margin call

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pages: 620 words: 214,639

House of Cards: A Tale of Hubris and Wretched Excess on Wall Street by William D. Cohan

asset-backed security, call centre, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Deng Xiaoping, diversification, Financial Instability Hypothesis, fixed income, Hyman Minsky, Irwin Jacobs, John Meriwether, Long Term Capital Management, margin call, merger arbitrage, money market fund, moral hazard, mortgage debt, mutually assured destruction, Myron Scholes, New Journalism, Northern Rock, Renaissance Technologies, Rod Stewart played at Stephen Schwarzman birthday party, savings glut, shareholder value, sovereign wealth fund, too big to fail, traveling salesman, Y2K, yield curve

On page seven of the accompanying presentation, Cioffi told them what they presumably already knew: He had $14 million in cash on hand to meet $145 million of “open margin calls” in the Enhanced Leverage Fund. At the end of July, after making the $145 million of margin calls, Cioffi predicted the fund would have a cash balance of $177 million. Friedman translated Cioffi's pitch into layman's terms. “He froze redemptions,” he said, “and he's got his lenders here to try and tell them— they all have the right, if he has unmet margin calls, to blow him out—so he's telling them: ‘Sit tight. I'm going to do all these sales and I'm going to have enough cash.' What you have is a roomful of people, some of who are awake and have made these margin calls, and have suddenly realized there are issues, and have marked the collateral down and made margin calls. Some of them are going, ‘Holy shit! Everybody else is making margin calls and we're not.' Well, the first thing all this did, when we got done, the margin calls just flooded in.”

Since these were the very assets that Thornburg (and Bear Stearns) used as collateral for its short-term borrowings, soon after February 14 the company's creditors made margin calls “in excess of $300 million” on its short-term borrowings. At first, Thornburg used what cash it had to meet the margin calls. But that did not stop the worries of its creditors. “After meeting all of its margin calls as of February 27, 2008, Thornburg Mortgage saw further continued deterioration in the market prices of its high quality, primarily AAA-rated mortgage securities,” the company wrote in a March 3 filing with the SEC. This new deterioration of the value of its prime mortgages resulted in new margin calls of $270 million—among them $49 million from Morgan Stanley, $28 million from JPMorgan on February 28, and $54 million from Goldman Sachs. This time, though, Thornburg was “left with limited available liquidity” to meet the new margin calls or any future margin calls.

At this point, Friedman said sarcastically, “We did it for you,” and then added seriously: “We did it because we had no choice, basically, but it's a good line.” Quental then spoke about the margin calls coming from the people sitting in the audience. “Obviously, we've taken in a heavy level of margin calls,” he said. “All of you are aware of that. We've covered all those calls up until yesterday, when we asked all of you to hold off until we had this meeting. We have some pending margin calls, which Ralph will talk about in a minute. We've made every attempt to meet the margin calls that have come in over the last few weeks, but they have been quite significant. We're also experiencing high margin calls in [the] High-Grade [Fund] as well. Lastly, the portfolio team is working hard at selling assets and focusing on the things that could move relatively quickly.


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

Related Terms: • Leverage • Margin Account • New York Stock Exchange—NYSE • Maintenance Margin • Margin Call 172 The Investopedia Guide to Wall Speak Margin Account What Does Margin Account Mean? A brokerage account in which the broker lends the customer cash to purchase securities. The loan in the account is collateralized by securities and cash. As the value of the stock drops, the account holder may be required to deposit more cash or sell a portion of the stock to bring the account back up to the proper margin levels. Investopedia explains Margin Account In a margin account, the investor is borrowing money from the broker to buy a security. By using leverage in this way, the investor magnifies his or her potential gains and losses. Related Terms: • Debt • Leverage • Margin Call • Interest Rate • Maintenance Margin Margin Call What Does Margin Call Mean? A broker’s demand for an investor to deposit additional money or securities to bring a margin account up to the minimum maintenance margin requirements; sometimes referred to as a fed call, maintenance call, or house call.

The Investopedia Guide to Wall Speak 31 Investopedia explains Buy to Cover These investors, who bet on a stock price’s decline, hope to buy back the shares at a lower price than the price at which the shares were sold short. There is no time frame for short investors, who can wait as long as they wish to repurchase the shares. However, if a stock begins to rise above the price at which the shares were shorted, the investors’ broker may force them to execute a buy to cover order to meet a margin call. To avoid margin calls, investors should keep enough buying power in their accounts to make a buy to cover trade, based on the current market price of the stock. Related Terms: • Maintenance Margin • Short (or Short Position) • Short Interest • Naked Shorting • Short Covering Buyback What Does Buyback Mean? The repurchase of outstanding shares (repurchase) by a company to reduce the number of shares outstanding in the market; companies buy back shares either to increase the value of available shares (reducing supply) or to eliminate threats by shareholders who may be planning a hostile takeover.

Investopedia explains Maintenance Margin As governed by the Federal Reserve’s Regulation T, when a trader buys on margin, key minimum margin requirements must be maintained throughout the life of the trade. First, a broker cannot extend any credit to accounts with less than $2,000 in cash (or securities). Second, the initial margin of 50% is required for each initial margin trade. Third, the maintenance margin states that an equity level of at least 25% must be maintained. The investor will receive a margin call if the value of securities falls below the maintenance margin. Related Terms: • Leverage • Margin Account • Regulation T—Reg T • Margin • Margin Call Managerial Accounting What Does Managerial Accounting Mean? The process of identifying, measuring, analyzing, interpreting, and communicating information in the pursuit of a company’s business goals. Also known as cost accounting. Investopedia explains Managerial Accounting The key difference between managerial accounting and financial accounting is that managerial accounting is intended to help managers within the organization make decisions.


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

More important, repo lenders watch the value of their collateral very carefully. If the value declines sufficiently, the hate-to-lose-money repo lender sends out a margin call—a demand for instant cash to make up for that loss in collateral value. If the margin call is not met, the bond can be liquidated or sold. Margin calls acutely concentrate the minds of traders, which makes their lives fundamentally different from those of traditional lenders or insurance company executives who see the world through long-term spectacles. The discipline imposed by short-term collateral funding gives investment bankers a profound respect for market valuation. They are equally likely to inflict margin calls on others (such as hedge funds) as they are to be on the receiving end of one. They live by the sword of market value or die by it. Think about owning a bond or loan in this new world.

Treasury announces MLEC initiative to rescue SIVs (October) King County, WA, discloses SIV exposure Merrill Lynch reports $6 billion of super-senior CDO losses and fires Stan O’Neal (November) Citigroup discloses $55 billion of subprime exposure and fires Chuck Prince Morgan Stanley discloses proprietary trading CDO losses Goldman Sachs reports record annual trading revenues of $31 billion; Dan Sparks, Josh Birnbaum, and other Goldman mortgage traders receive bonuses of $15–$20 million each PWC auditors express concern about implications of Goldman margin calls for AIG’s accounts; AIGFP chief Joseph Cassano concedes that if Goldman is right, AIG has lost $5 billion (December) AIG investor conference during which Cassano dismisses low-ball margin calls as “drive-bys” Goldman pitches distressed CDO trades to London hedge funds, creating prices to justify AIG margin calls John Paulson reports $20 billion in revenues from his “big short” on subprime Greg Lippmann receives $50 million bonus from Deutsche Bank Royal Bank of Scotland closes takeover of ABN AMRO 2008 (January) New York Insurance Department announces efforts to recapitalize monolines (February) HSH Nordbank files lawsuit against UBS over North Street 4 deal AIG publicly reveals that its auditor, PWC, has identified a “material weakness” in its CDO valuations and reports $11 billion of super-senior writedowns SEC’s Macchiaroli makes a return visit to Bear Stearns UBS reports full-year CDO writedowns of $18.7 billion (March) Bear Stearns suffers a loss in counterparty confidence and is taken over by J.P.

Meanwhile, down at the level of subprime originators, the virus of early payment defaults that Gasvoda had first detected in late 2006 was spreading to the warehouse of mortgage loans that the originators had transferred to Goldman after advancing cash to home owners. Because of the problems Gasvoda was having, Sparks had started to write down the market value of the originators’ mortgages, and that meant asking for additional margin to cover the difference. But when Sparks made his margin call, the originators couldn’t pay. As Gasvoda recounted to Sparks, “We just sent our guys in to collect some files. And they kicked our employees out of their building with a security guard.” Sparks and Gasvoda began to realize that the same thing was happening at all the Wall Street firms—they were demanding their money in buybacks or margin calls, and as a result the mortgage originators were dying like flies. Sparks was left with subprime mortgages he couldn’t sell and loans that weren’t being repaid. As he attended the weekly risk meetings with the heads of nine other key Goldman risk-taking businesses, Sparks felt himself once again under attack as he explained how the mortgage pipeline had unexpectedly malfunctioned.


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

This is not very important, for it is in the nature of a speculative boom that almost anything can collapse it. Any serious shock to confidence can cause sales by those speculators who have always hoped to get out before the final collapse, but after all possible gains from rising prices have been reaped. Their pessimism will infect those simpler souls who had thought the market might go up forever but who now will change their minds and sell. Soon there will be margin calls, and still others will be forced to sell. So the bubble breaks. Along with the downturn of the indexes Wall Street has always attributed importance to two other events in the pricking of the bubble. In England on September 20, 1929, the enterprises of Clarence Hatry suddenly collapsed. Hatry was one of those curiously un-English figures with whom the English periodically find themselves unable to cope.

No immediate explanation of the break was forthcoming. The Federal Reserve had long been quiet. Babson had said nothing new. Hatry and the Massachusetts Department of Public Utilities were from a week to a month in the past. They became explanations only later. The papers that Sunday carried three comments which were to become familiar in the days that followed. After Saturday's trading, it was noted, quite a few margin calls went out. This meant that the value of stock which the recipients held on margin had declined to the point where it was no longer sufficient collateral for the loan that had paid for it. The speculator was being asked for more cash. The other two observations were more reassuring. The papers agreed, and this was also the informed view on Wall Street, that the worst was over. And it was predicted that on the following day the market would begin to receive organized support.

