed supply such as real estate and stocks. Since the supply of these assets is fixed the prices rise above their “fundamentals.” Practical problems in short selling such assets prevent the prices from being bid down as standard theory suggests. The process continues until there is some real event that means returns on the assets will be low in the future. Another possibility is that the central bank is forced to restrict credit because of fears of “overheating” and inflation. The result of one or both of these events is that the prices of real estate and stocks collapse.

liquidity, and a large number of wealthy, risk-neutral speculators who hope to make a profit in case some bank has to sell off assets cheaply to get liquidity. The speculators hold some cash (the safe asset) in order to purchase the risky asset when its price at date 1 is sufficiently low. The return on the cash is low, but it is offset by the prospect of speculative profits when the price of the risky asset falls below its fundamental value. Suppose the risk neutral speculators hold some portfolio (Ls, Xs). They cannot short sell or borrow. In equilibrium they will be indifferent between the portfolio (Ls, Xs) and putting all their money in the risky asset. The impact of introducing the asset market can be illustrated using Figure 3.3. The graphs in this figure represent the equilibrium consumption levels of early and late consumers, respectively, as a function of the risky asset return R. For high values of R (i.e. R R*), there is no possibility of a bank run.


pages: 290 words: 84,375

China's Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle by Dinny McMahon

2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, American Society of Civil Engineers: Report Card, Andrei Shleifer, Asian financial crisis, bank run, business cycle, California gold rush, capital controls, crony capitalism, dark matter, Deng Xiaoping, Donald Trump, Edward Glaeser, eurozone crisis, financial innovation, fixed income, Gini coefficient, if you build it, they will come, income inequality, industrial robot, invisible hand, megacity, money market fund, mortgage debt, new economy, peer-to-peer lending, Ponzi scheme, Ronald Reagan, short selling, Silicon Valley, too big to fail, trickle-down economics, urban planning, working-age population, zero-sum game

Hardly anyone was doing the sort of vetting that Carnes and Huang were doing—which sometimes was as simple as visiting the factories to make sure companies were actually producing what they claimed—so the lies went undetected. “We were watching the market explode, but we wouldn’t buy anything, because we didn’t trust the numbers,” Carnes told me. And so, after share prices doubled in 2009, Carnes and Huang decided to short Chinese companies instead. Short selling is a way to make money if share prices fall. Generally speaking, short sellers, or “shorts”—and particularly activist shorts like Carnes and Huang who publicize the reasons why they believe share prices should fall—are reviled by companies and investors and anyone else with an interest in keeping share prices buoyant. However, Carnes and Huang faced more serious risks than opprobrium and scorn.

See enforcers and enforcement pollution, 38–39, 98, 154, 186–87, 207 population, 171–73 price fixing, salt, 145–46 private companies Chinese interests and, 13–18 proliferation of, 103 raising money, 99–100, 130 product safety scandals, 204–5 propaganda department, Erzhong, 46 proprietary technology, 180 protectionism, 43, 183–87 protests of confiscated goods, 157–61 corruption, 150 of expropriation of land, 75–76, 81–82, 83 investment failures, 112 of laid-off workers, 34–35, 36 political system and, 202–3 pollution and product safety, 207 Pu Guolin, 40 Pudong, 57–58 Q Qiao Runling, 59 Qiu Zhiming, 178 quotas, 167 R R&D spending, 180–83 Raleigh, NC, 69–70 Rather, Dan, 118 Ravens, Robert, 191–93, 197–98, 203–4 Reagan, Ronald, 175–76 real estate, companies investing in, 131, 189–90 Ren Hongbin, 34 resources, for aging population, 171–73 resources, imported clothing brands, 138 cotton and wool, 138 iron ore, x-xi state-owned firms and, 28 “restless hand,” 12 Rio Tinto, 28 Rise and Fall of Nations, The (Sharma), xiii risk taking at Erzhong, 29 investments, 113 WMPs, 110 See also innovation Romero, George A., 35 rules, relationship to, 23–24, 103, 109 S salt market, 144–47, 151–52, 157–61 savings, 123, 176–77 Schultz, Howard, 197 shadow banking, 105–12, 135–36 Shandong Province, 37, 138 Shandong Ruyi Science and Technology Group, 138 Shang Fulin, 130 Sharma, Ruchir, xiii Shenfu, 72 Shenyang, 125–26 Shenzhen,180 Shi Changxu, 27–28, 31–32 Shiyan, 39–40 short selling, of Chinese companies, 4 Sichuan Province, 25, 45, 150–51 silver mining, corruption in, 1–6, 15–18 Silvercorp Metals, 3–6, 15–18 Sinomach, 33–35 skyscrapers, 125–28 smartphones, 67 social stability, 12, 36, 208–11 commitment to, 137 corruption, 150 land expropriations, 76 threats to, 153–54, 155 Soros, George, xv South Carolina, 168 South Korea, 47 Springs, Leroy, 166 Stahl, Lesley, 66 Starbucks, 197 state vs. private interests blurring of, 11–13 police and, 5, 6–7 state-owned firms, 6–7 China vs. elsewhere, 30–35 debt held by, 31–32 housing for, 84–86 lending and, 130 purpose of, 28 steel industry, 43, 183–86 stimulus, xiii-xiv stimulus (economic), 80, 108, 124 subprime mortgage crisis, 69–73, 86–87, 108, 111, 194 subsidies, 38 land, 41–42 paper, 184 steel industry, 184 Subsidies to Chinese Industry (Haley), 184 Sun Liping, 150, 155–56 supply-side structural reform, 175–78 Switzerland, pen industry, 179–80 T Taobao, 206 Tasmania, 191–93, 204 taxes, 19–21 construction, 65–66 incentives, 67 infrastructure, 73 land development, 92 Liaoning Province, 21–24 salt and, 144–45 urbanization and, 54–56 zombie companies, 36–37 teddy bears, lavender, 191–93 Tencent, 180 textiles manufacturing, 166–70, 173–75, 188–90 threats.


pages: 302 words: 80,287

When the Wolves Bite: Two Billionaires, One Company, and an Epic Wall Street Battle by Scott Wapner

activist fund / activist shareholder / activist investor, asset allocation, Bernie Madoff, corporate governance, corporate raider, Credit Default Swap, Mark Zuckerberg, Ponzi scheme, price discrimination, Ronald Reagan, short selling, Silicon Valley, Tim Cook: Apple, unbiased observer

., 41, 44 Founder’s Circle, 149 FTC investigation of, 154, 159, 190–191, 203 (see also Herbalife: settlement with FTC) growth of, 57, 58, 79, 200 independent compliance auditor (ICA) for, 201 investigative report by Richard/Schulman, 20 market cap, 209 membership of Preferred Members and Distributors, 200 “Newest Way to Health” program of, 48–49, 53 nutrition clubs of, 18–20, 58, 65–66, 158, 160, 161, 192 overseas markets of, 48, 55, 57, 58, 89, 163, 195 President’s Team Summit, 66–67 as pyramid scheme, 13, 19, 20, 21, 46, 54, 60, 75, 80, 81, 83, 89, 90, 109, 140 143, 145, 146, 150, 151, 161, 164, 167, 190, 194, 196, 197, 198, 199 recruiting by, 54, 77, 80, 181, 189–190, 191, 192, 197, 198, 213 sales, 48, 54, 59, 78, 79, 80, 81, 96, 97, 131, 164, 191, 198, 201 sales leaders, 163–164, 192 SEC investigation of, 96 settlement with FTC, 194–195, 196, 197, 198, 200–201, 205, 209 shutting down, 189–190 stock prices of, 48, 53, 54, 55, 57, 60, 73, 76, 81, 82, 83, 84, 85, 88, 90, 96, 97, 98, 100, 111, 113, 130, 132, 133, 134, 139, 140, 142, 148, 150, 151, 152, 154, 155, 161, 163, 164, 167, 180, 193, 195, 197, 206, 214, 215 sued by California attorney general, 46, 47 survey commissioned by Paul Sohn concerning, 135–136 taken public/private, 48, 49, 53, 112, 209 testimonial video about, 191–192 top distributors, 52 training materials of, 20–21 video about distributors of, 196–197 website about Ackman unveiled by, 178 winner/loser concerning, 212–213 See also short selling: of Herbalife shares Herbalife Foundation, 211 Herera, Sue, 60 Hertz, 184 Hilal, Paul, 17, 72 Hirsch, Douglas, 75, 76 Hispanic Federation, 142, 143 Hispanic Magazine, 145 Hispanics, 135, 142–143, 145, 189, 190 Hoffman, Alan, 176–178, 192, 194, 196, 197, 207 Howard Hughes Corporation, 137 HRPT Property Trust, 102 Huffington Post, 178 Hughes, Darcy, 41 Hughes, Mark Reynolds, 41–43, 44, 45–47, 53, 84 and Ackman, 85 death of, 41–42, 48, 52 testifying before Congress, 46–47 Iberra, Mickey, 145 Icahn, Carl C., 1, 2, 33–35, 110–129, 131, 142, 150, 156, 182, 183 and Apple, 184–188 buying Herbalife stock, 110–111, 207, 208–209 calls to CNBC, 104–109, 112 cash hoard of, 100 at Delivering Alpha conference, 147 father of, 120 and FTC settlement, 199 getting out of Herbalife, 203, 204, 205, 206–207 and Herbalife board seats, 131–132 Icahn Manifesto, 118–119 in medical school, 116 as poker player, 115, 116 taking Herbalife private, 203, 209 uncle of (see Schnall, Elliot) wealth of, 127, 128, 129 See also Ackman, William A.: and Icahn; Johnson, Michael O.: and Icahn Icahn & Company, 118 Icahn Partners, 127 Iger, Robert, 51, 52 Indago Group, 12, 64 Ingram, Robert, 175 insider trading, 125–126, 132–133, 169 Intelligent Investor, The (Graham), 26–27 interest rates, 2, 156 investment banks, 77, 126, 203, 205, 206 iPhones, 184, 187, 188 Ira W.

., 137–138, 144 Sánchez, Loretta, 144 Sard, George, 167–168 Saxon Industries, 120–121 Schaitkin, Keith, 34, 35, 111 Schechter, David, 186 Schiller, Howard, 181 Schnall, Elliot, 116–117, 118 Schuessler, Jack, 36 Schulman, Diane, 12, 20 Schultz, Howard, 40 Sears department store chain, 37 Securities and Exchange Commission (SEC), 1, 10, 63, 64, 88, 91, 96, 112, 121, 125, 128, 139, 149, 150, 170, 205 investigating Ackman, 180 and Madoff, 190 Seyforth, Mark, 43–44 shale gas, 183 shareholder activists, 1–4, 9, 29, 36, 70, 82, 119, 127 impact on corporate culture, 213–214 share prices decreases, 6, 11, 16, 32, 38, 39, 63, 64, 71, 76, 82, 83, 93, 94, 100, 117, 119, 133, 151, 152, 154, 155, 163, 164, 174, 175, 179, 183–184, 187, 188, 193, 206 increases, 2, 3, 32, 36, 68, 70, 71, 84, 85, 88, 96, 97, 113, 129, 133, 134, 139, 140, 148, 150, 161, 165, 168, 169, 171, 180, 182, 183, 184, 187, 188, 195, 197, 211 Kennedy Slide on Wall Street (1962), 117 See also Herbalife: stock prices of; Valeant pharmaceutical company: stock prices of Shaw, Bryan, 133 short selling, 10, 12, 13, 30, 31, 59, 62, 63, 83, 108, 127, 147, 170, 174 of Herbalife shares, 17, 64–65, 66, 68, 72, 73, 75, 76, 109, 147, 148–149, 199, 201–202 and short squeezes, 85, 106, 107, 112, 139, 148, 202, 203, 215 Silverman, Howard, 117 Simplicity Pattern, 121 Singapore, 58 Singer, Paul, 164 Slater, Robert, 120 Slendernow company, 43, 44 Small Business Administration, 62 Société du Louvre, 113 Sohn, Paul, 134–137, 138–139, 143 Sohn special event, 75–81.


pages: 504 words: 143,303

Why We Can't Afford the Rich by Andrew Sayer

accounting loophole / creative accounting, Albert Einstein, anti-globalists, asset-backed security, banking crisis, banks create money, basic income, Boris Johnson, Bretton Woods, British Empire, business cycle, call centre, capital controls, carbon footprint, collective bargaining, corporate raider, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, crony capitalism, David Graeber, David Ricardo: comparative advantage, debt deflation, decarbonisation, declining real wages, deglobalization, deindustrialization, delayed gratification, demand response, don't be evil, Double Irish / Dutch Sandwich, en.wikipedia.org, Etonian, financial innovation, financial intermediation, Fractional reserve banking, full employment, G4S, Goldman Sachs: Vampire Squid, high net worth, income inequality, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), investor state dispute settlement, Isaac Newton, James Dyson, job automation, Julian Assange, Kickstarter, labour market flexibility, laissez-faire capitalism, land value tax, low skilled workers, Mark Zuckerberg, market fundamentalism, Martin Wolf, mass immigration, means of production, moral hazard, mortgage debt, negative equity, neoliberal agenda, new economy, New Urbanism, Northern Rock, Occupy movement, offshore financial centre, oil shale / tar sands, patent troll, payday loans, Philip Mirowski, plutocrats, Plutocrats, popular capitalism, predatory finance, price stability, pushing on a string, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, Steve Jobs, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transfer pricing, trickle-down economics, universal basic income, unpaid internship, upwardly mobile, Washington Consensus, wealth creators, WikiLeaks, Winter of Discontent, working poor, Yom Kippur War, zero-sum game

They may use hedging to protect themselves against losses, but they mostly use financial instruments aggressively rather than defensively, profiting from leveraged speculation on changes in the prices of assets, whether they be stocks, bonds, currencies, commodities like gold, copper or oil, or derivatives, and by buying up bankrupt and undervalued companies. They seek to profit from both rises and falls in prices, by buying assets in the hope that they will rise in price, or short-selling where they expect prices to fall. These are not merely responses to market shifts but ways of influencing those shifts, for example by inflating bubbles: they are weapons, not tools, as Ewald Engelen and co-researchers argue.137 On ‘Black Wednesday’, 16 September 1992, multi-billionaire George Soros made £1 billion by short-selling sterling – in anticipation of its being ejected from the European Exchange Rate Mechanism. In effect, he saw that the pound was overvalued, took on the Bank of England when it made frenzied efforts to defend the currency, and won.138 When the previously much-lauded Northern Rock bank got into trouble in 2008, hedge funds short-sold its shares and then bought them up when they’d hit rock bottom.139 When, in 2013, the UK’s Royal Mail was privatised by issuing shares at far below the market price, it was an aggressive hedge fund that became the largest shareholder.

This may benefit borrowers in the former case – or stimulate predatory lending. In the countries where interest rates are low, perhaps as a matter of policy for supporting investment, the carry trade switches funds away, undermining such policies. Attempts at national self-determination of economic development are frustrated. Speculators can make money on both sides of a bubble – not only buying in order to sell on the upside, but ‘short-selling’ on the downside. The latter practice works like this Imagine that prices of certain common, frequently traded shares, such as those of an oil company are expected to fall or already falling. The short-seller agrees to borrow some shares from an existing owner for a period of time, say six months, for a fee. If he (usually he) then sells them straightaway for, say, £10 each, and then later, when the price has fallen to £7, buys the same number of shares back at that price, he will then be able to return them to the original owner having made £3 per share minus the fee for borrowing them.


I Love Capitalism!: An American Story by Ken Langone

activist fund / activist shareholder / activist investor, Berlin Wall, Bernie Madoff, Bernie Sanders, business climate, corporate governance, East Village, fixed income, glass ceiling, income inequality, Paul Samuelson, Ronald Reagan, short selling, Silicon Valley, single-payer health, six sigma, VA Linux, Y2K, zero-sum game

See also specific stores Dole, Bob, 171 Donaldson, Bill, 183 Donovan, Dennis, 214 Drelles, Speros “Doc,” 126–27, 143–44, 168 Drexel, 79, 160 Dreyfus Corporation, 163, 169 Dreyfus Fund, 169 Druckenmiller, Fiona, 179 Druckenmiller, Stanley, 143–44, 168–69, 179, 265 Dunne, Frank, 78 Duquesne Capital, 169 Educator & Executive Life Insurance Company, 124 Edwards, Charlie, 123, 128–29 El Salvador, 263–64 Elderfields Road (Manhasset), 84–85, 117, 123 Electronic Data Systems (EDS), 111, 147, 152, 184 co-founder of, 167 and Collins Radio takeover, 102–3, 107–8 investing in, 102, 108, 123 IPO of, 91–99, 101–2 short-selling stocks of, 112–13 Elfun Trusts, 67–69 Eli Lilly, 144–45, 169, 255 Enron scandal, 186, 217 entrepreneurial ventures, 6–9, 23–26, 265 Epic Systems, 256 Epstein, Lou, 64–67 equipment trust certificates (ETCs), 36 Equitable Life, 64 and Bill McCurdy, 34–36, 46, 88–89 pays NYU tuition, 44 working at, 32–41, 44–47, 52–54, 56–57, 59 equities, 56, 73, 111, 117, 122, 160, 255 Erlbaum, Gary, 123, 129–31, 133, 163–66, 168, 265 Erlbaum, Steven and Michael, 129–30, 265 Evans Products, 81–83, 129–30 F.

Patrick’s Cathedral (New York City), 239, 243 Salem Leasing, 241, 252–53 salesmen, 54–64, 75–79, 105, 111, 125, 180, 250–51 Salomon Brothers, 90, 92, 112, 175, 247 Samuelson, Paul, 13 San Diego, California, 117–19, 121, 137, 144–45, 222 San Jose, California, 147–48 Sanders, Bernie, 249 Sands Point, Long Island, 117, 197 Sato, Steve, 121, 144, 235 Schapiro, Mary, 194–95, 200 Schenectady, New York, 209–10, 213 Schwartz, Alan, 114–15 Scott, Blaine, 98–99 Scruggs, Leonard Coe, 125 Sealy, 124, 139 Sears, 64, 254, 258 Seaver, Harry, 73 securities, 33, 41, 45, 50, 55, 57, 81, 117, 183, 192, 248 Securities and Exchange Commission (SEC), 59, 102–7, 119–21, 183 Security Pacific Bank (Los Angeles), 158–59 September 11, 2001, 185 Sexton, John, 197 Shearson, 163 Shearson, Hammill, 26–27, 69 Showalter, Paul, 17 Shroyer, Bruce, 78 Siemens, 181, 196–98 Sigma Chi fraternity, 13, 15–17, 24–25 Sigoloff, Sanford “Sandy,” 132, 138, 140–43, 145–52, 155 Silverman, Henry, 176–77 Singer, Paul, 223 Six Sigma management, 214 Skadden, Arps, 141 Sleeper, Matt, 24–26 Smilow, Joel, 179 Smith, Austin, 124 Smith, Bryan, 153 Smith, Derek, 168 Smutny, Rudy, 90, 108–10, 112, 122 Snowden, Herb, 124 socialism, 249–50 Somerville Lumber, 130 Southeast Bank (Miami), 155 Soviet Union, 46 Specter, Arlen, 171 Spector, Joe, 40–41 Spencer, Frank, 178–79 spirituality, 237–39, 242 Spitzer, Eliot, 187–88, 190–93, 195–96, 198–203, 217 Sporkin, Stanley, 105–7 stabilization rule, 103, 106–7 Standard Oil of New Jersey, 69–74 Standel, Paul, 124 statistics, 36–38 steel industry, 18–19, 56, 68–69, 184 Stein, Howard, 169 Steiner, Al and Phil, 58–63, 65 Steinhaus, Al, 166 Stern, Leonard, 175 Stirling Homex, 111–12 stock market, 161 analysts of, 71–75 “bear,” 124–25 “bull,” 192 computerization of, 183–84 downturns in, 52, 56–57, 59, 112, 188 rises in, 56, 192 See also New York Stock Exchange (NYSE) stocks common, 128–29, 155, 161 and “cram down,” 141 dividends for, 123, 144 inflating prices of, 187 large-cap, 255–56 nonqualified owners of, 119–21 options, 208, 210, 217, 219–20, 231, 245–46 preferred, 129, 155, 160–61 and proxy dispute, 119, 121, 223–25 publicly held, 131, 133–34, 139–40 secondary offerings of, 103 short selling of, 112–13 small float for, 112 strike price of, 208, 219–20, 246 value of, 93, 95, 98, 112–13, 131, 139–40, 144, 217 See also initial public offerings (IPOs); New York Stock Exchange (NYSE); specific companies subprime finance companies, 166 Summers, Bill, 189 Suozzi, Tom, 199 supply and demand, 14, 22–24, 57 Taft Stettinius & Hollister, 62–63 takeovers, unfriendly, 101–2, 150–51 Taussig, Andy, 224–25 taxes, 2, 86, 96–97, 138, 185, 200, 220, 252 Teague, Tommy, 241, 252–53 technology companies, 101, 118, 164, 167–68, 181, 185, 196–98, 244, 255–57.


pages: 304 words: 99,836

Why I Left Goldman Sachs: A Wall Street Story by Greg Smith

always be closing, asset allocation, Black Swan, bonus culture, break the buck, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, East Village, fixed income, Flash crash, glass ceiling, Goldman Sachs: Vampire Squid, high net worth, information asymmetry, London Interbank Offered Rate, mega-rich, money market fund, new economy, Nick Leeson, quantitative hedge fund, Renaissance Technologies, short selling, Silicon Valley, Skype, sovereign wealth fund, Stanford marshmallow experiment, statistical model, technology bubble, too big to fail

The VIX is widely followed and traded as a gauge of fear in the marketplace.) A lot of Daffey’s popularity stemmed from senior management’s sheer awe at his client base, which consisted of the biggest, smartest macro hedge funds in the world. Hedge funds are investment funds that can undertake a wide range of strategies, both going long (buying an asset with the view that it will rise in value) and getting short (selling an asset without actually owning it, betting it will go down in value). Because these funds are not highly regulated, they are open only to very large investors such as pension funds, university endowments, and high-net-worth individuals. Macro hedge funds—named for their tendency to bet on big-picture events such as movements in interest rates and currencies, as opposed to stock prices—command exceptional respect.

Handle: A term to describe the general level where a security is trading. If Google were trading at $634, you would say it was trading with a 6 handle. Or, applied to civilian life, “Jim put on so much weight, he is now trading with a 3 handle” (i.e., more than 300 pounds). Hedge fund: An investment fund that can undertake a wide range of strategies, including using leverage and derivatives, both going long (buying) and getting short (selling, without actually owning the asset). Because hedge funds are not highly regulated, they are only open to very large investors, such as pension funds, university endowments, and high-net-worth individuals. High-net-worth individuals: A polite term for people who are mega-rich or loaded. Hit a bid: To sell something at the price the market maker is willing to pay for it (i.e., the bid price).


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

asset allocation, buy and hold, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, post-work, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

The Rules of the Game The rules of the game and the appropriate behavior of its players also must be regulated. However, I hold as a general principle that government should, under nearly all circumstances, keep its hands off the free functioning of the marketplace. I wince when the Federal Reserve states its intention to raise asset prices—including “higher stock prices”—apparently irrespective of the level of underlying intrinsic stock values. Substantive limits on short selling are another nonstarter for me. The overriding principle should be: Let the markets clear, at whatever prices that willing and informed buyers agree to pay to willing and informed (but often better-informed) sellers. Individual investors need to wake up. Adam Smith–like, they need to look after their own best interests. Of course, that would mean that individual investors must demand much better, clearer, and more pointed disclosures.

If that principle holds in the ETF field—as it has done thus far in its relatively brief history—the substantially higher volatility of the ever-narrower sectors bodes ill for the returns that ETF investors actually earn. ETFs have continued to move away from simplicity and toward complexity. As this trend accelerates (I assume to no one’s surprise), obvious problems have arisen. While leveraged ETFs were designed to multiply the stock market’s gain for the bulls (or multiply its gains for the short-selling bears), it turns out that while the multiplier (now usually triple leverage) works well on a daily basis, it fails to deliver on that goal as days turn to months and then years. For example, the ProShares Ultra S&P 500 ETF seeks to double the return of the S&P 500 on a daily basis. But over the last five years, the ETF has produced a total return of −25 percent, while the index itself provided a return of 10.5 percent.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, business cycle, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, John Meriwether, joint-stock company, Kenneth Rogoff, Kickstarter, labour market flexibility, light touch regulation, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, negative equity, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, plutocrats, Plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce, zero-sum game

The theory assumes that news is automatically reflected in share prices, that there are no constraints on investors and that the market is populated (or at least dominated) by rational investors poring over each company’s accounts. In fact, investors can be shown to have a number of biases, such as selling their winning stocks and hanging on to their loss-makers. Efficient markets would allow investors to be able to sell short (i.e., bet on falling prices) as easily as they can bet on rising ones, but in fact regulators impose a host of restrictions on short-selling. History is also full of market anomalies, such as the over-performance of stocks in the month of January or the better performance of smaller companies. It is also hard to argue that markets are always efficiently priced when stocks were worth 23 per cent less on 20 October 1987 than they were worth at the start of trading the day before. Nevertheless, Alan Greenspan stuck to this view pretty consistently, even during the dot.com bubble, when companies with no declared profits or dividends were being valued at billions of dollars.