Again the ticker was far behind, and to add to the uncertainty an ice storm in the Middle West caused widespread disruption of communications. That afternoon and evening thousands of speculators decided to get out while—as they mistakenly supposed—the getting was good. Other thousands were told they had no choice but to get out unless they posted more collateral, for as the day's business came to an end an unprecedented volume of margin calls went out. Speaking in Washington, even Professor Fisher was fractionally less optimistic. He told a meeting of bankers that "security values in most instances were not inflated." However, he did not weaken on the unrealized efficiencies of prohibition. The papers that night went to press with a souvenir of a fast departing era. Formidable advertisements announced subscription rights in a new offering of certificates in Aktiebolaget Kreuger and Toll at $23.


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

The $100,000 you owe now constitutes 67 percent of the $150,000 ($15 × 10,000) market value of your WCOM shares, and you will receive a “margin call” to deposit immediately enough money ($25,000) into your account to bring you back into compliance with the 50 percent requirement. Further declines in the stock price will result in more margin calls. I’m embarrassed to reiterate that my devotion to WCOM (others may characterize my relationship to the stock in less kindly terms) led me to buy it on margin and to make the margin calls on it as it continued its long, relentless decline. Receiving a margin call (which often takes the literal form of a telephone call) is, I can attest, unnerving and confronts you with a stark choice. Sell your holdings and get out of the game now or quickly scare up some money to stay in it. My first margin call on WCOM is illustrative. Although the call was rather small, I was leaning toward selling some of my shares rather than depositing yet more money in my account.

(Readily granting that this doesn’t say much for the transparency of my financial practices, which would not likely be approved by even the most lax Familial Securities Commission, I plead guilty to spousal deception.) When she went upstairs, I ducked out of the store and made the margin call. My illicit affair with WCOM continued. Occasionally exciting, it was for the most part anxiety-inducing and pleasureless, not to mention costly. I took some comfort from the fact that my margin buying distantly mirrored that of WorldCom’s Bernie Ebbers, who borrowed approximately $400 million to buy WCOM shares. (More recent allegations have put his borrowings at closer to $1 billion, some of it for personal reasons unrelated to WorldCom. Enron’s Ken Lay, by contrast, borrowed only $10 to $20 million.) When he couldn’t make the ballooning margin calls, the board of directors extended him a very low interest loan that was one factor leading to further investor unrest, massive sell-offs, and more trips to Borders for me.

Kozlowski, Dennis Kraus, Karl Krauthammer, Charles Kudlow, Larry Lakonishok, Josef Landsburg, Steven Lay, Ken LeBaron, Blake Lefevre, Edwin Leibweber, David linguistics, power law and Lo, Andrew logistic curve lognormal distribution Long-Term Capital Management (LTCM) losing through winning loss aversion lotteries present value and as tax on stupidity Lynch, Peter MacKinlay, Craig mad money Malkiel, Burton management, manipulating stock prices Mandelbrot, Benoit margin calls margin investments buying on the margin as investment type margin calls selling on the margin market makers decimalization and World Class Options Market Maker (WCOMM) Markowitz, Harry mathematics, generally Greek movies and plays about outguessing the average guess risk and stock markets and Mathews, Eddie “maximization of expected value” principle mean value. see also expected value arithmetic mean deviation from the mean geometric mean regression to the mean using interchangeably with expected value media celebrities and crisis mentality and impact on market volatility median rate of return Merrill Lynch Merton, Robert mnemonic rules momentum investing money, categorizing into mental accounts Morgenson, Gretchen Motley Fool contrarian investment strategy PEG ratio and moving averages complications with evidence supporting example of generating buy-sell rules from getting the big picture with irrelevant in efficient market phlegmatic nature of mu (m) multifractal forgeries mutual funds expert picks and hedge funds index funds politically incorrect rationale for socially regressive funds mutual knowledge, contrasted with common knowledge Nash equilibrium Nash, John Neff, John negatively correlated stocks as basis of mutual fund selection as basis of stock selection stock portfolios and networks Internet as example of price movements and six degrees of separation and A New Kind of Science (Wolfram) Newcomb, Simon Newcombe, William Newcombe’s paradox Niederhoffer, Victor Nigrini, Mark nominal value A Non-Random Walk Down Wall Street (Lo and MacKinlay) nonlinear systems billiards example “butterfly effect” or sensitive dependence of chaos theory and fractals and investor behavior and normal distribution Nozick, Robert numbers anchoring effect Benford’s Law and Fibonacci numbers and off-shore entities, Enron Once Upon a Number (Paulos) online chatrooms online trading optimal portfolio balancing with risk-free portfolio Markowitz efficient frontier of options. see stock options Ormerod, Paul O’Shaughnessy, James P/B (price-to-book) ratio P/E ratio interpreting measuring future earnings expectations PEG variation on stock valuation and P/S (price to sales) ratio paradoxes Efficient Market Hypothesis and examples of Newcombe’s paradox Parrondo’s paradox St.


pages: 293 words: 88,490

The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction by Richard Bookstaber

"Robert Solow", asset allocation, bank run, bitcoin, business cycle, butterfly effect, buy and hold, capital asset pricing model, cellular automata, collateralized debt obligation, conceptual framework, constrained optimization, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, dark matter, disintermediation, Edward Lorenz: Chaos theory, epigenetics, feminist movement, financial innovation, fixed income, Flash crash, Henri Poincaré, information asymmetry, invisible hand, Isaac Newton, John Conway, John Meriwether, John von Neumann, Joseph Schumpeter, Long Term Capital Management, margin call, market clearing, market microstructure, money market fund, Paul Samuelson, Pierre-Simon Laplace, Piper Alpha, Ponzi scheme, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, Richard Feynman, risk/return, Saturday Night Live, self-driving car, sovereign wealth fund, the map is not the territory, The Predators' Ball, the scientific method, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, tulip mania, Turing machine, Turing test, yield curve

Some of this will be spelled out in the governance structure and policies and procedures, some will be communicated to their investors.18 And during times of crisis, some of the heuristics are hard wired, without any ability for the agents to alter their course; most notably when it relates to issues of margin calls or forced liquidations due to reduced availability of funding.19 Each agent has its own set of heuristics. These will vary from one agent to the next, but generally speaking, the heuristics will be along these lines: the prime broker limits the funding it provides based on the collateral it holds and the haircut required by the cash provider; the trading desk will make a market based on the internal limits it is given for inventory, where those limits will depend on the availability of funding and the willingness to hold risky inventory; hedge funds maintain a target leverage—too high and there is the risk of margin calls and forced liquidation, too low and their returns suffer; and cash providers lend based on the dollar value of the collateral and a haircut based on the perceived creditworthiness of a borrower and the liquidity of the market.

Nobody thought they were merely having another bad day as Lehman imploded on Sunday, September 14, 2008. A crisis has is its own dynamic, often one without precedent. In the financial markets our day-to-day mode of operation is to reduce meaningful interactions, to fly under the radar. We try to minimize the impact of our transactions to keep from moving the market and to protect against signaling our intent. But not so when a crisis hits. When investors face margin calls, when banks face runs or teeter on default, the essential dynamic of a crisis cascades through the system, changing prices, raising credit concerns, and altering the perception of risk, thereby affecting others, even those not directly exposed to the events precipitating the crisis. We’ve all learned from each of these crises. We change our strategies, throw out some financial instruments and cook up some new ones.

People need to shoot from the hip; they have to decide quickly or decisions will be made for them. Any notion of an analytical process gives way because the world does not look rational—at least it does not follow normal assumptions and what you would normally observe. Meanwhile, the common crowd that shared similar views, that is more or less comfortable with the level of the market and the pace of the world, scurries in all directions. Some are fighting for their lives in the face of margin calls and redemptions, others stepping onto the sidelines to become observers. Can we tell any of this ahead of time? The Four Horsemen of the Econopalypse Social and economic interactions, colored by experience, are parts of human nature that, when joined together, create complexity that exceeds the limits of our understanding. Things happen and we don’t know why. And even if that untidy result is in some way quantifiable, human limits are the core of why economic methods fail with crises, because crises are the times when this complexity is most clearly evident and these limits are most constraining.


pages: 336 words: 101,894

Rogue Trader by Nick Leeson

corporate governance, margin call, Nick Leeson, price anchoring, the market place

Sure enough, they had written that I should provide daily reconciliations of the margin calls. The report contained a background note: BFS [Baring Futures Singapore] must deposit both initial margin and, if appropriate, variation margin on all contracts open with SIMEX on behalf of clients, which are mainly Baring Securities offices. BFS in turn requests margin deposits from clients. Leaving aside certain timing differences and other minor exceptions, all figures should agree. If they do not it is possible that either SIMEX or BFS are calling for incorrect margin amounts… There is no check to ensure that the amounts called by SIMEX or BFS are the same. The note concluded: ‘At present it is theoretically possible for fictitious house trades to be booked to BFS’s system and extra margin called.’ I went along to see Baker and Manson, waving a copy of the draft report.

I was sure our phones were tapped: it was just impossible that so many big tickets could get in front of me. They’d beaten me by less than a second every time. I’d lost more money, God knows how much more. I’d gone in trying to reduce the position and ended up buying another 4,000 contracts. I tried to clear my head: today was Thursday, and my birthday was just two days away now. SIMEX would make a margin call tomorrow for at least another $40 million. It could never happen. I was giving up the fight. I slipped away from the trading floor and walked quickly outside. I nodded and grinned at a few people. I noticed a lot of astonished, elated faces staring at me, sweating and flushed as if they’d just come off a dance floor. Traders looked at me and knew I’d done an amazing volume of trade; they marvelled at the sheer amount of business I’d got through.

But if they then saw the true balance of the 88888 account – which was automatically part of their system – and subsequently saw the open position as 100 contracts, they would immediately question what this liability was. Then they’d find out that not only was it an unauthorised position, it was larger than most of the authorised ones. I’d be marched off the trading floor and leave my stripy jacket behind. The third problem was the most ominous of all. Each day SIMEX makes a margin call and requests funds. In a highly complicated calculation, SIMEX demands margin payments to take into account not only any money you’d lost today but also the money you might lose, under normal market conditions, the next day. The contracts in Account 88888 would show up on their screens as a Barings client account, and they would send through a request for a small percentage of the liability, depending upon the market’s volatility.


pages: 289 words: 77,532

The Secret Club That Runs the World: Inside the Fraternity of Commodity Traders by Kate Kelly

Bakken shale, bank run, business cycle, Credit Default Swap, diversification, fixed income, Gordon Gekko, index fund, light touch regulation, locking in a profit, London Interbank Offered Rate, Long Term Capital Management, margin call, paper trading, peak oil, Ponzi scheme, risk tolerance, Ronald Reagan, side project, Silicon Valley, Sloane Ranger, sovereign wealth fund, supply-chain management, the market place

But instead, those peak prices from July 2008 had reversed, dropping the U.S. oil contract price based on the future price of West Texas crude from nearly $150 to about $34 during the winter of 2008 and 2009, turning what Delta had thought would be insurance policies to help it survive inflated jet-fuel prices into expensive liabilities. The airline’s bad timing had been such that at the end of 2008, unexpectedly low crude prices had resulted in margin calls, or demands for additional cash from its banks, of $1.2 billion, the sum required simply to keep the poorly functioning hedges intact. It was much the same scenario that Emirates Airline had faced during that period, when Morgan Stanley’s ingenious plan for curbing the Middle Eastern carrier’s exposure to runaway fuel expenses led instead to a crushing margin call of more than $4 billion, prompting John Mack’s emergency visit to Dubai. Compared to 2009, the year 2010 was far better for Delta. But it still involved a slight loss from its attempted hedges of $89 million.

_r=0. A Texas native . . . new chief executive: Dan Reed, “Executive Suite: Delta Chief Takes Unlikely Flight Path,” USA Today, February 14, 2008, http://usatoday30.usatoday.com/travel/flights/2007-10-21-delta-ceo-anderson_N.htm and author reporting. $1.2 billion: Matt Cameron, “Airlines Use Aircraft as Alternative to Cash in Margin Calls,” Risk, August 17, 2009, http://www.risk.net/print_article/risk-magazine/news/1530797/airlines-aircraft-alternative-cash-margin-calls. new record high each month: Food and Agriculture Organization of the United Nations, “World Food Prices Reach New Historic Peak,” February 3, 2011, http://www.fao.org/news/story/en/item/50519/icode/. twenty-six-year-old Tunisian fruit and vegetable vendor: Kareem Fahim, “Slap to a Man’s Pride Set Off Tumult in Tunisia,” New York Times, January 21, 2011, http://www.nytimes.com/2011/01/22/world/africa/22sidi.html?

In five short months, West Texas contract prices collapsed from their height of nearly $150 to less than $70 and kept going. The floor of the Emirates trading range had now been pierced, and although the cost of West Texas crude was by now impossibly low—ranging in the $50s by November—the cost of the “swap” portion of the trade the airline had arranged with Morgan Stanley, which was repriced every day based on the latest market movements, was exploding. At that point, Morgan made a massive “margin call,” or demand for additional cash as a down payment on the ongoing swap trade, to Emirates of more than $4 billion. The put options, or rights to sell crude, that the carrier had sold to Morgan were by now well below their “strike,” or target price. While the details of the paper transaction were confusing, the economic impact of it could be understood simply: if Morgan Stanley had wanted to collect on the puts, Emirates could, effectively, have had to buy crude oil from Morgan for $70 per barrel and receive as little as $50 per barrel in return.


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

The investor who only sold short warrants had dramatic successes mixed with the spectacular losses. This last strategy would in practice have had even greater losses than indicated. For instance, after Mack Trucks warrants were sold short at 17⁄, they rose to 35fl. This seems to indicate that the investor was wiped out! But actually, depending on how quickly his broker reacted, he would have received margin calls as the warrants rose above 22fi. We assume that he then covered part of his short position rather than ante up more money. If he received a margin call for every 1 point rise in the warrant, his loss would amount to about $20,000 because the warrant then fell from 35fl to 23/8. If his broker were not alert and he was asked to cover only when the warrant rose more than 1 point, his loss would have been greater. In actual practice, with the warrant moving as much as 3 or 4 points in one day, he would probably have suffered a more severe loss.

For example, if the 200 Molybdenum warrants we sold short rise from 13 to 20, the lender demands $200 times the point rise, or $1,400 additional collateral. This reduces our margin to $420 from an initial $1,820. However, to meet the 30% maintenance margin requirement, our broker wants on deposit 30% of the current market value of the 200 warrants. They are at 20, the market value is $4,000, and 30% of this is $1,200. We will get a margin call from our broker requesting us to increase the margin from $420 to $1,200. We deposit the additional $780 if we wish 38 to remain short; otherwise the broker will cover our short position. Most margin accounts are not opened by investors who intend to sell short but buy customers who wish to buy without putting up the full price. To illustrate, suppose we bought 1,000 Molybdenum warrants at 13.

The warrants steadily declined from this point and on July 29 an additional 200 warrants were sold short in the same account at 3fi without depositing any additional margin. When the warrants fell from 51/8 to 3fi, enough purchasing power was generated to sell short the additional 200 warrants. Of course, if one had been sure that the decline would be continuous, more warrants should have been shorted at every possible opportunity. Soon after the additional 200 warrants were shorted, we received a margin call. When we protested, the margin clerk recalculated and still claimed margin was required. Finally, however, when the head margin clerk tallied the account, he was satisfied that no margin was needed. This once again indicated that we must constantly check our own accounts and not blindly accept the statements of brokerage houses. (In fairness we point out that calculations in a mixed account, namely one short and long simultaneously, may not be simple.


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

This avoided any need to shut down a profitable trade because of one-sided margin calls. A trader might be short interest rates on one side of a position and long interest rates on the other side of the position. If overall interest rates decline, one side of the position loses money and the other side makes money. If the margin were marked to market on only one side of the trade, the trader would have a financing problem—even though the trade had not lost money. This problem famously caused the Metallgesellschaft failure in 1993. Traders built an oil arbitrage in longer-dated oil forward contracts and hedged the position by rolling over short-term oil futures contracts. The latter require daily mark-to-market on the futures exchange, but the former do not. As the price of oil moved against them, the traders had to meet margin calls on the futures, without receiving any profits from the forwards, which were not marked to market.

When Bear did not respond to requests for more capital, Merrill Lynch seized $850 million in collateral and tried to sell it, finding very few buyers and fast-sinking prices. These illiquid securities found little market enthusiasm. It was over. Bids were coming in at 50 cents. Merrill was selling us out. There were not bids on half the items. That’s when the world woke up. That could be the wake-up call. That margin call. —Jimmy Cayne, former CEO of Bear Stearns (Cohan 2010) Overcoming Cayne’s resistance, Bear Stearns took over counterparties’ repo positions on the less-levered fund, a move designed to relieve the stress the hedge funds felt from counterparty margin calls. On June 21, Bear announced that it would provide up to $3.2 billion for the fund to take over these counterparty positions. The hedge fund fiasco also highlighted problems with management communication. Before going into the executive committee meeting to discuss the troubled hedge funds, Jimmy Cayne asked Steve Begleiter how much money was in the hedge funds.

Once you kick the snowball down the hill, then the large funds had no choice but to de-lever, because the big funds, like AQR, have trouble unwinding big trades in a week. So they had to start de-levering right away and this caused the self-fulfilling prophecy. Think of it as a margin requirement. Leverage is asset size divided by account equity. You usually change your leverage by changing your numerator. If you lose a lot of money, leverage starts going up rapidly and involuntarily because of the denominator. You may be subject to a margin call. You can’t wait until this margin call to begin selling the numerator.25 If you have billions on each side of a market-neutral portfolio, you cannot wait too long to begin reducing your positions. You come in on Monday, you can’t wait for four days, so you start unwinding today. The big guys had to start de-levering, funds, like GSAM, BGI, Citadel, and AQR.26 This never happened before, so there was no rule for when to cut the positions.


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

Brokers that had been willing to lend freely to the shadowbankers suddenly reversed themselves now that their trades were going wrong: Rather than accepting $1 million of collateral, or “margin,” to back every $100 million of bonds, the brokers demanded $3 million or $5 million to protect themselves from the danger that a hedge fund might prove unable to repay them. To meet the brokers’ margin calls, hedge funds had to liquidate holdings on a grand scale: If you are leveraged one hundred to one, and if your broker demands an extra $4 million in margin, you have to sell $400 million worth of bonds—quickly. As hedge funds liquidated bond positions, the selling pressure drove their remaining holdings down, triggering yet further margin calls from brokers. The scary pyramiding of debt, which had fueled the bond bubble in good times, now accelerated its implosion. Some two weeks after the yen shock, on March 1, yet more bad news buffeted the markets. New data suggested that U.S. inflation was more of a threat than had been feared; in keeping with the Greenspan view, the yield on ten-year Treasury bonds jumped by fifteen basis points.

In practice, of course, it was hard to feel so confident. Citadel had planned for a crisis, but not a crisis on this scale, and nothing could insulate it from what was going on around it. Other hedge funds, which had done less to lock in their financing securely, faced margin calls that forced them to dump convertible bonds and other positions; the weight of their selling caused Citadel to suffer yet more losses. Rumors that Citadel might be about to go under seemed to surface at dizzying speed. Citadel had been hit with margin calls! The Fed was calling Citadel’s trading partners, asking the size of their exposures! The truth was that the Fed was indeed calling around Wall Street, telling banks not to pull loans; but whether this saved Citadel or served to fuel the rumor mill could be debated. On some days in October, CNBC parked a truck outside the Citadel Center.

New data suggested that U.S. inflation was more of a threat than had been feared; in keeping with the Greenspan view, the yield on ten-year Treasury bonds jumped by fifteen basis points. But although economic logic explained the reaction in the United States, no such logic could explain what happened next: Bond markets in Japan and Europe cratered. Far from being spooked by an expected surge in inflation, Japan was grappling with the threat of deflation, and yet ten-year Japanese interest rates jumped by seventeen basis points on March 2. As brokers issued yet more margin calls to hedge funds, the logic of leverage transmitted the trouble to Europe. In order to raise capital, hedge funds off-loaded an estimated $60 billion worth of European bond holdings, and long-term interest rates spiked upward.18 The frenzy of selling created sharp losses across Wall Street. Paul Tudor Jones, whose great strength was to sense how other traders were positioned, failed to spot the danger in Europe, and in the spring of 1994 his fund was down sharply.