Rubin, Robert Rueff, Jacques Rumsfeld, Donald Russia Sack, Alexander St Augustine Saint-Simon, duc de Salamis (city) Santelli, Rick Sarkozy, Nicholas Saudi Arabia savings savings glut Sbrancia, Belen Schacht, Hjalmar Scholes, Myron shale gas Second Bank of the United States Second World War Securities and Exchange Commission seignorage Shakespeare, William share options Shiller, Robert short-selling silver Singapore Sloan, Alfred Smith, Adam Smith, Fred Smithers & Co Smithsonian agreement Snowden, Philip Socialist Party of Greece social security Société Générale solidus Solon of Athens Soros, George sound money South Africa South Korea South Sea bubble sovereign debt crisis Soviet Union Spain special drawing right speculation, speculators Stability and Growth pact stagnation Standard & Poor’s sterling Stewart, Jimmy Stiglitz, Joseph stock markets stop-go cycle store of value Strauss-Kahn, Dominque Strong, Benjamin sub-prime lending Suez canal crisis Suharto, President of Indonesia Sumerians supply-side reforms Supreme Court (US) Sutton, Willie Sweden Swiss franc Swiss National Bank Switzerland Sylla, Richard Taiwan Taleb, Nassim Nicholas taxpayers Taylor, John tea party (US) Temin, Peter Thackeray, William Makepeace Thailand Thatcher, Margaret third world debt crisis Tiernan, Tommy Times Square, New York tobacco as currency treasury bills treasury bonds Treaty of Versailles trente glorieuses Triana, Pablo Triffin, Robert Triffin dilemma ‘trilemma’ of currency policy Truck Act True Finn party Truman, Harry S tulip mania Turkey Turner, Adair Twain, Mark unit of account usury value-at-risk (VAR) Vanguard Vanity Fair Venice Vietnam War vigilantes, bond market Viniar, David Volcker, Paul Voltaire Wagner, Adolph Wall Street Wall Street Crash of 1929 Wal-Mart wampum Warburton, Peter Warren, George Washington consensus Weatherstone, Dennis Weimar inflation Weimar Republic Weinberg, Sidney West Germany whales’ teeth White, Harry Dexter William of Orange Wilson, Harold Wirtschaftswunder Wizard of Oz, The Wolf, Martin Women Empowering Women Woodward, Bob Woolley, Paul World Bank Wriston, Walter Xinhua agency Yale University yen yield on debt yield on shares Zambia zero interest rates Zimbabwe Zoellick, Robert Philip Coggan is the Buttonwood columnist of the Economist.


pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

bank run, banking crisis, banks create money, Basel III, Bretton Woods, business cycle, call centre, capital controls, cashless society, central bank independence, credit crunch, David Graeber, debt deflation, double entry bookkeeping, eurozone crisis, financial exclusion, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, informal economy, information asymmetry, intangible asset, land reform, London Interbank Offered Rate, market bubble, market clearing, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, negative equity, Northern Rock, price stability, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, risk-adjusted returns, seigniorage, shareholder value, short selling, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, unorthodox policies

When applied to economics and banking, disaster myopia explains the psychological reasons why bankers are unable to incorporate the risk of asset prices falling into their lending decisions. An example of disaster myopia can be seen in Herring and Wachter’s (2002) model, in which real estate markets are prone to bubbles because the supply of real estate is fixed (in the short term) and difficult to short sell. As a result house prices rarely fall, and this leads to disaster myopia amongst bankers, who therefore lend more money than they otherwise would into the property market, pushing up prices in the process. Disaster myopia also occurs during a crash. The occurrence of a low frequency shock (such as a bubble bursting in the housing market) in the recent past leads decision makers to overestimate the probability of a similar shock occurring soon after.

A recent working paper by economists at the IMF unpicks this common interpretation of events: “The Reichsbank president at the time, Hjalmar Schacht, put the record straight on the real causes of that episode in Schacht (1967). Specifically, in May 1922 the Allies insisted on granting total private control over the Reichsbank. This private institution then allowed private banks to issue massive amounts of currency, until half the money in circulation was private bank money that the Reichsbank readily exchanged for Reichsmarks on demand. The private Reichsbank also enabled speculators to short-sell the currency, which was already under severe pressure due to the transfer problem of the reparations payments pointed out by Keynes (1929). It did so by granting lavish Reichsmark loans to speculators on demand, which they could exchange for foreign currency when forward sales of Reichsmarks matured. When Schacht was appointed, in late 1923, he stopped converting private monies to Reichsmark on demand, he stopped granting Reichsmark loans on demand, and furthermore he made the new Rentenmark non-convertible against foreign currencies.


pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

"Robert Solow", accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, Black Swan, Bretton Woods, business cycle, buy and hold, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, information asymmetry, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, Philip Mirowski, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, savings glut, short selling, structural adjustment programs, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, unorthodox policies, value at risk, Washington Consensus, zero-sum game

Rather than simply rely on passive correlations that are out there in the world to ensure your safety, such as the inverse relationship that typically prevails between the USD and the euro, banks can adopt particular strategies, or trade derivative instruments with specific characteristics, so that the gains from one set of exposures covers (hedges) any losses in another.23 In principle then, a combination of portfolio diversification and hedging—if appropriately executed in a given market environment—will at the very least keep your investments safe. Think the market will go down? Short sell one asset (profit from a stock price falling by borrowing the stock for a fee, selling it, and then buying it back when its cheaper), and take a long position (buy and hold) in an uncorrelated asset as cover. Want to benefit from the market going up? Use options (the right to buy or sell an asset at a predetermined price) to increase leverage (amplify the bet) while taking a short position as cover.

See risk-management techniques Portugal, 3, 4 bailout in, 71–73 Eurozone Current Account Imbalances, 78 fig. 3.1 Eurozone Ten-Year Government Bond Yields, 80 fig. 3.2 government debt 2006–2012, 47 fig. 2.3 slow growth crisis, 68–71 “Positive Theory of Fiscal Deficits and Government Debt in a Democracy, A” (Alesini), 167 Posner, Richard, 55 Prescott, Edward, 55, 157 President’s Conference on Unemployment, 120 Prices and Production (Hayek), 144 Principles of Political Economy (Mill), 116 Quiggin, John, 55 and Australian expectations-augmented austerity, 209 “zombie economics”, 10, 234 Rand, Ayn Atlas Shrugged, 130 rational expectations hypothesis, 42 Real Business Cycle school, 157 real estate “collateralized debt obligation”, 28 “tranching the security”, 28, 30–31 equity, 28 mezzanine, 28 senior, 28 “uncorrelated within their class”, 27–28 REBLL alliance, 103, 178–180, 179–180, 205, 216–226, 217 fig. 6.1 GDP and consumption growth in 2009, 221 table 6.1 See also names of countries recapitalization, 45, 52 Reinhardt, Carmen, 11, 73, 241 Ricardian equivalence, 41, 49 Ricardo, David, 115–117, 117–119, 171 in Germany, 195 risk-management techniques, 49 hedging, 32 long position, 32 options, 32 portfolio diversification, 31 short sell, 32 Ritschl, Albrecht, 193 Road to Serfdom, The (Hayek), 144 Robins, Lionel, 144 Robinson, Joan, 122, 126 Rodrik, Dani, 162, 163 Rogoff, Kenneth, 11, 73 Romania austerity in, 18, 103, 190, 216–226, 217 fig. 6.1, 221 Romney, Mitt, 243 Roosevelt, Franklin Delano, 126 administration policies, 128 balancing the budget, 188 Röpke, Wilhelm, 138 Rothbard, Murray, 148 Sachs, Jeffrey, 60 Saez, Emanuel, 243 Say’s law, 137 Sbrancia, M.


Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals by David Aronson

Albert Einstein, Andrew Wiles, asset allocation, availability heuristic, backtesting, Black Swan, butter production in bangladesh, buy and hold, capital asset pricing model, cognitive dissonance, compound rate of return, computerized trading, Daniel Kahneman / Amos Tversky, distributed generation, Elliott wave, en.wikipedia.org, feminist movement, hindsight bias, index fund, invention of the telescope, invisible hand, Long Term Capital Management, mental accounting, meta analysis, meta-analysis, p-value, pattern recognition, Paul Samuelson, Ponzi scheme, price anchoring, price stability, quantitative trading / quantitative finance, Ralph Nelson Elliott, random walk, retrograde motion, revision control, risk tolerance, risk-adjusted returns, riskless arbitrage, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, source of truth, statistical model, stocks for the long run, systematic trading, the scientific method, transfer pricing, unbiased observer, yield curve, Yogi Berra

A similar logic applies to the costs of acting on information (e.g., commissions, slippage, bid-asked spreads). Unless investors were compensated for incurring trading costs there would be no point to their trading activities, which are required by EMH to move the price to its rational level. The bottom line is that any factor that limits trading—costs to trade, costs to generate information, the rule that impairs short-selling, and so forth—limits the ability of the market to attain efficiency. It simply does not hold logically that there would be no compensation to those engaged in trading. The Assumptions of EMH To appreciate the arguments made by EMH’s critics, it is necessary to understand that EMH rests on three progressively weaker assumptions: (1) investors are rational, (2) investors’ pricing errors are random, and 344 METHODOLOGICAL, PSYCHOLOGICAL, PHILOSOPHICAL, STATISTICAL FOUNDATIONS (3) there are always rational arbitrage investors to catch any pricing errors.

As envisioned by efficient market advocates, an arbitrage trade goes something like this: Consider two financial assets, stocks X and Y, which sell at equal prices and which are equally risky. However, they have different expected future returns. Obviously, one of the two assets is improperly priced. If asset X has a higher future return, then to take advantage of the mispricing, arbitrageurs would buy asset X while short-selling Y. With the activities of like-minded arbitrageurs, the price of each stock will converge to its proper fundamental value.29 Market efficiency attained in this manner assumes there are always arbitrageurs ready, willing, and able to jump on these opportunities. The better ones become very wealthy, Theories of Nonrandom Price Motion 345 thereby enhancing their ability to drive prices to proper levels, while the irrational investors eventually go broke losing their ability to push prices away from equilibrium levels.

If the observations are serially correlated, as might be the case in a time series, the variance reduction is slower than the square root rule suggests. 36. The population has a finite mean and a finite standard deviation. 37. The general principle that bigger samples are better applies to stationary processes. In the context of financial market time series, which are most likely not stationary, old data may be irrelevant, or even misleading. For example, indicators based on short selling volume by NYSE specialists seem to have suffered a decline in predictive power. Larger samples may not be better. 38. The Central Limit Theorem applies to a sample for which observations are drawn from the same parent population, which are independent, and in which the mean and standard deviation of the parent population are finite. 39. This figure was inspired by a similar figure in Lawrence Lapin, Statistics for Modern Business Decisions, 2nd ed.


pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

algorithmic trading, asset-backed security, bank run, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, buy and hold, collateralized debt obligation, computer age, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, large denomination, Long Term Capital Management, market bubble, Martin Wolf, Menlo Park, mobile money, money market fund, Monroe Doctrine, moral hazard, mortgage debt, Myron Scholes, new economy, oil shale / tar sands, oil shock, old-boy network, peak oil, plutocrats, Plutocrats, Ponzi scheme, profit maximization, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, shareholder value, short selling, sovereign wealth fund, The Chicago School, Thomas Malthus, too big to fail, trade route

Few senators, congressmen, and treasury officials, however happy to bluster on the fiscal ramparts attacking federal deficits, showed any parallel disturbance over private sector debt and fiscal legerdemain—at least not before August opened the private debt sector equivalent of Pandora’s box. Before long, scrutiny had exposed the largest array of financial abuses since congressional hearings on 1920s practices amplified the basis for an eventual barrage of New Deal statutes. Some of these had involved regulating securities markets, undocumented securities issuance, short selling, margin trading, and housing loans; others called for requiring federal deposit insurance and the divorce of commercial banking from the securities business; and still others specified prohibiting open-market operations by individual Federal Reserve banks, the operation of “pools” within exchanges, so-called bucket shops, the private ownership of gold, and more. The seventy-year-old list itself is less important than its strong hint of yet another regulatory wave.