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

The upshot of all this is that the hedge fund earns a lower interest rate on the cash backing its short sales than the interest rate on the loan that finances the long positions. • Margin call. When implementing leverage or short-selling, you cannot be as laid back as a long-term unleveraged investor. You need to monitor your positions and cash levels continuously to make sure that your cash levels are above the minimum margin requirement. If a hedge fund has insufficient cash in its margin account (e.g., because of losses on its positions), it receives a margin call from its prime broker. This means that it receives notice that it needs to add cash to its account or reduce positions. If the hedge fund does not do one or the other, the prime broker will liquidate the positions. Receiving a margin call is itself a negative. Even if the hedge fund successfully adds cash, repeated margin calls are a sign of problems and can eventually lead the prime broker to terminate the arrangement or increase margin requirements.

When short sellers are forced to close their short positions, they are forced to buy the share back and, when many short sellers do this simultaneously, the stock price can be driven up—a “short squeeze.” A short squeeze feeds on itself: As the buying drives the price up, more short sellers may be forced to close their positions as they cannot make their margin calls, leading to further buying, higher prices, and more margin calls. There are two reasons why short sellers face margin calls when stock prices rise. First, their positions are marked to market each day, so if a stock price increases from $100 to $105, then short sellers must pay $5 per share shorted. Second, when prices move against a short seller, the dollar value of the position increases, leading to higher margin requirements (since margins are typically a fixed percentage of value).

For example, when I have taught my class on hedge fund strategies, I have often presented MBA students with a great trade, for instance, a pure arbitrage such as one of the negative stub trades (discussed further in chapter 16, event-driven investments). Once the students have figured out the trade, I ask them to size the position, and most students invest at least 40% of their capital in the trade. The following week, we see how they would have fared. Almost every student’s position blows up (except one or two students who would not do the trade at all). Indeed, simulating their margin equity shows that they could not meet their margin calls and were forced to liquidate most of their position, thus ending up with a loss, or completely broke, even when the trade finally converged. One simple and effective way to reduce the risk of being blown up by a single position—and ensure greater diversification—is to have position limits. For instance, James Chanos makes sure that all his positions are less than 5% of his net asset value (NAV), trimming positions back as they approach this limit


pages: 302 words: 84,428

Mastering the Market Cycle: Getting the Odds on Your Side by Howard Marks

activist fund / activist shareholder / activist investor, Albert Einstein, business cycle, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, if you build it, they will come, income inequality, Isaac Newton, job automation, Long Term Capital Management, margin call, money market fund, moral hazard, new economy, profit motive, quantitative easing, race to the bottom, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, secular stagnation, short selling, South Sea Bubble, stocks for the long run, superstar cities, The Chicago School, The Great Moderation, transaction costs, VA Linux, Y2K, yield curve

Prior to the Crisis, senior or “leveraged” loans—even those with credit problems—had rarely traded at prices below 96 cents on the dollar. Thus we felt we were well insulated from the possibility of margin calls (demands from lenders for additional equity capital) that, under our borrowing agreement, could come only if the average market price of the loans in the portfolio got down to 88. But in the aftermath of the Lehman bankruptcy, loan prices fell to unprecedented levels, pressured by, among other things, banks’ fire sales of portfolios abandoned by levered holders who received margin calls of their own and failed to meet them. Thus 88—and a margin call and meltdown—became a real possibility for us. We were able to get time to respond from our lender, and we set about raising additional equity from the fund’s investors with which to reduce the fund’s leverage from 4-to-1 to 2-to-1.

Thus most of them came forward with the increased equity we requested. At the newly reduced level of leverage, the fund was protected from a margin call unless the average price of our loans fell to an unimaginable 65. But with the total absence of buyers and the continuation of margin-call- and hedge-fund-withdrawal-related selling, the loan market continued to spiral downward, as the notion of “the right price” gave way to widespread concern that no price could be counted on to hold. Thus the average price on our loan portfolio neared 70. It fell to me to get the leverage down from 2-to-1 to 1-to-1, in which case we could completely eliminate the contractual covenant that introduced the risk of a margin call. Now I was offering the fund’s investors a chance to pay to retain the fund’s loans at yields to maturity that were well into double digits, and levered returns on the overall fund in the 20s (before fees and potential losses due to defaults).

Large numbers of mortgage defaults led to downgradings, covenant breaches and payment defaults on mortgage backed securities. The downgradings, breaches and defaults caused the prices of mortgage backed securities to collapse, and the resultant loss of confidence caused the market liquidity for these instruments to dry up. With terrified buyers taking to the sidelines—and terrified holders increasingly eager to sell (or forced to sell by margin calls)—the result was a dramatic downward spiral in the prices of mortgage backed securities. These negative developments collided head-on with new regulations, designed to increase transparency, which required banks’ assets to be “marked to market.” But with prices in free-fall and liquidity non-existent, it was hard to have faith in any price chosen. When banks marked down their assets to be appropriately conservative, the implied losses shocked investors, contributing to further panic, which caused prices to decline further, and so on.


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

It was about to announce a devastating $24 billion third-quarter loss. The financial crisis was a tough time to be any financial firm, but it was an impossible time to be a financial firm that provided insurance against the failure of other financial firms and financial instruments. As those firms and instruments lost value, AIG was getting crushed by incessant margin calls, prompting rating agencies to consider new downgrades, which would lead to additional margin calls. The company was once again on the brink of default itself, even after our twelve-figure assistance package. Default was not an option, not unless we wanted a global stampede that could have made the aftermath of Lehman look relatively mild. But we didn’t want to keep throwing money into a bottomless pit. AIG was starting to look like our Vietnam.

I also warned that the firms that ended up with subprime exposure would find it even harder than usual to assess their risks, because of the complexity and the newness of the financial instruments into which the mortgages were sliced and diced. And I explained that the drift of risk from simple loans in traditional banks to structured products in leveraged nonbanks increased the danger of a “ ‘positive feedback’ dynamic,” a vicious cycle that could amplify a crisis. If asset prices fell, firms and investors would need money to meet margin calls, prompting fire sales that would drive asset prices even lower, and so on. But March 2007 was pretty late in the game to be warning about subprime. And my view was that the only effective way to reduce the risks ahead was for supervisors to make sure significant financial firms had enough capital and liquidity to survive a crisis. “The most productive focus of policy attention has to be on improving the shock absorbers in the core of the financial system,” I said.

We also failed to anticipate the savage depth of the Great Recession, or the debilitating feedback loop between problems in the financial system and problems in the broader economy. A mere drop in housing prices could not have triggered mass mortgage defaults or depression-level losses in the banking system, but as unemployment increased and jobless homeowners missed payments, actual and expected mortgage losses increased as well, triggering margin calls and selloffs of mortgage-related assets, making the economy, unemployment, and the housing market worse. We weren’t prepared for that kind of doom loop. You could say our failures of foresight were primarily failures of imagination, like the failure to foresee terrorists flying planes into buildings before September 11. But severe financial crises had happened for centuries in multiple countries, in many shapes and forms, always with pretty bad outcomes.


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

He felt lucky to be able to pick Levin’s brain during such a critical time. Over sushi and wine, the two started hashing out their ideas about what had triggered the meltdown. By the time they were through—they closed the restaurant—they had a working hypothesis that would prove prescient. A single, very large money manager had taken a serious hit from subprime assets, they theorized. That, in turn, would have triggered a margin call from its prime broker. Margin call: two of the most frightening words in finance. Investors often borrow money from a prime broker to buy an asset, say a boatload of subprime mortgages. They do this through margin accounts. When the value of the asset declines, the prime broker calls up the investor and asks for additional cash in the margin account. If the investor doesn’t have the cash, he needs to sell something to raise it, some liquid holding that he can get rid of quickly.

Ratings agencies such as Moody’s and Standard & Poor’s were also downgrading large swaths of CDOs, pushing their value down even further and prompting more forced selling. Margin calls on funds with significant subprime holdings were rolling across Wall Street. Funds that primarily owned mortgages were stranded, since the only way they could raise cash would be to dump the very assets that were plunging in value. Multistrat funds, however, had more options. At least one of these funds—there may have been several—had a large, highly liquid equity quant book, Rothman and Levin reasoned. The fund manager must have looked around for assets he could dump with the utmost speed to raise cash for the margin call, and quickly fingered the quant equity book. The effects of that sell-off would have started to ripple through other funds with similar positions.

The only way to squeeze more cash from the wafer-thin spreads was to leverage up—precisely what had happened in the 1990s to Long-Term Capital Management. By 1998, nearly every bond arbitrage desk and fixed-income hedge fund on Wall Street had copied LTCM’s trades. The catastrophic results for quant funds a decade later were remarkably similar. Indeed, the situation was the same across the entire financial system. Banks, hedge funds, consumers, and even countries had been leveraging up and doubling down for years. In August 2007, the global margin call began. Everyone was forced to sell until it became a devastating downward spiral. Near midnight, Rothman, luggage still in tow, hopped in a cab and told the driver to take him to the Four Seasons. As he leaned back in the cab, exhausted, he pondered his next move. He was scheduled to fly to Los Angeles the next day to visit more investors. But what was the point? The models were toast. Forget it, he thought, deciding to cancel the L.A. trip.


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 volatile markets, values deviate significantly from actual values if the security is held to maturity. Prices are prone to manipulation. Banks may mark positions at high prices to prevent complex, illiquid securities being sold at a discount, and pushing down values. If the securities actually traded, then the lower market price would be used to value positions, increasing losses and margin calls for more collateral on already cash-strapped investors. Alternatively, a lower price is used to force margin calls and selling, allowing dealers to buy the assets cheaply. The entity’s own credit risk was now required to be used to establish the value of its liabilities, resulting in gains for credit downgrades and losses for credit upgrades. If a bank has issued $100 bonds and the market price drops to $80 (80 percent), then it records a gain. During the financial crisis, banks recorded substantial profits from revaluing their own liabilities—bizarrely increasing profits as their financial condition deteriorated.