One pioneer, Professor Merton Miller, for years a board member of the Chicago Mercantile Exchange, enthused over derivatives as “essentially industrial raw materials” created to deal with uncertainty and volatility. He argued that “contrary to the widely held perceptions, derivatives have made the world a safer place, not a more dangerous one.”7 But professors frequently go overboard. In 1990, when U.S. economist William Sharpe, in accepting his Nobel Prize, insisted that unrestricted short selling was necessary for efficient markets, wags pointed out that it was restricted even in the United States.8 Over the years, a handful of critical academicians and several billionaire investors—Warren Buffett, George Soros, and William H. (Bill) Gross—would emerge as relentless critics of derivatives, bubbles, and alleged market efficiency. Yale’s Robert Shiller scoffed at the Efficient Market Hypothesis, commenting after the 1987 crash that the “efficient market hypothesis is the most remarkable error in the history of market theory.


pages: 385 words: 118,901

Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street by Sheelah Kolhatkar

Bernie Madoff, Donald Trump, family office, fear of failure, financial deregulation, hiring and firing, income inequality, light touch regulation, locking in a profit, margin call, medical residency, mortgage debt, p-value, pets.com, Ponzi scheme, rent control, Ronald Reagan, short selling, Silicon Valley, Skype, The Predators' Ball

Was the government supposed to be looking into possible allegations of fraud at Fairfax or criminal activity of short sellers at hedge funds who were shorting Fairfax stock? Cantwell wanted Bowe to explain every aspect of Fairfax’s 160-page complaint. Bowe spent the next three hours describing the charges and the evidence behind them, telling them about SAC and the other hedge funds Fairfax believed were targeting them, the false rumors and prank phone calls, the short selling and the allegations of insider trading. While he spoke, Kang took notes. The atmosphere was chilly, but Cantwell said that they would look into Fairfax’s claims against the hedge funds. She thanked him and said goodbye. — Michael Bowe was not raised to avoid conflict. In some ways he sought it out. Most everything he knew about life he’d learned growing up in Pearl River, a town an hour north of Manhattan crammed with Irish bars and knickknack shops.

Though his role was supposed to be secret, he immediately told Martoma. As the keynote presenter at the conference, Gilman would be one of the first people to have access to the full, unblinded bapi test results. Elan and Wyeth worked to ensure that there wouldn’t be any leaks. While Gilman was getting ready to present the drug trial results to the rest of the world, the stock market continued to crash. On July 15, the SEC issued an emergency ban on short selling of financial stocks in an attempt to calm the market, a desperate measure that only served to scare investors even more. Watching SAC’s portfolios lose money every day was an unusual experience for Cohen, and one he did not enjoy. He had lost all confidence that the situation could be brought under control through government intervention or anything else. He sent a company-wide email, warning of further financial violence.


The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, Moorad Choudhry

asset allocation, asset-backed security, bank run, Bretton Woods, buy and hold, collateralized debt obligation, credit crunch, discounted cash flows, discrete time, disintermediation, fixed income, high net worth, intangible asset, interest rate derivative, interest rate swap, large denomination, locking in a profit, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, money market fund, moral hazard, mortgage debt, paper trading, Right to Buy, short selling, stocks for the long run, time value of money, value at risk, Y2K, yield curve, zero-coupon bond, zero-sum game

For example, on November 14, 2001, Bloomberg reports the on-the-run 5year Treasury note (3.5% coupon maturing November 15, 2006) was “on special” such that the overnight repo rate was 0.65%. At the time, the general collateral rate was 2.13%. There are several factors contributing to the demand for special collateral. They include: ■ government bond auctions—the bond to be issued is shorted by dealers in anticipation of new supply and due to client demand; ■ outright short selling whether a deliberate position taken based on a trader’s expectations or dealers shorting bonds to satisfy client demand; 7 Perhaps the issue is in great demand to satisfy borrowing needs. Repurchase and Reverse Repurchase Agreements 131 ■ hedging including corporate bonds underwriters who short the relevant maturity benchmark government bond that the corporate bond is priced against; ■ derivative trading such as basis trading creating a demand for a specific bond; ■ buy-back or cancellation of debt at short notice.

See Defensive securities; U.S. government securities amortization, 105 borrowing/lending, 124 dealer, 69 holders, payment, 154 lending, 122 market, 138 life, 109 on special, 132, 257 par amount, 28 purchase, 212 reversing in, 123 reversing out, 122 specialness, 131 Securities and Exchange Act of 1933, 68 Securities and Exchange Commission (SEC), 68 Rule 415, 81 shelf registration, 83 Securities Industry Association Standard Securities Calculation Methods, 7 Security Description (DES), 13, 50, 54, 60, 82 presentation, 177, 184, 194– 195, 201, 205 Security Display (DES), 8, 10 Segregated customer account, 127 Self-liquidating commercial transaction, 97 Seller, 119–120, 126 margin amount, 144 margin percentage, 144 Seller/servicer, quality, 187 Selling Group of Discount Note Dealers, 48 Semiannual interest rate, determination, 21 Senior tranche, 182–183, 192 cash flow characteristics, 184 Senior/subordinated structures, 181–183 Sequential (SEQ), 190 Sequential-pay CMOs, 162, 175 structures, 168 Sequential-pay tranche (SEQ), 162–168, 202 Servicing fee, 154 spread, 152 Setting date, 234 Settlement date, 113, 210, 216, 223. See also Forward rate agreements; Swaps usage, 232 day, 74 difference. See Quote/settlement frequency. See Fixed-rate payments payment, 214 price, 211 sum, 223 Settlement money, 120, 125, 137 326 Shelf registration. See Securities and Exchange Commission Shifting interest structure, 183 Short cash, 2 Short futures, 210 Short positions, 210, 225 covering, 133 Short selling, 130 Short-dated yield curve, 130 Short-duration portfolios, 161 Short-run liabilities, excess, 285 Short-term ABS, 5, 187 Short-term assets, 285 Short-term balloon loan, 153 Short-term borrowing, 153 Short-term debt, 66, 292 instruments, 4, 85 obligations, 46 Short-term discount instruments, 23 Short-term fixed-rate products, 101, 151 Short-term fluctuations, 292 Short-term funding requirement, 87–88 Short-term funds, 68.


pages: 573 words: 115,489

Prosperity Without Growth: Foundations for the Economy of Tomorrow by Tim Jackson

"Robert Solow", bank run, banking crisis, banks create money, Basel III, basic income, bonus culture, Boris Johnson, business cycle, carbon footprint, Carmen Reinhart, Cass Sunstein, choice architecture, collapse of Lehman Brothers, creative destruction, credit crunch, Credit Default Swap, David Graeber, decarbonisation, dematerialisation, en.wikipedia.org, energy security, financial deregulation, Financial Instability Hypothesis, financial intermediation, full employment, Growth in a Time of Debt, Hans Rosling, Hyman Minsky, income inequality, income per capita, Intergovernmental Panel on Climate Change (IPCC), Internet of things, invisible hand, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Rogoff, Kickstarter, laissez-faire capitalism, liberal capitalism, Mahatma Gandhi, mass immigration, means of production, meta analysis, meta-analysis, moral hazard, mortgage debt, Naomi Klein, new economy, offshore financial centre, oil shale / tar sands, open economy, paradox of thrift, peak oil, peer-to-peer lending, Philip Mirowski, profit motive, purchasing power parity, quantitative easing, Richard Thaler, road to serfdom, Robert Gordon, Ronald Reagan, science of happiness, secular stagnation, short selling, Simon Kuznets, Skype, smart grid, sovereign wealth fund, Steve Jobs, The Chicago School, The Great Moderation, The Rise and Fall of American Growth, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, universal basic income, Works Progress Administration, World Values Survey, zero-sum game

A year in the Keynesian sun This understanding should have led to a profound re-examination of the growth-based economic paradigm. But very little of that actually happened. The mainstream response had more the character of an addict reaching for the bottle to cure a hangover from the night before. Anything, to get growth back again, as fast as possible, no matter what the cost. Some concessions to a more responsible financial sector were initiated. Practices like short-selling were suspended; increased capital adequacy requirements were called for; there was, briefly, a grudging acceptance of the need to cap executive remuneration (bonuses) in the financial sector.33 Admittedly, this last concession was born more of political necessity in the face of huge public outcry over the bonus culture than through recognition of a point of principle. Within only a few months of the crisis, huge executive bonuses were being paid again.

Within only a few months of the crisis, huge executive bonuses were being paid again. As early as December 2008, Goldman Sachs paid out $2.6 billion in end-of-year bonuses in spite of its $6-billion-dollar bailout by the US government, justifying these on the basis that they helped to ‘attract and motivate’ the best people.34 Many such responses were seen as short-term interventions, designed to facilitate the restoration of business as usual. Short-selling was suspended for six months, rather than banned. Capital adequacy requirements were relatively modest and only to be phased in slowly. The part-nationalisation of financial institutions was justified on the basis that shares would be sold back to the private sector as soon as reasonably possible, something that in many cases still hasn’t been achieved.35 Extraordinary though some of these interventions were, they were largely regarded as temporary measures.


pages: 433 words: 125,031

Brazillionaires: The Godfathers of Modern Brazil by Alex Cuadros

affirmative action, Asian financial crisis, big-box store, BRICs, cognitive dissonance, creative destruction, crony capitalism, Deng Xiaoping, Donald Trump, Elon Musk, facts on the ground, family office, high net worth, index fund, invisible hand, Jeff Bezos, Mark Zuckerberg, NetJets, offshore financial centre, profit motive, rent-seeking, risk/return, Rubik’s Cube, savings glut, short selling, Silicon Valley, sovereign wealth fund, stem cell, The Wealth of Nations by Adam Smith, too big to fail, transatlantic slave trade, We are the 99%, William Langewiesche

Of course, Esteves had also helped to make Eike possible. Pactual underwrote all of Eike’s stock offerings since MMX in 2006. (And later, when crisis struck, it would engulf Esteves too.) Eike and Esteves hadn’t always gotten along. Eike once called up Esteves to yell at him when one of his analysts wrote a negative report on OGX. More recently, Eike believed that Esteves’s traders had been short-selling OGX’s shares. But he was desperate, and the investing class loved Esteves. The first thing Esteves did was to announce a billion-dollar credit line for EBX, a sign of his confidence in Eike’s empire. The markets reacted as hoped. OGX’s stock price jumped sixteen percent in a single day. Reportedly, Eike went around the office saying, in English, “The magic Eike is back!” Esteves’s competitors, though, seemed to take the deal as a sign they wouldn’t be first in line for future fees—and thus had less of an incentive to hedge their criticism.

I interviewed Esteves on August 1, 2012. Details on his life are from press reports and reporting for Alex Cuadros and Cristiane Lucchesi, “BTG’s Esteves Drives ‘Better Than Goldman’ Rise in Bank’s Clout,” Bloomberg Markets, September 10, 2012. 219“would sell his own mother to gain power.” From Consuelo Dieguez, “De elefante a formiga,” Piauí, November 2006. 220Eike believed that Esteves’s traders had been short-selling. From Gaspar, Tudo ou Nada, 395. 220“The magic Eike is back!” From Lauro Jardim, “Auto-confiança máxima,” Veja, March 10, 2013. CHAPTER 9: THE BACKLASH 221Esteves had just given an interview. David Friedlander, Raquel Landim, and Ricardo Grinbaum, “‘É natural que a participação do Eike nas empresas caia de 60% para 30%,’” O Estado de S. Paulo, March 23, 2013. People call this newspaper Estadão for short. 221a colleague of mine uncovered more secret guarantees.


pages: 430 words: 140,405

A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence G. Mcdonald, Patrick Robinson

asset-backed security, bank run, business cycle, collateralized debt obligation, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, diversification, fixed income, high net worth, hiring and firing, if you build it, they will come, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, naked short selling, negative equity, new economy, Ronald Reagan, short selling, sovereign wealth fund, value at risk

Just as crooked financial officers in now-bankrupt corporations had sought to bamboozle their accountants and investors, now the Wall Street elite, the lawyers and bankers, set out to bamboozle the SEC regulators. We suddenly had a commando squad of MIT- and Harvard-educated multimillionaires preparing to go into combat against $120,000-a-year civil service regulators. It never did seem like an even match to me. What Wall Street’s financial maestros came up with while the SEC guys were consumed with backdated options, insider trading, and naked short-selling was something brand-new—a fee-generating machine hereinafter referred to as the dreaded credit derivatives, also known as securitization. They invented a method of turning a thousand mortgages into a bond with an attractive coupon of 7 or 8 percent. This high-yield bond could be traded, and hence turned into a profit generator; it would enable the mortgage brokers, investment banks, and bondholders to reap a very nice annual reward—just so long as the homeowners kept right on paying on time every month, and the U.S. housing market held up the way it always had.