Financial Gravity In 2007, everyone discovered what Joseph Conrad knew: “[a civilized life is] a dangerous walk on a thin crust of barely cooled lava which at any moment might break and let the unwary sink into fiery depths.”1 The end arrived unexpectedly, reflecting author Alexander Pope’s description of the collapse of the 1720 South Sea Bubble: “Most people thought it wou’d come but no man prepar’d for it; no man consider’d it would come like a thief in the night, exactly as it happens in the case of death.”2 Air Pockets As interest rates increased from 1 percent to 5.25 percent per annum, reflecting higher oil and food prices, U.S. house prices stalled and then fell. Subprime mortgages predicated on low rates, rising house prices and the ability to refinance on favorable terms defaulted. Losses were significant but not huge. But mortgage defaults also triggered paper losses on highly rated securities used as collateral for borrowing. Borrowers sold everything to meet the need for cash to margin calls, forcing down prices setting off new margin calls, causing losses to radiate through the financial system. In 1929, JP Morgan’s Thomas Lamont had tried to calm markets: “There has been a little distress selling.... Air holes caused by a technical condition...the situation was ‘susceptible of betterment.’”3 As the stock market fell, John D. Rockefeller issued a statement: “Believing that the fundamental conditions of the country are sound...my son and I have for some time been purchasing sound common stocks.”

Transmission of subprime losses Traditional investors who had not themselves borrowed to buy the securities found themselves having to sell as paper losses reached certain levels, triggering real losses. They were also indirectly caught up in the death throes of leveraged funds. Unable to borrow directly, they had invested in hedge funds, SIVs and CDOs to access the hidden fruit of leverage. As the value of the securities used as collateral fell, investors who had borrowed found lenders asking for more collateral. Hedge funds, conduits, and SIVs did not have the money to meet the margin calls. Forced selling set off of a new round of price falls, restarting the entire cycle. At Bear Stearns, Ralphie’s Funds owned AAA and AA-rated MBSs funded by $600 million in equity and $10 billion in short-term borrowings. In good times, the leverage ensured good returns but now it worked in reverse. A 1 percent fall in the value of the fund assets was roughly equivalent to a loss of $100 million (about 16 percent of the equity).


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

These problems did not seem pressing during the boom, when the financial system appeared unusually stable, conventional wisdom held that home prices would continue to rise indefinitely, and many in Wall Street, Washington, and academia believed that serious financial crises were a thing of the past. But once the housing bubble popped, fear of losses created a financial stampede, as investors and creditors frantically reduced their exposure to anything and anyone associated with mortgage-backed securities, triggering fire sales (where cash-starved investors are forced to sell their assets at any price) and margin calls (where investors who bought assets on credit are forced to put up more cash) that in turn triggered more fire sales and margin calls. The financial panic paralyzed credit and shattered confidence in the broader economy, and the resulting job losses and foreclosures in turn created more panic in the financial system. A decade later, that doom loop of financial fear and economic pain has begun to recede in the public memory. But it’s hard to overstate just how chaotic and frightening it was.

It can go at any time, for rational or irrational reasons. When it goes, it usually goes quickly, and it’s hard to get back. A financial crisis is a bank run writ large, a crisis of confidence throughout the system. People get scared and want their money back, which makes the money remaining in the system less safe, which makes more people want their money back, a self-reinforcing doom loop of fear, fire sales, capital shortfalls, margin calls, and credit contractions that can produce a stampede for the exits. Once a stampede begins, it becomes rational to run to avoid getting trampled, and hesitation can be deadly. Perception and reality both matter, because runners will keep running until they’re confident not only that they don’t have a rational reason to run, but that others will have the confidence to stop running as well. Fear is hardwired into the human psyche, and the herd mentality is powerful, which makes stampedes hard to predict and hard to stop.

And if your creditor suddenly demands repayment of the loan, or forces you to post additional collateral, you might have a real problem, especially if you don’t have a lockbox full of Treasuries for emergency use only. You might have to sell the asset immediately to avoid default, and if others with similar assets hold similar fire sales, the price of the assets will drop further, triggering more fire sales and margin calls and defaults, and so on down the drain. If you happen to be a financial firm, your creditors might sour on your commercial paper, stop renewing your overnight repo loans, or force you to post more collateral, the modern equivalents of bank runs. That’s how panic spread after the housing bubble popped. Before the crisis of 2008, many large financial institutions were increasingly leveraged, in some cases borrowing more than $30 for every dollar of shareholder capital, affording very limited protection against losses.


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

But any hopes that the worst had passed were shattered before the market closed on Wednesday. An avalanche of sell orders in the last hour of trading pushed stocks down sharply, which triggered a fresh round of margin calls and more forced selling.39 The Dow suffered what was then its largest one-day point loss in history, falling 20.7 points (6.3 percent) to close at 305.3. Because the sell-off was so sharp and came so late in the day, an unprecedented number of margin calls went out that night, requiring investors to post significantly more collateral to avoid having their positions closed out when the market opened on Thursday.40 Many equity holders would be required to sell. Everyone who worked on the exchange was alerted to be prepared for the big margin calls and sell orders that would come Thursday morning. Policemen were posted throughout the financial district in the event of trouble.

Stocks fell sharply on Saturday, October 19, which saw the second-highest trading volume ever in a Saturday session and the decline became self-reinforcing on the downside. A wave of margin calls went out after the close, which required those who owned stocks on leverage to either put up more cash (which was hard to come by) or sell stocks, so they had to sell stocks.34 Sunday’s New York Times headline read, “Stocks driven down as wave of selling engulfs the market.”35 Still, traders widely expected that the market would recover when it opened again on Monday. Over the weekend, Thomas Lamont of J.P. Morgan, looking at the economy, wrote to President Herbert Hoover that the “future appears brilliant.”36 The week of October 21 began with heavier selling. One analyst described Monday’s waves of sell orders as “overwhelming and aggressive.”37 Trading volume again broke records. Another wave of margin calls went out and distressed selling among levered players was prevalent.38 But markets rallied into the end of Monday’s session, so losses were smaller on Monday than they’d been on Saturday.

–New York Times March 10, 2008 Slipping Away “As you know we have a vague fear that the degree of levered counterparty positions that have built up over the years creates a kind of house of financial cards. With financial markets making new lows, new problems are popping up. More and more entities are failing on margin calls, and this is flowing through to the dealers who have the exposures when entities fail on margin. Financials were crushed Monday as rumors of liquidity trouble at Bear Stearns flew. While we don’t have any view on rumors, the quantity of major entities failing on margin calls (TMA, Carlyle Financial) is likely creating trouble at many dealers. The counterparty exposures across dealers have grown so exponentially that it is difficult to imagine any one of them failing in isolation. Bear Stearns has entered a non-equilibrium situation, as its business, in all likelihood, cannot be sustained at current market prices.


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

The change order can specify the change in the limit price, the order type (buy or sell), and the number of units to process. A change order can also be placed to cancel an existing limit order. Some execution counterparties may charge a fee for a change order. A margin call close order is one order traders probably want to avoid. It is initiated by the executing counterparty whenever a trader trades on margin and the amount of cash in the trader’s account is not sufficient to cover two times the losses of all open positions. The margin call close is executed at market at the end of day, which varies depending on the financial instrument traded. Most broker-dealers and ECNs provide phone support for clients. If customer computer system or network connectivity breaks down for whatever reason, a customer can phone in an order.

As Table 6.3 shows, on an average day between October 1, 2003 and May 14, 2004, the most common orders—both by number of orders and by volume—were stop-loss or take-profit (22 percent and 23 percent, Daily Distributions of Trades per Trade Category in FX Spot of Oanda TABLE 6.3 FXTrade, a Toronto-Based Electronic FX Brokerage, as Documented by Lechner and Nolte (2007) Transaction Record Buy Market (open) Sell Market (open) Buy Market (close) Sell Market (close) Limit Order: Buy Limit Order: Sell Buy Limit Order Executed (open) Sell Limit Order Executed (open) Buy Limit Order Executed (close) Sell Limit Order Executed (close) Buy Take-Profit (close) Sell Take-Profit (close) Buy Stop-Loss (close) Sell Stop-Loss (close) Buy Margin Call (close) Sell Margin Call (close) Change Order Change Stop-Loss or Take-Profit Cancel Order by Hand Cancel Order: Insufficient Funds Cancel Order: Bound Violation Order Expired Total: Percentage of Orders per Order Count 13.10 10.61 8.27 10.27 5.41 4.76 3.22 Mean Daily Trading Volume in EUR Percentage of Orders by Trade Volume percent percent percent percent percent percent percent 167,096 135,754 110,461 140,263 61,856 48,814 23,860 2.92 percent 14,235 1.20 percent 0.46 percent 6,091 0.52 percent 0.46 percent 6,479 0.55 percent 3.14 3.49 2.18 2.55 0.12 0.17 3.01 22.36 14.13 11.48 9.34 11.86 5.23 4.13 2.02 1.09 1.64 1.67 1.98 0.06 0.10 5.18 22.71 percent percent percent percent percent percent percent percent percent percent percent percent percent percent percent 12,858 19,401 19,773 23,391 733 1,213 61,229 268,568 percent percent percent percent percent percent percent percent 2.41 percent 0.28 percent 44,246 10,747 3.74 percent 0.91 percent 0.20 percent 860 0.07 percent 0.65 percent 100.04 percent 4,683 1,182,611 0.40 percent 100.00 percent 72 HIGH-FREQUENCY TRADING Popularity of Orders as a Percentage of Order Number and Total TABLE 6.4 Volume among Orders Recorded by Oanda between October 1, 2003 and May 14, 2004 Number of Orders, Daily Average Total Volume in EUR Percent of All Open Orders That Are Buy Orders 55 percent 55 percent Percent of Market Orders That Are Buy Orders 55 percent 55 percent Percent of Open Buy Limit Orders Executed Percent of Open Sell Limit Orders Executed 60 percent 61 percent 39 percent 29 percent Total Long Positions Opened per Day 1,647 190,956 Closing the Long Position Sell Market (close) Sell Take-Profit (close) Sell Stop-Loss (close) Sell Limit Order Executed (close) Sell Margin Call (close) 63 21 16 3 1 73 10 12 3 1 Order Type Total Short Positions Opened per Day Closing the Short Position Buy Market (close) Buy Take-Profit (close) Buy Stop-Loss (close) Buy Limit Order Executed (close) Buy Margin Call (close) percent percent percent percent percent 1,367 61 23 16 3 1 percent percent percent percent percent percent percent percent percent percent 149,989 74 9 13 4 0 percent percent percent percent percent respectively), buy market open (13 percent and 14 percent), sell market open (11 percent), and sell market close (10 percent and 12 percent by order number and volume, respectively).