Whatever the hell else happened in this great financial man-o’-war, where no one could see the hand that held the tiller, I was among the safest possible company. I thought back to my dad’s old alma mater, Notre Dame, and the legend of the most famous college folklore in the world. I even made my own rewrite: Outlined against sunny New York autumn skies, the Four Horsemen rode again. In financial lore, their names were Debt, Bankruptcy, Short Selling, and Fraud. Their real names were Kirk, Gelband, Gatward, and McCarthy. The backup battalions, which surrounded them every step of the way, were no less accomplished. Especially Christine Daley, for it was she who administered my first serious test of character and knowledge in the first week of my employment at Lehman. The subject was one of the largest energy producers in the United States, the wholesale electricity giant Calpine, out of San Jose, California.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business cycle, business process, buy and hold, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, stocks for the long term, survivorship bias, The Great Moderation, Thomas Bayes, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

The Bank of England has been the most dramatic flip-flopper in terms of how to approach the process, whereas the Fed and ECB have been more consistent, each with different results and different aims. This mismatch creates opportunity for an alpha-seeking macro fund. Broadening the discussion to government policy makers, things such as TARP getting voted down and then voted for, or the banning of short selling, or allowing Lehman to go bust and then bailing out AIG a few days later—these things seemed pretty random. They were far from random—many were quite predictable. But this is not the same as saying they were easy. It was clear the week before it happened that Lehman would be let go. Our fund had battened down the hatches the week before, so we did not have a single deal open with Lehman. We cut leverage in preparation for the big impending storm because U.S.

See Risk premia payment Price/earnings (P/E) multiples, exchange rate valuation (relationship) Primary Dealer Credit Facility, placement Prime broker risk Princeton University (endowment) Private equity cash flow production tax shield/operational efficiency arguments Private sector debt, presence Private-to-public sector risk Probability, Bayesian interpretation Professor, The bubble predication capital loss, avoidance capital management cataclysms, analysis crowding factor process diversification efficient markets, disbelief fiat money, cessation global macro fund manager hedge fund space historical events, examination idea generation inflation/deflation debate interview investment process lessons LIBOR futures ownership liquidity conditions, change importance market entry money management, quality opportunities personal background, importance portfolio construction management positioning process real macro success, personality traits/characteristics (usage) returns, generation risk aversion rules risk management process setback stocks, purchase stop losses time horizon Titanic scenario threshold trades attractiveness, measurement process expression, options (usage) personal capital, usage quality unlevered portfolio Property/asset boom Prop shop trading, preference Prop trader, hedge fund manager (contrast) Protectionism danger hedge process Public college football coach salary, public pension manager salary (contrast) Public debt, problems Public pensions average wages to returns endowments impact Q ratio (Tobin) Qualitative screening, importance Quantitative easing (QE) impact usage Quantitative filtering Random walk, investment Real annual return Real assets Commodity Hedger perspective equity-like exposure Real estate, spread trade Real interest rates, increase (1931) Real macro involvement success, personality traits/characteristics (usage) Real money beta-plus domination denotation evolution flaws hedge funds, differentiation impacts, protection importance investors commodity exposure diversification, impact macro principles management, change weaknesses Real money accounts importance long-only investment focus losses (2008) Real money funds Commodity Hedger operation Equity Trader management flexibility frontier, efficiency illiquid asset avoidance importance leverage example usage management managerial reserve optimal portfolio construction failure portfolio management problems size Real money managers Commodity Investor scenario liquidity, importance long-term investor misguidance poor performance, usage (excuse) portfolio construction valuation approach, usage Real money portfolios downside volatility, mitigation leverage, amount management flaws Rear view mirror investment process Redemptions absence problems Reflexivity Rehypothecation Reichsmarks, foreign holders (1922-1923) Relative performance, inadequacy Reminiscences of a Stock Operator (Lefèvre) Renminbi (2005-2009) Repossession property levels Republic of Turkey examination investment rates+equities (1999-2000) Reserve currency, question Resource nationalism Returns forecast generation maximization momentum models targets, replacement Return-to-worst-drawdown, ratios (improvement) Reward-to-variability ratio Riksbank (Sweden) Risk amount, decision aversion rules capital, reduction collars function positive convexity framework, transition function global macro manager approach increase, leverage (usage) measurement techniques, importance parameters Pensioner management pricing reduction system, necessity Risk-adjusted return targets, usage Risk assets, decrease Risk-free arbitrage opportunities Risk management Commodity Hedger process example game importance learning lessons portfolio level process P&L, impact tactic techniques, importance Risk premia annualization earning level, decrease specification Risk/reward trades Risk-versus-return, Pensioner approach Risk-versus-reward characteristics opportunities Roll yield R-squared (correlation) Russia crisis Russia Index (RTSI$) (1995-2002) Russia problems Savings ratio, increase Scholes, Myron Sector risk, limits Securities, legal lists Self-reinforcing cycles (Soros) Sentiment prediction swings Seven Sisters Sharpe ratio increase return/risk Short-dated assets Short selling, ban Siegel’s Paradox example Single point volatility 60-40 equity-bond policy portfolio 60-40 model 60-40 portfolio standardization Smither, Andrew Socialism, Equity Trader concern Society, functioning public funds, impact real money funds, impact Softbank (2006) Soros, George self-reinforcing cycles success Sovereign wealth fund Equity Trader operation operation Soybeans (1970-2009) Special drawing rights (SDR) Spot price, forward price (contrast) Spot shortages/outages, impact Standard deviation (volatility) Standard & Poor’s 500 (S&P500) (2009) decrease Index (1986-1995) Index (2000-2009) Index (2008) shorting U.S. government bonds, performance (contrast) Standard & Poor’s (S&P) shorts, coverage Stanford University (endowment) State pension fund Equity Trader operation operation Stochastic volatility Stock index total returns (1974-2009) Stock market increase, Predator nervousness Stocks hedge funds, contrast holders, understanding pickers, equity index futures usage shorting/ownership, contrast Stops, setting Stress tests, conducting Subprime Index (2007-2009) Sunnies, bidding Super Major Survivorship bias Sweden AP pension funds government bond market Swensen, David equity-centric portfolio Swiss National Bank (SNB) independence Systemic banking crisis Tactical asset allocation function models, usage Tactical expertise Tail hedging, impact Tail risk Take-private LBO Taleb, Nassim Tax cut sunset provisions Taxes, hedge Ten-year U.S. government bonds (2008-2009) Theta, limits Thundering Herd (Merrill Lynch) Time horizons decrease defining determination shortening Titanic funnel, usage Titanic loss number Titanic scenario threshold Topix Index (1969-2000) Top-line inflation Total credit market, GDP percentage Total dependency ratio Trade ideas experience/awareness, impact generation process importance origination Traders ability Bond Trader hiring characteristics success, personality characteristics Trades attractiveness, measurement process hurdle money makers, percentage one-year time horizon selection, Commodity Super Cycle (impact) time horizon, defining Trading decisions, policy makers (impact) floor knowledge noise level ideas, origination Tragedy of the commons Transparency International, Corruption Perceptions Index Treasury Inflation-Protected Securities (TIPS) trade Triangulated conviction Troubled Asset Relief Program (TARP) Turkey economy inflation/equities (1990-2009) investment rates+equities (1999-2000) stock market index (ISE 100) Unconventional Success (Swensen) Underperformance, impact Undervaluation zones, examination United Kingdom (UK), two-year UK swap rates (2008) United States bonds pricing debt (1991-2008) debt (2000-2008) home prices (2000-2009) hyperinflation listed equities, asset investment long bonds, market pricing savings, increase stocks tax policy (1922-1936) trade deficit, narrowing yield curves (2004-2006) University endowments losses impact unlevered portfolio U.S.


The Trade Lifecycle: Behind the Scenes of the Trading Process (The Wiley Finance Series) by Robert P. Baker

asset-backed security, bank run, banking crisis, Basel III, Black-Scholes formula, Brownian motion, business continuity plan, business process, collapse of Lehman Brothers, corporate governance, credit crunch, Credit Default Swap, diversification, fixed income, hiring and firing, implied volatility, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, margin call, market clearing, millennium bug, place-making, prediction markets, short selling, statistical model, stochastic process, the market place, the payments system, time value of money, too big to fail, transaction costs, value at risk, Wiener process, yield curve, zero-coupon bond

Risk managers and control departments have various ways of dealing with leveraged risk. They may insist that the trading desk posts a reserve into an account to be held for losses on leveraged trades; they may allow some degree of leverage, but under limits; or they may enforce a hedging strategy as can be seen in the example in Table 5.3. TABLE 5.3 Leverage Product/Term 0–1 month 1–3 months 3–12 months 1 year–5 years Short call options Short put options Short sell Writing credit 2× 1/2× 1× 1/50 4× 1/4× 3× 1/25 8× 1/8× 5× 1/10 15× Maximum loss 10× 1/5 Explanatory notes: For options and selling short we assume spot prices will change more over a greater period of time. 2× indicates the loss is double the change in spot price 8× when the loss is eight times etc. For products involving the writing of credit insurance, loss is a fraction of the total payout in the event of default.