As Table 6.3 shows, on an average day between October 1, 2003 and May 14, 2004, the most common orders—both by number of orders and by volume—were stop-loss or take-profit (22 percent and 23 percent, Daily Distributions of Trades per Trade Category in FX Spot of Oanda TABLE 6.3 FXTrade, a Toronto-Based Electronic FX Brokerage, as Documented by Lechner and Nolte (2007) Transaction Record Buy Market (open) Sell Market (open) Buy Market (close) Sell Market (close) Limit Order: Buy Limit Order: Sell Buy Limit Order Executed (open) Sell Limit Order Executed (open) Buy Limit Order Executed (close) Sell Limit Order Executed (close) Buy Take-Profit (close) Sell Take-Profit (close) Buy Stop-Loss (close) Sell Stop-Loss (close) Buy Margin Call (close) Sell Margin Call (close) Change Order Change Stop-Loss or Take-Profit Cancel Order by Hand Cancel Order: Insufficient Funds Cancel Order: Bound Violation Order Expired Total: Percentage of Orders per Order Count 13.10 10.61 8.27 10.27 5.41 4.76 3.22 Mean Daily Trading Volume in EUR Percentage of Orders by Trade Volume percent percent percent percent percent percent percent 167,096 135,754 110,461 140,263 61,856 48,814 23,860 2.92 percent 14,235 1.20 percent 0.46 percent 6,091 0.52 percent 0.46 percent 6,479 0.55 percent 3.14 3.49 2.18 2.55 0.12 0.17 3.01 22.36 14.13 11.48 9.34 11.86 5.23 4.13 2.02 1.09 1.64 1.67 1.98 0.06 0.10 5.18 22.71 percent percent percent percent percent percent percent percent percent percent percent percent percent percent percent 12,858 19,401 19,773 23,391 733 1,213 61,229 268,568 percent percent percent percent percent percent percent percent 2.41 percent 0.28 percent 44,246 10,747 3.74 percent 0.91 percent 0.20 percent 860 0.07 percent 0.65 percent 100.04 percent 4,683 1,182,611 0.40 percent 100.00 percent 72 HIGH-FREQUENCY TRADING Popularity of Orders as a Percentage of Order Number and Total TABLE 6.4 Volume among Orders Recorded by Oanda between October 1, 2003 and May 14, 2004 Number of Orders, Daily Average Total Volume in EUR Percent of All Open Orders That Are Buy Orders 55 percent 55 percent Percent of Market Orders That Are Buy Orders 55 percent 55 percent Percent of Open Buy Limit Orders Executed Percent of Open Sell Limit Orders Executed 60 percent 61 percent 39 percent 29 percent Total Long Positions Opened per Day 1,647 190,956 Closing the Long Position Sell Market (close) Sell Take-Profit (close) Sell Stop-Loss (close) Sell Limit Order Executed (close) Sell Margin Call (close) 63 21 16 3 1 73 10 12 3 1 Order Type Total Short Positions Opened per Day Closing the Short Position Buy Market (close) Buy Take-Profit (close) Buy Stop-Loss (close) Buy Limit Order Executed (close) Buy Margin Call (close) percent percent percent percent percent 1,367 61 23 16 3 1 percent percent percent percent percent percent percent percent percent percent 149,989 74 9 13 4 0 percent percent percent percent percent respectively), buy market open (13 percent and 14 percent), sell market open (11 percent), and sell market close (10 percent and 12 percent by order number and volume, respectively).


The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis by Tim Lee, Jamie Lee, Kevin Coldiron

active measures, Asian financial crisis, asset-backed security, backtesting, bank run, Bernie Madoff, Bretton Woods, business cycle, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, debt deflation, distributed ledger, diversification, financial intermediation, Flash crash, global reserve currency, implied volatility, income inequality, inflation targeting, labor-force participation, Long Term Capital Management, Lyft, margin call, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, negative equity, Network effects, Ponzi scheme, purchasing power parity, quantitative easing, random walk, rent-seeking, reserve currency, rising living standards, risk/return, sharing economy, short selling, sovereign wealth fund, Uber and Lyft, uber lyft, yield curve

Entering that year, LTCM managed just under US$5 billion, but with an estimated leverage of 25 to 1, it controlled securities worth US$125 billion. Leverage not only multiplies the assets under a hedge fund’s control; it also directly reduces its margin for error, in turn making the portfolio much less stable. Even a relatively small loss on a highly levered portfolio can trigger a margin call. To meet the margin call, positions must be liquidated, often in adverse market conditions, and a vicious circle of forced selling can be triggered. In other words, the US$125 billion of securities controlled by LTCM was vastly more unstable than that same amount under the control of a traditional investor. While LTCM’s use of leverage was extreme, the same principles apply to any levered portfolio; both its influence on markets and its instability, particularly during bad times, are increased.

Assume, for example, that “the person” is a bank, or a shadow bank, or a hedge fund, or a corporation—an entity that does not feel any such things. Could such an entity ever need one more dollar to save its life as surely as if it were a person starving to death? It could if, and only if, it were levered. It could need one more dollar in the face of ruin risk. It could need one more dollar to answer the fatal margin call. One more dollar has value even to a speculator who does not need it for himself. Because someone else, somewhere, does. So its value is the yield it can earn by lending it out to give that person or entity the leverage she needs, by trading with her to give her the liquidity she needs. A dollar is most valuable when it can earn the most. In a levered world, in a world dominated by carry and its risks, that time is when volatility is high and rising.

(This happened in Eastern Europe, in particular, but also in the Eurozone during 2008.) The Fed lends dollars to the European Central Bank or appropriate national central bank, which then on-lends the dollars to the distressed borrower (via a domestic bank). The effect of this is that the dollar borrower, who has in place a carry trade, is not forced to liquidate his position; he is relieved from the pressure of the margin call that afflicts levered traders during a carry crash. In the absence of the central bank intervention, he would be forced to buy dollars in the The Fundamental Nature of the Carry Regime 105 foreign exchange market to repay his dollar funding, an act that would put further downward pressure on the domestic currency exchange rate with the dollar. The central banks’ action in extending the liquidity swap is analytically equivalent, from a monetary economics perspective, to central bank intervention in the foreign exchange markets.


pages: 483 words: 143,123

The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters by Gregory Zuckerman

activist fund / activist shareholder / activist investor, addicted to oil, American energy revolution, Asian financial crisis, Bakken shale, Bernie Sanders, Buckminster Fuller, corporate governance, corporate raider, credit crunch, energy security, Exxon Valdez, housing crisis, hydraulic fracturing, Kickstarter, LNG terminal, margin call, Maui Hawaii, North Sea oil, oil rush, oil shale / tar sands, oil shock, peak oil, Peter Thiel, reshoring, self-driving car, Silicon Valley, sovereign wealth fund, Steve Jobs, urban decay

He also blamed himself for not anticipating the troubles and securing the crucial financing. Suddenly, he was in a personal bind. Souki had been unwilling to sell any of his nearly three million Cheniere shares, worried about the message it might send investors and confident that bigger gains were ahead. So he had borrowed money to pay for his expensive lifestyle, pay his taxes, and pay other expenses, using the shares as collateral. As the stock plummeted, Souki received a margin call from his lenders, forcing him to sell over two million of his shares to pay back the debt. By the end of June 2008, he was left with just 600,000 shares of his company, worth nearly $3 million. A few weeks later, the stock was below three dollars a share. Souki was worth a few million dollars, but it mostly was in real estate, which wasn’t liquid and was tumbling in value. He sold his private jet and a boat to raise some cash.

The Goldman manager relayed disturbing news: The Chesapeake shares that McClendon had used as collateral had dropped so dramatically that they no longer held enough value to back the approximately $300 million that McClendon had borrowed from the investment bank. Come up with more collateral fast or we’re going to have to sell your shares to help satisfy your debts, the Goldman executive told McClendon. The Chesapeake cofounder was getting a “margin call” from Goldman, as if he were a gambler under pressure to repay debts to his bookie after a bad losing streak. Only in this case, the bookie was facing his own strains caused by the plummeting market. McClendon had to do something to stop Goldman. If they sold his shares, Chesapeake likely would sink even further and he’d suffer the kind of embarrassment few chief executives had ever endured.

“What I never dreamed could happen, did happen,” McClendon later said.3 “I honestly did not feel it was risky to have one dollar of margin debt for every three dollars of stock value.” On Friday, October 10, McClendon tried to explain what had happened to shareholders. The company issued a statement saying that McClendon had “involuntarily” sold “substantially all” of his Chesapeake stock over the previous three days to satisfy margin calls, blaming the “extraordinary circumstances of the worldwide financial crisis.” “In no way do these sales reflect my view of the company’s financial position or my view of Chesapeake’s future performance potential,” McClendon said in the statement, adding that he was “very disappointed” by the turn of events. For a few days, McClendon appeared down and discouraged. His face looked so haggard that colleagues wondered if he’d managed any sleep.