Bob Steiner (2012) Mastering Financial Calculations: A Step-by-step Guide to the Mathematics of Financial Market Instruments, Financial Times/Prentice Hall. 377 Index 30/360 date calculation 350–1 ABSs see asset backed securities abusive behaviour, traders 223 acceptance testing see user acceptance testing accounting 161–9 balance sheet 161–4 financial reports 168–9 profit and loss account 164–8 accrual accrual convention 349–50 accrued profit and loss 165 actual/actual date calculation 350 advisory services 269, 370 aggregation of calculations 342 trades 101–2 agricultural commodities 56 algorithms 184 amendment to a trade 108 American options 29, 66 amortising bonds 47, 48 analytics 271–2 see also quantitative analysts animal products 56 application programming interface (API) 270 architects, IT 187 asset backed securities (ABSs) 47 asset classes 33–59 bonds and credit 46–53 commodities 29, 53–8 equities 44–5 foreign exchange 40–4 interest rates 33–40 and products 17 trade matrix 71–2 trading across 58–9 asset holdings see holdings asset managers 10, 168–9 at-the-money options 66 audit 191–2 average trades, exotic options 68 back book trading 132 back office (operations) 183, 227, 316 back testing 317 back-to-back trades 152 bad data 105, 317–20 balance sheet 161–4 banks culture and conduct 203 interbank systems 158 reasons for trading 9–10 retail banks 222 traders’ internal accounts 123 Barclays Capital 219 barrier options 68 base rate, interest rates 35 Basel II 144 Basel III 205 baskets exotic options 68 FX trades 41–2 BCP see business continuity planning bearer securities 124 Bermudan options 66 bespoke trades 69–70 bid/offer spread 310 binary options 68–9 black box (mathematical library) 238, 241, 270 black box testing 301 Black Scholes formula 346 board of directors 193–4 bond basis deltas 175 379 380 bonds 27, 28, 29, 46–53 coupon payments 47, 48, 106–7 RABOND project case study 225–35 sovereign debt 46 tradeflow issues 49 types 46–7 bonuses 220–1 booking of a trade 85, 93–4 bootstrapping 348–9 boundary testing 351 breaches, dealing with 155–6 breaks, settlement 356–7 brokers 5–6, 10, 75 buckets (time intervals) 148–9 bullying behaviour 223 business continuity planning (BCP) 373 calculation process 337–52 see also valuation process bootstrapping 348–9 calibration to market 351 dates 349–51 example 337–8 mark-to-market value 339–40 model integration 352 net present value 338–9, 343–8 risks 352 sensitivity analysis 347–8 calibration process, valuation 351 call options 62, 63 cancellation of a trade 109 capital adequacy ratio (CAR) 144 case studies 225–52 EcoRisk project 235–47 OTTC equity confirmation project 247–52 RABOND project 225–35 cash balance sheet item 162 exchange dates 86 exercise 111 settlement 98, 99 cashflows American options 30 asset holdings 117–24 bank within a bank 123 consolidated reporting 122 custody of securities 123–4 diversification 122–3 realised and unrealised P&L 122 INDEX reconciliation 121 risks 124 treatment of 119–20 value of 120–1 credit default swaps 31 deposits 23 discount curve 38–9 equity spot trades 26 fixed bonds 27, 28 floating bonds 27, 28 foreign exchange swaps 25 future trades 20–1 loans 22 options 27–30, 345–6 post booking 96–7 risks 367 spot trades 19 swap trades 24 unknown, options valuation 345–6 zero bonds 27, 29 CDSs see credit default swaps Central Counterparty Clearing (CCP) 210–12 change coping with 260–1, 284 to a trade 105–10 clearing 210–12 Cliquet (ratchet options) 68 collateral 108, 153–4, 156, 212–13 COM (common object model) 246 commodities 29, 53–8 cash settlement 99 characteristics 55–6 currency 57 definition 55 example 53–5 localised production 57 OTC commodities 56 physical settlement 57–8 profit curve 54–5 time lag 57 tradeflow issues 58 types 56 utility of 57 common object model (COM) 246 communication 188, 197–8, 254–5, 259–60, 305, 371 competition analysis 269 compliance officers 192–3 confirmation of a trade 94–6, 247–52, 355 conflicts and tensions 196–7, 198–9, 360–1 381 Index consolidated reporting 122 consolidation of processes 283–4 control see also counterparty risk control; market risk control people involved in 189–99, 224 of report generation 335 conversion, currency 344 correlation risk 131, 363 counterparties changes to a trade 108 correlation between 364 identification of 85 Counterparty Clearing, Central 210–12 counterparty risk control 147–60, 364–5 activities of department 154–7, 190–1 collateral 153–4, 156 counterparty identification 153 default consequences 148 limit imposition 152–3 management interface 157 measurement of risk 149–52, 155, 156 non-fulfilment of obligations 147–8 payment systems 158–60 quantitative analyst role 268 risks in analysing credit risk 157–8 settlement 356 time intervals 148–9 coupon payments, bonds 47, 48, 106–7 credit default swaps (CDSs) 30–1, 51–2, 65–6, 175, 209 credit exposure 150–1 credit quantitative analysts 274 credit rating companies 231–2 credit risk see also counterparty risk control; credit default swaps; credit valuation adjustment bonds 46–53 default 51 definition 50 documentation 50–1 market data 316 measurement of 209 recovery rate 52–3 risks in analysing 157–8 types of risk 131 credit valuation adjustment (CVA) 207–13 debt valuation adjustment 209 definition 208 funding valuation adjustment 209 measurement of 208 mitigation 210 netting 211–12 portfolio-based 213 rehypothication 212–13 credit worthiness 51–2, 155 creditors, balance sheet item 163 CreditWatch 232 culture of banks 203 currency conversion 344 exposure to 4 precious metals as 57 reporting currency 42 value of holdings 120–1 currency swaps, foreign exchange 41 current (live) market data 79, 314 curves, market data 310–13 custodians 98, 124 customer loyalty 199 CVA see credit valuation adjustment data 307–25 absence of 368 authentic data 368 back testing 317 bad data 105, 317–20 bid/offer spread 310 corrections to 321–2 data feeds 226 expectations 309–10 extreme values 317 implied data 323 integrity of 322–4 internal data 321 interpolation 319 market data 107–8, 180, 292, 308–17 processes 286 risks 324–5, 367–8 sources of 320–1, 323 storage 309 testing 302 time series analysis 320 types of 308–10 validity of 307 vendors 321 data cleaning 320 data discovery 319–20 data engineering 319 databases 250–1, 308 382 dates calculation of 349–51 exercise of trades 111 final settlement 113 internal and external trades 102 relating to a trade 86–7 settlement 101, 113 on trade tickets 102 debt, exposure to 127 debt valuation adjustment (DVA) 209 debtors, balance sheet item 162 default 51, 131, 148 see also credit default swaps delivery versus payment (DvP) 98 delta hedging 133 delta risk 130 deltas 175 deposits 23, 35 derivatives 61–72 see also futures and forwards; options; swaps digital options 68–9 directors, role of 193–4 discount curve, interest rates 38–9 discounting, NPV calculation 343–4, 345 diversification 122–3 dividends 105–6 documentation credit risk 50–1 EcoRisk project case study 240–1 legal documents 84–5 processes 287 risks 356, 374 settlement 98 Dodd–Frank Act 206–7 dreaming ahead 131–2 due diligence 192, 292 duties (fees) 97 DVA (debt valuation adjustment) 209 DVO1, risk measure 138 DvP (delivery versus payment) 98 economic data 84 EcoRisk project, case study 235–47 documentation 240–1 functionality 243–4 Graphical User Interface 237–8 mathematical library 238, 241 solution 238–40 testing 239–40 valuation problem debugging 242–3 INDEX electronic exchanges 6 electronic systems 92 email 92 EMIR (European Markets Infrastructure Regulation) 202–3 employees see people involved in trade lifecycle end of day roll 103, 181–2 end of month reports 182 energy products 56 equal opportunities 219–20 equities 26, 44–5, 247–52 errors confirmation process 95 in data 322 P&L corrections 171 post booking 97 in reports 333–4 European Markets Infrastructure Regulation (EMIR) 202–3 European options 29, 66 exceptions, processes 322 exchange price 75 exchanges 6, 86, 320 execution of a trade 89–93 exercise, option trades 64, 110–12, 357–8 exotic options 67–9, 109, 235–47, 346 expected loss 150 exposure 4, 125–8, 130–2, 150–1, 155, 156 fault logging 302–4 fees 97, 169 finance department 191, 316 financial products 17–31 bonds 27, 28, 29, 46–53, 106–7, 225–35 credit default swaps 30–1, 51–2, 65–6, 175, 209 deposits 23, 35 equities 26, 44–5, 247–52 futures 20–1, 35–6, 40–1, 61, 62, 77, 127, 311, 312 FX swaps 25, 41 loans 21–3 options 27–30, 61–9, 77, 109–12, 127, 235–47, 345–6, 357–8 spot trades 18–19, 40, 127 swaps 23–5, 30–1, 36–7, 41, 107, 312–13 financial reports 168–9 financial services industry 8–10 fixed assets, balance sheet item 161 fixed bonds 27, 28, 47, 48 fixed and floating coupons 127 383 Index fixed for floating swaps 23–4 fixed loans 22 fixing date 86 fixings 107–8 float for fixed/float for float 36 floating bonds 27, 28 floating loans 22 floating rate notes (FRNs) 47 flow diagrams 287 FoP (free of payment) 98 foreign exchange (FX) 40–4 baskets 41–2 FX drift 42–3 reporting currency 42 swaps 25, 41 tradeflow issues 43–4 forward rate agreement (FRA) 37–8 see also futures and forwards free of payment (FoP) 98 FRNs (floating rate notes) 47 front book trading 132 front line support staff 186 front office EcoRisk project, case 235–47 market risk control 142 risks 375–6 fugit 112 fund managers 10 funding valuation adjustment (FVA) 209 futures and forwards 20–1, 35–6, 40–1, 61, 62 gold futures 311, 312 leverage 77 risks 127 FVA (funding valuation adjustment) 209 FX see foreign exchange gamma risk 130 gearing 77–8 gold futures 311, 312 governance 204 Graphical User Interface (GUI) 237–8 hedge funds 10, 168–9, 212–13 hedging strategies 133–4 hedging trades 128 help desks 247 historical market data 314 holdings 117–24 asset types 118 bank within a bank 123 consolidated reporting 122 custody of securities 123–4 diversification 122–3 realised and unrealised P&L 122 reconciliation 121 risks 124 value 120–1 human resources see people involved in trade lifecycle human risks 194–9, 359–61 hybrid trades 69–70 identification details, trades 83–4 illiquid products 140 illiquid trades 339 in person trades 92 in-the-money options 66 incentives 195 industrial metals 56 information technology (IT) architects 187 case studies 225–52 communication 259–60 dependency on 284 EcoRisk project 235–47 equity confirmation project 247–52 infrastructure 186 IT divide 253–66 business functions 255–6 business requirements 261–3 coping with change 260–1 do’s and don’ts 263 IT blockers 258 IT requirements 263–4 misuse of IT 256–7 organisational blockers 257–8 problems caused by 255 project examples 265–6 solution 259–60 language of 254 legacy systems 282 operators 188 project managers 187–8 quality control 260 and quantitative analysts 271–4 RABOND project 225–35 risks 375–6 staff 185–9, 197, 217–18, 253–66 testers 188–9 and traders 258 384 infrastructure, IT 186 instantaneous risk measures 138 insurance 30–1, 50 integration testing 300 interbank systems 158 interbank trading (LIBOR) 39 interest rates 21–3, 33–40 base rate 35 credit effects 39 deltas 175 deposits 35 discount curve 38–9 forward rate agreement 37–8 futures 35–6, 311–12 market participants 34–5 option valuation 67 products 35–8 quantitative analysts 274 swaps 23–5, 36–7 time value of money 33–4 tradeflow issues 39–40 vegas 175 interim delivery of projects 259 internal audit 191–2 International Swaps and Derivatives Association (ISDA) 50 investment banks 9–10 investments, balance sheet item 161 ISDA (International Swaps and Derivatives Association) 50 IT see information technology kappa risk 130 knock in/knock out, barrier options 68 knowledge, risks 359–60 legacy IT systems 282 legal department 189, 293, 316 legal documents 84–5 legal risks 50, 369 leverage 64–6, 76–9 LIBOR (interbank trading) 39 libraries 184–5 lifecycle of a trade see trade lifecycle limit orders 129 limits and credit worthiness 155 imposing 152–3 market risk control 141 line managers 222 INDEX linear derivatives 61, 62 liquidity 73–5, 202, 375 litigation 370 live trading 7 loans 21–3 management see also project management; risk management of changes 109–10 counterparty risk control 157 fees 169 market data usage 317 new products 292 responsibilities of 193–4 risks 374 of teams 229–31 margin payments 156 mark-to-market value 339–40 market data 180, 292, 308–17 business usage 315–17 changes as result of 107–8 curves and surfaces 310–13 sets of 314 market participants 4–5 market risk control 135–45, 190, 363–4 allocation of risk 139 balanced approach 143 controlling the risk 140–1 human factor 143 limitations 142–3 market data usage 316 methodologies 135–9 monitoring of market risk 140 need for risk 139 quantitative analyst role 268 regulatory requirements 143–4 responsibilities 141–2 market sentiment 340 matching of records 94–5 mathematical libraries 238, 241, 270 mathematical models evolution of 343 new products 293 parameters 341 prototypes 238–9 quantitative analyst role 183–5 risks 373 validation team 189–90 maturity of a trade 8, 67, 86, 112–13 MBS see mortgage backed securities 385 Index metal commodities 56, 57 middle office (product control) market data usage 316 new products 293 RABOND project, case study 225–35 role of 180–2 missing data 317 mobile phones 92 models see mathematical models Monte Carlo technique 346–7 mortgage backed securities (MBS) 47 multilateral netting 211–12 NatWest Markets, EcoRisk project 235–47 net present value (NPV) 338–9, 343–8 netting 152, 211–12 new products 289–95 checklist 292–3 evolution of 294 market data 292 market risk control 140 process development/improvement 279–88 risks 194, 294–5, 369 testing 291–2 trial basis for 290–2 new trade types 156 nonlinear derivatives 62–9 nostro accounts 99 NPV see net present value official market data 314 offsetting of risks 128 OIS (overnight indexed swap) 39 operational risks 355–8 operations department 183, 227, 316 operators, IT 188 options 27–30, 61–9 credit default swaps 65–6 exercise 110–12 exotic options 67–9, 109, 235–47, 346 leverage 64–6, 77 risks 127, 357–8 terminology 66 trade process 64–6 valuation 67, 345–6 orders 90–1, 357 OTC see over-the-counter trading OTTC equity confirmation project, case study 247–52 out-of-the-money options 66 over-the-counter (OTC) trading 6–7 clearing 210 commodities 56 price 75 overnight indexed swap (OIS) 39 overnight processes 101–5 P&L see profit and loss parallel testing 301 pay 203, 220–1 payment systems 106–7, 158–60, 357 pension funds 10 people involved in trade lifecycle 177–200 see also working in capital markets back office 183, 227, 316 compliance officers 192–3 conflicts and tensions 196–9, 360–1 control functions 189–99 counterparty risk control department 190–1 finance department 191, 316 human risks 194–9 information technology 185–9, 197, 217–18, 253–66 internal audit 191–2 legal department 189, 293, 316 line managers 222 management 193–4 market risk control department 190 middle office 180–2, 225–35, 293, 316 model validation team 189–90 personality and outlook 194–5, 244–5, 273 programmers 187, 244–5 quantitative analysts 183–5, 267–75 researchers 179–80 revenue generation 177–89 sales department 179, 227, 315, 375 senior managers 126 staffing levels 195 structurers 179 supervisors 204 testers 298–9 traders 125–6, 177–8, 218–23, 226–7, 258, 268, 315, 361 trading assistants 178 trading managers 126, 193 training of staff 193 performance reports 169 personality and outlook 194–5, 244–5, 273 PFE (potential future exposure) 151 physical assets, exercise 111 386 physical commodities, settlement 57–8, 99 planning of processes 282–3 recovery plans 203–4 risks 360 post booking processes 96–7 postal trades 92–3 potential future exposure (PFE) 151 power, abuses of 220, 221–2 pre-execution of a trade 89–91 precious metals 56, 311, 312 premiums 31 price 75–6, 138–9 pricing methods EcoRisk project, case study 235–47 short-term pricing 183 process development/improvement 279–88 coping with change 284 current processes 285–7 evolution of processes 280–1 improving the situation 284–7 inertia 287–8 inventory of current systems 282–4 planning 282–3 timing 288 producers 5 product appetite 4 product control see middle office product development see new products profit curve, commodity trading 54–5 profit and loss (P&L) accounts 164–8 accrued and incidental 165 example 165–6 individual trades 166–7 realised and unrealised 165 responsibility for producing 167 risks associated with reporting 167–8 rogue trading 168 attribution reports 171–6 benefits of 171–2 example 173–6 market movements 173, 175 process 172–3 unexplained differences 173 balance sheet item 163 end of day 182 realised and unrealised 122, 165 programmers 187, 244–5 see also quantitative analysts INDEX project management 225–47, 259, 262 project managers 187–8 proprietary (‘prop’) trading 203 prototypes, IT projects 238–9 provisional trades 89–90, 357–8 put options 62, 63 PVO1, risk measure 138 quality control, IT 260 see also testing quantitative analysts (quants) 183–5, 267–75 and IT professionals 271–4 role of 267–9, 270 seating arrangements 270–1 working methods 269–70 RABOND project, case study 225–35 management 229–31 outcome 233–5 reports 227–9 team management 229–31 traders 226–7 random market data 314 rapid application development (RAD) 260, 281 ratchet options (Cliquet) 68 ratings companies 231–2 raw data 323 raw reporting 331 real world of capital markets see working in capital markets realised P&L 122 receipts 156 reconciliation 121 recovery plans 203–4 recovery rates 52–3, 176 redundancy, processes 282 reform of banks 203 registered securities 123–4 regression testing 302 regulation 201–13, 223–4 authorities 202 Basel II and III 144, 205 credit valuation adjustment 207–13 external 192 internal 224 market risk control 143–4 new products 293 problems 204–5 requirements 202–4 387 Index risk-weighted assets 205–7 risks 369 rehypothication 212–13 remuneration 203, 220–1 reporting currency 42 reports 327–36 accuracy 330–1, 368 calculation process 342 configuration 331–2 consolidated reporting 122 content 328–9 control issues 335 dimensions 333 distribution 329–30, 335, 369 dynamic reports 332–3 end of month reports 182 enhancements 335 errors in 333–4 false reporting 375 financial reports 168–9 frame of reference 333 middle office role 180–1 OTTC equity confirmation project 250, 251 performance reports 169 presentation 329 problems 333–4 profit and loss 167, 171–6 RABOND project 227–9 raw reporting 331 readership 328, 329, 368–9 redundancy of 334–5 requirements 328–33 risks 335–6, 368–70 security issues 335, 368 timing 330 types of 330 reputation, risk to 356, 370 research 268, 375 researchers 179–80 reserve accounts 141 reset date 86 resettable strike, exotic options 68 retail banks 222 revenue generation, people involved in 177–89 rho risk 130 risk 13–16 see also counterparty risk control; market risk control advisory services 370 appetite for 4 business continuity planning 373 calculation process 352 cashflows 124, 367 changes to a trade 110 communication 371 confirmation 95–6, 355 control departments 224 correlation 363 data 324–5, 367–8 definition 13 documentation 356, 374 exercise 112 front office 375–6 human risks 194–9, 359–61 information technology 375–6 instantaneous measures 138 legal risks 369 liquidity 74–5, 375 litigation 370 management risks 374 measures 130, 138, 149–52, 155, 156 model approval 373 new products 140, 194, 294–5, 369 operational risks 355–8 orders 91 origin of risks 126–8 payment systems 357 provisional trades 90, 357–8 quantifying 14 regulation 369 reports 335–6, 368–70 reputation 356, 370 risk-weighted assets 205–7 sales 375 settlement 100, 355–7 short-term thinking 360 straight through processing 357 support activities 376 systematic 202–3, 375–6 testing 304–5, 370–1 types 130–2 unexpected charges 356 unforeseen 16, 353 valuation process 352, 373 risk management 13, 15, 125–34 in absence of trader 128–9 dreaming ahead 131–2 EcoRisk project case study 235–47 hedging strategies 133–4 hedging trades 128 388 risk management (continued) offsetting of risks 128 senior managers 126 traders 125–6, 361 trading managers 126 trading strategies 132 rogue trading 168 sales data 84 sales department 179, 227, 315, 375 SBC Warburg, equity confirmation project, case study 247–52 scenario analysis 136, 198–9, 341 scope creep 187, 264 scrutiny of trades 96 securities, custody of 123–4 security issues 181, 335, 368 semi-static data 309 senior managers 126 sensitivity analysis 138, 347–8 settlement 97–101, 147–8 breaks 101, 356–7 commodities 99 dates 101, 113 nostro accounts 99 quick settlement 101 risks 100, 355–7 shares 44–5 see also equities short selling 65 short-term pricing 183 short-term thinking 195–6, 360 silo approach 257 simple products 70–1 smoke testing 301 sovereign debt 46 speculators 5 spot prices 61, 62, 63, 67, 76–7 spot testing 301 spot trades 18–19, 40, 127 spread of bid/offer 310 spreadsheets 184, 238 staff see people involved in trade lifecycle stale data 105, 318 Standard & Poor’s (S&P) ratings 231–2 static data 309 stop-loss hedging 133–4 stop orders 129 storage of data 309 straight through processing (STP) 93–4, 357 INDEX stress, staff 222, 244–5 stress testing 302 strike price, options 67 structured trades 69–70 structurers 179 supervisors 204 support activities, risks 376 surfaces, market data 310–13 swaps credit default 30–1, 51–2, 65–6, 175, 209 fixings 107 foreign exchange 25, 41 interest rate 23–5, 36–7 yield curves 312–13 swaptions 66 synthetic equities (index) 45 systems see also information technology amalgamation 104–5 analytics 271–2 electronic systems 92 integrated 261 legacy IT systems 282 risks 375–6 testing 251–2, 300 tail behaviour, predicting 143, 364 team management 229–31 telephone transactions 91–2 tensions and conflicts 196–9, 360–1 testing 297–305 back testing 317 boundary testing 351 extreme values 352 fault logging 302–4 importance of 298 mathematical models 239 new products 291–2 risks 304–5, 370–1 stages 300–1 testers 188–9, 298–9 types of 301–2 unit testing 300 user acceptance testing 237, 239–40, 252, 264, 301 when to perform 299–300 theft 355 theta risk 130 time intervals (buckets) 148–9 time lag, commodities 57 389 Index time series analysis 320 timeline of a trade 79, 86–7 trade blotters 93 trade lifecycle 89–115 booking 93–4 business functions 11 changes during lifetime 105–10 confirmation 94–6 equity trades 45 example trade 113–15 execution 91–3 exercise 110–12 maturity 112–13 new products 293 overnight processes 101–5 post booking 96–7 pre execution 89–91 settlement 97–101 trade tickets 102 trade/trading 3–12 see also trade lifecycle anatomy 83–7 business functions 11 complicated trades 340 consequences of 7–8 definition 10–12 financial products 17–31 live trading 7 matching of records 94–5 policies 8 reasons for 3, 9–10 timeline 79, 86–7 transactions 5–7 types 132 tradeflow issues bonds 49 commodities 58 foreign exchange 43–4 interest rates 39–40 traders 177–8, 218–22, 223, 226–7, 258, 268 bonuses 220–1 market data usage 315 risk management 125–6, 361 trading assistants 178 trading desks 70–1, 256–7 trading floor 217–18, 235–6 trading managers 126, 193 training of staff 193 tranche correlation 131 treasury desk 71 trials for new products 290–2 trust 197, 222 UAT see user acceptance testing underlying 83 unexplained differences, P&L reports 173 unforeseen risk 16, 353 unit testing 300 unknown cashflows 345–6 unrealised P&L 122 unwinding a trade, cost of 76 user acceptance testing (UAT) 237, 239–40, 252, 264, 301 validation of models 189–90 valuation process see also calculation process calibration to market 351 mark-to-market value calculation 339–40 middle office role 181 NPV calculation 338–9, 343–8 options 67 problem debugging 242–3 risks 352, 364, 373 valuation systems 269 value at risk (VaR) 136–8, 341 vega (kappa) risk 130 vegas 175 vendors, data services 321 volatility 67, 130 volume of a trade, price effect 76 white box testing 301 workarounds 303 working in capital markets 217–24 see also case studies; people involved in trade lifecycle in 1990s 217–19 culture clashes 219 equal opportunities 219–20 office politics 220–2, 246 positive/negative aspects 222–3 yield curves 312–13 zero bonds 27, 29, 47 Index compiled by Indexing Specialists (UK) Ltd WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA.