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

In one day, the Dow was down over 25 percent, and the small caps [small capitalization stocks], which is what I owned, were down by a third. In that type of market, where there are no bidders, it doesn't make any difference what you own; everything collapses. That in itself might not have been catastrophic, as the market eventually recovered. The problem was that I was heavily leveraged, and I had a huge margin call. Although I could have borrowed the money to cover my margin call, I thought doing so would be unwise. It was a valuable, albeit traumatic, lesson in the evils of leverage. How much did you lose? I don't remember the exact intramonth figures, but I can tell you that I was up over 100 percent for nine months going into the fourth quarter, and I finished the year only slightly above breakeven. How did you feel during the October crash, especially given the fact you were so heavily leveraged?

I had gone from $165,000 at the start of June to a deficit of over $350,000. In addition, I had lost over $100,000 apiece in accounts I had for my mother, father, and aunt. I still have the trade slips right here in my desk drawer. It wasn't until last year—seventeen years after this happened—that I was able to pull them out and look at them. I had a margin call in excess of one million dollars on my account, which is what I would have had to put up if I wanted to hold the short stock position instead of buying it back. Technically, you are supposed to have five days to meet the margin call, but the firm was on me to cover the position right away. M A R K D. C O O K * That night I called my mother, which was the hardest phone call I ever had to make. I felt like a complete failure. I felt like I should be put in shackles and hauled away. "Mom," I said, "I need to talk to you."

The margin on short-option positions at that time was sometimes less than the premium I collected from the sale of the options. In 1979 when gold prices exploded, I sold options on gold stocks. I figured out that I could sell a combination [the simultaneous sale of a call and put] on ASA for more money than the margin I had to put up for the trade. At that time, the margin department hadn't figured this out. As a result, I could put on any size position and not get a margin call. There was only one slight problem—the stock took off on me. I made a little bit on the puts, which expired worthless, but lost a lot on the calls, which went way in the money. It was back to the drawing board again. How did you have enough money to cover your losses? Oh, I was a very good broker. I was the second from the top first-year broker nationwide for the firm. In 1981 I worked out a system for selling options when their premiums seemed too high and found someone to program the rules for me.


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

Suppose that a crude oil futures trader initiates a long position in 100 August 2014 contracts at the futures price of $104.00 per unit. a. What initial margin must be posted to his account? b. The tick size in CL is $.01/bbl and the contract refers to 1000 bbl of underlying crude oil. Therefore a movement in the futures price of $.01/bbl corresponds to how many dollars? c. How many ticks would the CL futures price have to move downward in order for the trader to receive a margin call? d. How much must be deposited into the account once the margin call is received? In order to understand the application of all of the definitions in this section, some examples will help. Example 1 1. An individual sells (shorts) one Dec. Comex (part of the Cmegroup) gold futures contract at $F0,T=$1600/oz. To get the specifications for this contract, one goes to cmegroup.com and looks under metals. The symbol for this contract is GC.

It is pretty clear that the investor lost money here due to the futures price rising against a short futures position. The amount of the loss is, The minus sign indicates a loss. Would the investor receive a margin call? In order to answer this question, we have to calculate the ‘equity’ in the investor’s account. The precise definition is given in definition 9 above. Customer’s Equity =Initial Margin(s)+unrealized gains on open futures positions–unrealized losses on open futures positions =$7425–$2000 =$5425<$6750=maintenance margin level. Indeed, there would be a margin call. The investor would have to supply an additional amount into his account to bring the equity up to the initial margin (not just to the maintenance margin level). In this case, $2000 would have to be put into the account.

However, when the price of the underlying dramatically increases (as in S&P 500 futures), one can expect initial margin requirements to also increase. b. Maintenance Margin is a level. This level must be maintained at all times. Think of this as 75 to 80% of the initial margin level. The rule is that, if the equity in a customer’s account falls below the maintenance margin level, then the customer gets a margin call requiring him to deposit funds into the account in order to bring the equity back to the initial margin level. 9. The Equity in a customer’s account consists of initial margins plus unrealized gains on open futures positions minus any unrealized losses on open futures positions. 10. The Close of the Market is roughly the last 30–60 seconds of trading during the close. During the market’s close, transactions take place frequently at a range of prices called the Closing Range. 11.


pages: 400 words: 124,678

The Investment Checklist: The Art of In-Depth Research by Michael Shearn

Asian financial crisis, barriers to entry, business cycle, call centre, Clayton Christensen, collective bargaining, commoditize, compound rate of return, Credit Default Swap, estate planning, intangible asset, Jeff Bezos, London Interbank Offered Rate, margin call, Mark Zuckerberg, money market fund, Network effects, pink-collar, risk tolerance, shareholder value, six sigma, Skype, Steve Jobs, supply-chain management, technology bubble, time value of money, transaction costs, urban planning, women in the workforce, young professional

The other way is for the manager to take out a loan, using the stock as collateral, to pay the tax, which has the effect of deferring the tax. The main risk to this is that if the stock price drops below a certain price, the manager will face a margin call. Managers Who Sell Stock to Meet Margin Calls During 2008, when the S&P 500 dropped by more than 37 percent, many managers had to sell stock to meet margin calls. One of the more noteworthy sales during this time was from Aubrey McClendon, co-founder and CEO of Chesapeake Energy Corporation, who was forced to sell 94 percent of his holdings for $569 million to meet margin calls when Chesapeake’s stock price dropped 65 percent.33 Key Points to Keep in Mind Learn about the Background of Senior Managers The most logical predictor of the future success of a business is its management.

The liquidity will depend on whether the business has permanent equity capital or uses short-term funds, which are temporary and thus a more risky source of capital. One business that uses permanent equity capital instead of short-term funds to finance its business is global asset manager Brookfield Asset Management. In 2010, Brookfield was funded by $30 billion of permanent equity capital. CEO Bruce Flatt explained why, “This is capital that does not come due, has no margin calls and whether it trades for less in the market due to external factors has very little effect on the capital base.”9 Over the years, Brookfield has been strengthening its permanent equity capital in order to strengthen its balance sheet. For example, in 2001 when Brookfield converted debentures, which are mid- to long-term debt, into common shares, this added permanent equity to Brookfield’s capital base.

To gain full perspective on insider purchases and sales, read the notes to Forms 3, 4, and 5, which often disclose the reason for the purchase or sale. If you are unable to determine the motivation behind the purchases or sales, then you do not have enough information to draw a conclusion, and you need to be careful to not make assumptions. Some of the most common reasons are listed here and described in more detail in the following paragraphs: 10b5–1 programs Tax purposes Margin calls Personal reasons, such as commitments to charities that need to be funded Executive Officers Who Sell Shares under the Terms of a 10b5–1 Program A 10b5–1 program is set up under SEC regulation designed to allow insiders to buy or sell company shares in an orderly pattern without having to worry about allegations of improper use of insider information. The plans vary in complexity, but they generally specify the amount, price, and date of the purchase or sale of a stock.


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

I.B.M. had closed at 361, down 37½. And so it went. In brokerage offices, employees were kept busy—many of them for most of the night—at various special chores, of which by far the most urgent was sending out margin calls. A margin call is a demand for additional collateral from a customer who has borrowed money from his broker to buy stocks and whose stocks are now worth barely enough to cover the loan. If a customer is unwilling or unable to meet a margin call with more collateral, his broker will sell the margined stock as soon as possible; such sales may depress other stocks further, leading to more margin calls, leading to more stock sales, and so on down into the pit. This pit had proved bottomless in 1929, when there were no federal restrictions on stock-market credit. Since then, a floor had been put in it, but the fact remains that credit requirements in May of 1962 were such that a customer could expect a call when stocks he had bought on margin had dropped to between fifty and sixty per cent of their value at the time he bought them.

Since then, a floor had been put in it, but the fact remains that credit requirements in May of 1962 were such that a customer could expect a call when stocks he had bought on margin had dropped to between fifty and sixty per cent of their value at the time he bought them. And at the close of trading on May 28th nearly one stock in four had dropped as far as that from its 1961 high. The Exchange has since estimated that 91,700 margin calls were sent out, mainly by telegram, between May 25th and May 31st; it seems a safe assumption that the lion’s share of these went out in the afternoon, in the evening, or during the night of May 28th—and not just the early part of the night, either. More than one customer first learned of the crisis—or first became aware of its almost spooky intensity—on being awakened by the arrival of a margin call in the pre-dawn hours of Tuesday. If the danger to the market from the consequences of margin selling was much less in 1962 than it had been in 1929, the danger from another quarter—selling by mutual funds—was immeasurably greater.

Breaking down the public individuals into income categories, the Exchange calculated that those with family incomes of over twenty-five thousand dollars a year were the heaviest and most insistent sellers, while those with incomes under ten thousand dollars, after selling on Monday and early on Tuesday, bought so many shares on Thursday that they actually became net buyers over the three-day period. Furthermore, according to the Exchange’s calculations, about a million shares—or 3.5 per cent of the total volume during the three days—were sold as a result of margin calls. In sum, if there was a villain, it appeared to have been the relatively rich investor not connected with the securities business—and, more often than might have been expected, the female, rural, or foreign one, in many cases playing the market partly on borrowed money. The role of the hero was filled, surprisingly, by the most frightening of untested forces in the market—the mutual funds. The Exchange’s statistics showed that on Monday, when prices were plunging, the funds bought 530,000 more shares than they sold, while on Thursday, when investors in general were stumbling over each other trying to buy stock, the funds, on balance, sold 375,000 shares; in other words, far from increasing the market’s fluctuation, the funds actually served as a stabilizing force.


pages: 261 words: 86,905

How to Speak Money: What the Money People Say--And What It Really Means by John Lanchester

asset allocation, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, blood diamonds, Bretton Woods, BRICs, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collective bargaining, commoditize, creative destruction, credit crunch, Credit Default Swap, crony capitalism, Dava Sobel, David Graeber, disintermediation, double entry bookkeeping, en.wikipedia.org, estate planning, financial innovation, Flash crash, forward guidance, Gini coefficient, global reserve currency, high net worth, High speed trading, hindsight bias, income inequality, inflation targeting, interest rate swap, Isaac Newton, Jaron Lanier, joint-stock company, joint-stock limited liability company, Kodak vs Instagram, liquidity trap, London Interbank Offered Rate, London Whale, loss aversion, margin call, McJob, means of production, microcredit, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, negative equity, neoliberal agenda, New Urbanism, Nick Leeson, Nikolai Kondratiev, Nixon shock, Northern Rock, offshore financial centre, oil shock, open economy, paradox of thrift, plutocrats, Plutocrats, Ponzi scheme, purchasing power parity, pushing on a string, quantitative easing, random walk, rent-seeking, reserve currency, Richard Feynman, Right to Buy, road to serfdom, Ronald Reagan, Satoshi Nakamoto, security theater, shareholder value, Silicon Valley, six sigma, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, sovereign wealth fund, Steve Jobs, survivorship bias, The Chicago School, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, trickle-down economics, Washington Consensus, wealth creators, working poor, yield curve

What, though, if the price of wheat drops by more than the margin you have put up? Say it falls by $15,000. Then the person who sold you the wheat rings you up and says, sorry old boy, margin call, we need some more money to cover that wheat you’ve bought. You stump up another $10,000 to cover the new margin. That’s fine if you have the money—but if you don’t, and especially if you have bought lots of similar contracts and have lots of margin calls arriving simultaneously, then suddenly you’re in real trouble. If you had gone the full monty and used your $100,000 to buy $1,000,000 of wheat on margin, you’d have just used the power of margin to lose all your money, and another $50,000 on top. In finance, a margin call can also be triggered by doubts about an institution’s creditworthiness. In the collapse of Lehman Brothers, one of the short-term triggers was other banks deciding Lehman needed to put up more collateral—in effect to raise more money against the possibility of a margin call.