pages: 505 words: 142,118

A Man for All Markets by Edward O. Thorp

3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy and hold, buy low sell high, carried interest, Chuck Templeton: OpenTable:, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, Stanford marshmallow experiment, statistical arbitrage, stem cell, stocks for the long run, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

The way to profit was to sell them short. To sell a security short you borrow the desired quantity through your broker from someone who owns it, sell it in the marketplace, and collect the proceeds. Later you have to repurchase it at whatever price then prevails to meet your contractual obligation to return what you borrowed. If your buy-back price is below your earlier sale price, you win. If it is higher, you lose. Short selling overpriced warrants was profitable on average but risky. The same was true for buying stocks. The two risks largely canceled each other when we hedged the warrants by purchasing the associated common stock. In a historical simulation our optimized method made 25 percent a year with low risk, even during the great 1929 stock market crash and its aftermath. As we worked on theory, Kassouf and I were investing for ourselves in warrant hedges, which also made 25 percent per year.

The name hedge fund probably came about when the journalist Alfred Winslow Jones, inspired by what he learned after researching an article he was writing about investments, started a partnership in 1949. In addition to buying stocks he believed were cheap, he attempted to limit, or “hedge,” risk by also selling short shares he believed were overpriced. The short seller profits if the price falls and loses if the price rises. Short selling allows an investor to profit in a down market; a fund like Jones’s can, potentially, have more stable returns. Though Jones’s idea didn’t receive wide attention at first, a 1966 article in Fortune magazine by Carol Loomis, “The Jones Nobody Keeps Up With,” announced that Jones’s hedge fund had beaten all of the several hundred mutual funds over the last ten years and the possibilities became widely apparent.


Firefighting by Ben S. Bernanke, Timothy F. Geithner, Henry M. Paulson, Jr.

Asian financial crisis, asset-backed security, bank run, Basel III, break the buck, Build a better mousetrap, business cycle, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Doomsday Book, financial deregulation, financial innovation, housing crisis, Hyman Minsky, income inequality, invisible hand, Kenneth Rogoff, labor-force participation, light touch regulation, London Interbank Offered Rate, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, pets.com, price stability, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, savings glut, short selling, sovereign wealth fund, special drawing rights, The Great Moderation, too big to fail

At this point Tim had tried to arrange so many shotgun marriages that Wall Street executives were calling him “eharmony.” But potential megamergers like Goldman–Wachovia and Morgan–Citi didn’t really make sense; Wachovia and Citi had their own challenges despite their insured deposits, and the matches raised two-drunks-in-a-ditch concerns. Meanwhile, we reluctantly encouraged the SEC to impose a temporary ban on the short selling of shares of financial firms, something we had resisted for months, and never would have considered in less extreme circumstances. We hated the idea of prohibiting bets against companies in trouble—it felt like outlawing negative reviews, which could undermine confidence in the marketplace we wanted to protect—but Morgan Stanley was on the brink of collapse, and Goldman would have followed, with major commercial banks close behind.


pages: 443 words: 51,804

Handbook of Modeling High-Frequency Data in Finance by Frederi G. Viens, Maria C. Mariani, Ionut Florescu

algorithmic trading, asset allocation, automated trading system, backtesting, Black-Scholes formula, Brownian motion, business process, buy and hold, continuous integration, corporate governance, discrete time, distributed generation, fixed income, Flash crash, housing crisis, implied volatility, incomplete markets, linear programming, mandelbrot fractal, market friction, market microstructure, martingale, Menlo Park, p-value, pattern recognition, performance metric, principal–agent problem, random walk, risk tolerance, risk/return, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process

This process consists of a stopping time τ ∈ S, a consumption process c(·) positive and F−progressively measurable, and an Fτ measurable random variable ξ : → [0, ∞) representing the lump-sum consumption at time τ . We regard πi (t) as the proportion of an agent’s wealth invested in stock i at time t; the remaining proportion 1 − π ∗ (t)1m = 1 − m i=1 πi (t) is invested in the money market. These proportions are not constrained to take values in the interval [0, 1]; in other words, we allow both short selling of stocks and borrowing at the interest rate of the bond. For a given, nonrandom, initial capital x > 0, let X (·) = X x,π ,C (·) denote the wealth process corresponding to a portfolio/consumption pair (π(·), C(·)) as above. This wealth process is defined by the initial condition X x,π ,C (0) = x and the equation dX (t) = m m πi (t)X (t){bi (t)dt + i=1 σij (t)dWj (t)} (11.10) i=1 + {1 − m πi (t)}X (t)r(t)dt − dC(t) i=1 = r(t)X (t)dt + X (t)π ∗ (t)σ (t)dW0 (t) − dC(t), X (0) = x > 0, where we have set t W0 (t) W (t) + θ(s)ds, 0 ≤ t ≤ T

This process consists of a stopping time τ ∈ S0 , a consumption process c(·) positive and F−progressively measurable, and an Fτ measurable random variable ξ : → [0, ∞) representing the lump-sum consumption at time τ . We regard πi (t) as the proportion of an agent’s wealth invested in stock i at time t; the remaining proportion 1 − π ∗ (t)1m = 1 − m i=1 πi (t) is invested in the money market. These proportions are not constrained to take values in the interval [0, 1]; in other words, we allow both short selling of stocks and borrowing at the interest rate of the bond. For a given, nonrandom, initial capital x > 0, let X (·) = X x,π ,C (·) denote the wealth process corresponding to a portfolio/consumption pair (π(·), C(·)) as above. This wealth process is defined by the initial condition X x,π ,C (0) = x and the equation dX (t) = m πi (t)X (t){bi (t)dt + m i=1 σij (t)dWj (t)} i=1 + {1 − m πi (t)}X (t)rdt − dC(t) i=1 = rX (t)dt + X (t)π ∗ (t)σ (t)dW0 (t) − dC(t), X (0) = x > 0, (11.38) where we have set W0 (t) W (t) + t θ(s)ds, 0 ≤ t < ∞


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, business cycle, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy, zero-sum game

Mr Garber concluded that ‘As long as some doubt remains about the permanence of Stage III exchange rates [i.e. the currency union], the existence of the currently proposed structure of the ECB and Target does not create additional security against the possibility of an attack. Quite the contrary, it creates a perfect mechanism to make an explosive attack on the system.’39 Such an attack could take the form of a run on banks in a vulnerable country or actions (short-selling of bank stock, for example) that would cause such a run. Thus the creation of gigantic creditor and debtor positions inside the ECB might destroy the credibility of the system. Figure 11. Current Account Balances (per cent of GDP) Source: IMF World Economic Outlook Database The actions of the central banks helped countries in difficulty. But they have not provided much, if any, direct support for public debt.

That is roughly a thousand times larger than its closest legislative cousin, Glass-Steagall. Dodd-Frank makes Glass-Steagall look like throat-clearing. The situation in Europe, while different in detail, is similar in substance. Since the crisis, more than a dozen European regulatory directives or regulations have been initiated, or reviewed, covering capital requirements, crisis management, deposit guarantees, short-selling, market abuse, investment funds, alternative investments, venture capital, OTC derivatives, markets in financial instruments, insurance, auditing and credit ratings. These are at various stages of completion. So far, they cover over 2000 pages. That total is set to increase dramatically as primary legislation is translated into detailed rule-writing. For example, were that rule-making to occur on a US scale, Europe’s regulatory blanket would cover over 60,000 pages.


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Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, liberal capitalism, light touch regulation, Long Term Capital Management, Louis Pasteur, low cost airline, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, Mikhail Gorbachev, millennium bug, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, Plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, working poor, zero-sum game, éminence grise

He is a classic productive entrepreneur, creating wealth, challenging incumbents and now having to compete with copycat versions of his product as his patents expire. Contrast his contribution to wealth generation with Goldman Sachs’ ‘Fabulous’ Fab Tourre, the executive who is alleged to have invented a financial instrument at the instigation the Paulson hedge fund to make a billion dollars by short selling. Goldman rebut the accusation; but even if it is disproved, something similar will certainly have been concocted by someone in the run-up to the financial crash. Over the past generation, Britain has created the conditions for other ‘Fabulous’ investors to make fortunes by fair means or foul, while neglecting the innovation ecosystem that might have had made it easier for Ritchie and others like him to grow their companies.

., 64, 65 Rowthorn, Robert, 292, 363 Royal Bank of Scotland (RBS), 25, 150, 152, 157, 173, 181, 199, 251, 259; collapse of, 7, 137, 150, 158, 175–6, 202, 203, 204; Sir Fred Goodwin and, 7, 150, 176, 340 Rubin, Robert, 174, 177, 183 rule of law, x, 4, 220, 235 Russell, Bertrand, 189 Russia, 127, 134–5, 169, 201, 354–5, 385; fall of communism, 135, 140; oligarchs, 30, 65, 135 Rwandan genocide, 71 Ryanair, 233 sailing ships, three-masted, 108 Sandbrook, Dominic, 22 Sands, Peter (CEO of Standard Chartered Bank), 26 Sarkozy, Nicolas, 51, 377 Sassoon, Sir James, 178 Scholes, Myron, 169, 191, 193 Schumpeter, Joseph, 62, 67, 111 science and technology: capitalist dynamism and, 27–8, 31, 112–13; digitalisation, 34, 231, 320, 349, 350; the Enlightenment and, 31, 108–9, 112–13, 116–17, 121, 126–7; general-purpose technologies (GPTs), 107–11, 112, 117, 126–7, 134, 228–9, 256, 261, 384; increased pace of advance, 228–9, 253, 297; nanotechnology, 232; New Labour improvements, 21; new opportunities and, 33–4, 228–9, 231–3; new technologies, 232, 233, 240; universities and, 261–5 Scotland, devolving of power to, 15, 334 Scott, James, 114–15 Scott Bader, 93 Scott Trust, 327 Second World War, 134, 313 Securities and Exchanges Commission, 151, 167–8 securitisation, 32, 147, 165, 169, 171, 186, 187, 196 self-determination, 85–6 self-employment, 86 self-interest, 59, 60, 78 Sen, Amartya, 51, 232, 275 service sector, 8, 291, 341, 355 shadow banking system, 148, 153, 157–8, 170, 171, 172, 187 Shakespeare, William, 39, 274, 351 shareholders, 156, 197, 216–17, 240–4, 250 Sher, George, 46, 50, 51 Sherman Act (USA, 1890), 133 Sherraden, Michael, 301 Shiller, Robert, 43, 298, 299 Shimer, Robert, 299 Shleifer, Andrei, 62, 63, 92 short selling, 103 Sicilian mafia, 101, 105 Simon, Herbert, 222 Simpson, George, 142–3 single mothers, 17, 53, 287 sixth form education, 306 Sky (broadcasting company), 30, 318, 330, 389 Skype, 253 Slim, Carlos, 30 Sloan School of Management, 195 Slumdog Millionaire, 283 Smith, Adam, 55, 84, 104, 112, 121, 122, 126, 145–6 Smith, John, 148 Snoddy, Ray, 322 Snow, John, 177 social capital, 88–9, 92 social class, 78, 130, 230, 304, 343, 388; childcare and, 278, 288–90; continued importance of, 271, 283–96; decline of class-based politics, 341; education and, 13, 17, 223, 264–5, 272–3, 274, 276, 292–5, 304, 308; historical development of, 56–8, 109, 115–16, 122, 123–5, 127–8, 199; New Labour and, 271, 277–9; working-class opinion, 16, 143 social investment, 10, 19, 20–1, 279, 280–1 social polarisation, 9–16, 34–5, 223, 271–4, 282–5, 286–97, 342; Conservative reforms (1979-97) and, 275–6; New Labour and, 277–9; private education and, 13, 223, 264–5, 272–3, 276, 283–4, 293–5, 304; required reforms for reduction of, 297–309 social security benefits, 277, 278, 299–301, 328; contributory, 63, 81, 283; flexicurity social system, 299–301, 304, 374; to immigrants, 81–2, 282, 283, 284; job seeker’s allowance, 81, 281, 298, 301; New Labour and ‘undeserving’ claimants, 143, 277–8; non-contributory, 63, 79, 81, 82; targeting of/two-tier system, 277, 281 socialism, 22, 32, 38, 75, 138, 144, 145, 394 Soham murder case, 10, 339 Solomon Brothers, 173 Sony, 254–5 Soros, George, 166 Sorrell, Martin, 349 Soskice, David, 342–3 South Korea, 168, 358–9 South Sea Bubble, 125–6 Spain, 123–4, 207, 358–9, 371, 377 Spamann, Holger, 198 special purpose vehicles, 181 Spitzer, Matthew, 60 sport, cheating in, 23 stakeholder capitalism, x, 148–9 Standard Oil, 130–1, 132 state, British: anti-statism, 20, 22, 233–4, 235, 311; big finance’s penetration of, 176, 178–80; ‘choice architecture’ and, 238, 252; desired level of involvement, 234–5; domination of by media, 14, 16, 221, 338, 339, 343; facilitation of fairness, ix–x, 391–2, 394–5; investment in knowledge, 28, 31, 40, 220, 235, 261, 265; need for government as employer of last resort, 300; need for hybrid financial system, 244, 249–52; need for intervention in markets, 219–22, 229–30, 235–9, 252, 392; need for reshaping of, 34; pluralism, x, 35, 99, 113, 233, 331, 350, 394; public ownership, 32, 240; target-setting in, 91–2; threats to civil liberty and, 340 steam engine, 110, 126 Steinmueller, W.


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Confessions of a Wall Street Analyst: A True Story of Inside Information and Corruption in the Stock Market by Daniel Reingold, Jennifer Reingold

barriers to entry, Berlin Wall, corporate governance, estate planning, Fall of the Berlin Wall, fixed income, George Gilder, high net worth, informal economy, margin call, mass immigration, new economy, pets.com, Robert Metcalfe, rolodex, Saturday Night Live, shareholder value, short selling, Silicon Valley, stem cell, Telecommunications Act of 1996, thinkpad, traveling salesman, undersea cable

In the Qwest–US West deal, I thought the decision to dramatically cut US West’s dividend was wise, since it freed up money to invest in cell-phone service and high-speed Internet access, among other things. Plus the stocks had fallen so far that they were now good values. Based on my models, I saw Qwest shares rising as much as 33 percent and US West’s 28 percent. But I wasn’t totally sanguine either. “Our rating is Accumulate instead of Buy,” I wrote. “Despite such attractive upside, we anticipate the usual pressure from short-selling arbs and the approximate one year wait until merger close. We are also concerned about increasing wholesale [long distance] pricing pressure and new initiative startup costs at both companies.” Megan and I immediately started to work on a similar report on Global Crossing and Frontier. But, within a few days, I began to have second thoughts. Merrill was going to make about $20 million, but most of the fee depended on the deal actually being consummated.

Assurance of Discontinuance in the Matter of Citigroup Global Markets, April 22, 2003, Exhibit 2, “Undertakings,” p. 14. 4. U.S. Securities and Exchange Commission, 17 CFR Part 242, approved February 20, 2003. 5. Mark Pincus, “Will SEC Ever Make Corporate Insiders Pay for Fraud,” http://markpincus.typepad.com/markpincus/2005/03/will_the_sec_ev_html. Glossary arbitrage, general—The practice of buying securities in one market and shorting (selling) them in another, with the goal of capturing as profit any price discrepancies between the two markets. arbitrage, merger—The practice of seeking to make a profit on the difference between the stock prices of companies involved in a merger. In most cases, arbs bet that the merger will be completed within a certain time frame and that the acquiree’s (target’s) stock price will eventually rise to the offered takeout price as the deal nears completion.