As the title suggests, it’s an account of manias, panics, and crashes in history, and proves incontrovertibly that these are facts of life that just won’t go away. The great lesson of Kindleberger’s book is to be wary of certainty. The history of manias, panics, and crashes is largely the story of people who were certain: nothing makes it more likely that you will get something completely wrong than the certainty that you have got something completely right. margin call When you buy something on margin—usually a derivative—you are putting down only a piece of the full price of an asset, to cover the amount that is thought to be at risk. Say you’re buying $100,000 of wheat futures, with a contract date a year away. You’re certain not to want all that wheat, and you and the person selling to you are well aware of the fact: what you’re doing is holding on to the contract for a bit and then selling it on.

In the collapse of Lehman Brothers, one of the short-term triggers was other banks deciding Lehman needed to put up more collateral—in effect to raise more money against the possibility of a margin call. margin, high and low Margin in this sense is the amount of profit a business owner makes by selling something. An Italian restaurant owner once told me that more than anything else in the world, he loves pasta. I asked him why, expecting an answer along the lines of Marcella Hazan’s remark that nothing had contributed more to the sum of human happiness than humble-seeming pasta. He said, “Because of the margin.” With some of his simpler pastas, his ingredient costs were as low as $1 a serving and he could charge as much as $12. The normal margin in the restaurant business is 200 percent on the cost of food, so he was well ahead; with his other dishes, with pricier ingredients, the margin was sometimes less than 100 percent.


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

The forms of sabotage in the financial system have changed and evolved over time. The principle, however, has remained: if you want to make money – real money – in finance, you need to find ways of sabotaging either your clients, your competitors or the government. If you are big enough, you can succeed on all three fronts. 2 WE ALL ARE IN IT TOGETHER Sabotage and the Cycle of Debt Will Emerson, a senior bank executive played by Paul Bettany in the movie Margin Call, explains the function of banking to a younger colleague, who is about to lose his job in the upcoming financial meltdown: If people want to live like this… with their big cars and these houses that they haven’t even paid for. Then you are necessary. The only reason they can continue to live like kings is because we’ve got our fingers on the scale in THEIR favor. And if I were to take my finger off… Then the whole world gets really fucking fair, really fucking quickly.

But, doing so, they cannot play it ‘fair’ and by the rules of the market. Collectively, they need to do exactly what Veblen observed more than a hundred years ago: they make money by sabotaging their clients, their competitors, their governments and, ultimately, the market itself. 3 BE FIRST, BE SMARTER AND CHEAT Sabotage by Financial Innovation Another character from the movie Margin Call, John Tuld, beautifully played by Jeremy Irons and based apparently on a composite of the real-life personalities of John Thain of Merrill Lynch and Lehman’s Dick Fuld, lectures his board at a critical point of reckoning for his bank: ‘There are three ways to make a living in this business… Be first, be smarter or cheat.’1 But what if you don’t have to choose between the three ways? A combination of the three tactics, according to John Tuld, would probably constitute the Holy Grail of truly big money in finance.

By March 2008 Sloan’s clients had withdrawn $25bn from Bear.17 Bear’s fatal week began late on a frozen day, Friday, 7 March 2008, when a major European bank18 declined Bear’s request for a short-term $2bn loan.19 ‘Being denied such a loan is the Wall Street equivalent of having your buddy refuse to front you $5 the day before pay day,’ Fortune wrote.20 On the following Monday a major rating agency downgraded all MBSs issued by Bear.21 On Tuesday, 11 March, the Fed announced that it would make $200bn in Treasury securities available for struggling securities firms, starting on 27 March.22 Investors drew the conclusion that the Federal Reserve was preparing to bail out a failing securities firm, and Bear Stearns appeared to be a likely institution of concern. That very Tuesday, Bear’s new CFO, Samuel L. Molinaro, went on CNBC to dispel the rumours about Bear’s position: ‘There is no liquidity crisis. No margin calls. It’s nonsense,’ he said emphatically. As he was on air, three major Wall Street banks, Goldman Sachs, Credit Suisse and Deutsche Bank, received a large amount of novation requests for Bear Stearns from hedge funds, among them Citadel Investment and Paulson & Co.23 Novation requests enable financial firms to sell a contract which transfers credit risk to a third party in exchange for a fee. The timing of those novation requests, and the fact that they were triggered by hedge funds and sent only to three banks, is a cause célèbre for the conspiracy theorists.


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

Once their selling causes prices to fall, momentum buyers lose their interest. Overly optimistic buyers lose their confidence, and sellers become more confident. Late buyers especially worry about their positions, and often start selling to stop their losses. Traders who financed their positions on margin may have to sell their positions to satisfy margin calls from their brokers. Other long holders who have placed stop loss orders also will start to sell. Order anticipators may anticipate these margin calls and stop orders, and sell before them. A crash occurs when the combined effect of all their selling causes prices to fall quickly. * * * ▶ You Believe You Are Right, but … (Confidence Is Everything) Even when value traders believe that prices greatly differ from fundamental values, they may lack the confidence to trade on their opinions.

For example, RCA—which proved to be one of the strongest radio stocks—did not rise to a new high until 34 years after the crash. FIGURE 28-1. Dow Jones Industrial Average, 1900-1950 Source: Dow Jones and Co., at www.djindexes.com. The crash partly occurred because traders needed to sell stock to satisfy margin calls following the decline in stock prices over the previous month. Much selling undoubtedly also was due to value traders who sold the market short, and to speculators who anticipated the sell orders that the margin calls would create. * * * ▶ Market Failures or Market Corrections? Analysts generally cannot attribute the large price changes that occur in broad-based market crashes to unexpected bad fundamental news of commensurate importance. Many people therefore believe that crashes demonstrate that markets do not produce informative prices.

The various exchanges therefore amended their coordinated halt rules in early 1998 to provide for halts at 10, 20, and 30 percent thresholds, as described above. ◀ Source: NYSE Rule 80B at www.nyse.com/pdfs/lm9815.pdf. * * * Finally, a trading halt rule may decrease transitory volatility by allowing traders greater time to respond to intraday margin calls and to remove stop loss orders. When traders are unable to satisfy their margin calls, brokers will trade to stop their losses. Since stop loss orders further imbalance an uninformed order flow, a halt that reduces their numbers may reduce transitory volatility. Arguments Against Opponents of trading halts and price limits offer two arguments that suggest these circuit breakers may actually increase transitory volatility. First, if traders fear that a halt will occur before they can submit their orders, they may submit their orders earlier to increase the probability that they execute.


pages: 464 words: 117,495

The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management by Alexander Elder

additive manufacturing, Atul Gawande, backtesting, Benoit Mandelbrot, buy and hold, buy low sell high, Checklist Manifesto, computerized trading, deliberate practice, diversification, Elliott wave, endowment effect, loss aversion, mandelbrot fractal, margin call, offshore financial centre, paper trading, Ponzi scheme, price stability, psychological pricing, quantitative easing, random walk, risk tolerance, short selling, South Sea Bubble, systematic trading, The Wisdom of Crowds, transaction costs, transfer pricing, traveling salesman, tulip mania, zero-sum game

In his desperate effort to succeed, he'd have to take on large positions—and the slightest wiggle of the market will quickly put him out of business. A successful trader is a realist. He knows his abilities and limitations. He sees what's happening in the markets and knows how to react. He analyzes the markets without cutting corners, observes himself, and makes realistic plans. A professional trader cannot afford illusions. Once an amateur takes a few hits and gets a few margin calls, he swings from cocky to fearful and starts developing strange ideas about the markets. Losers buy, sell, or avoid trades due to their fantastic ideas. They act like children who are afraid to pass a cemetery or look under their bed at night because they are afraid of ghosts. The unstructured environment of the market makes it easy to develop fantasies. Most people who grow up in Western civilization have several similar fantasies.

Intelligent and hardworking people who have succeeded in their careers often feel drawn to trading. Why do they fail so often? What separates winners from losers isn't intelligence or secrets, and certainly not education. The Undercapitalization Myth Many losers think that they would trade successfully if they had a bigger account. People destroy their accounts either by a string of losses or a single abysmally bad trade. Often, after the loser is sold out, unable to meet a margin call, the market reverses and moves in the direction he expected. He starts fuming: had he survived another week, he would have made a fortune instead of losing! Such people look at market reversals that come too late and think that those turns confirm their methods. They may go back to work and earn, save, or borrow enough money to open another small account. History repeats itself: The loser gets wiped out, the market reverses and “proves” him right, but only too late—he's been sold out again.

With $40,000 in your account, you may control about a million dollars' worth of merchandise, be it pork bellies or stock index futures. For example, if gold trades at $1,500/oz and you buy a 100-oz contract on a $7,500 margin and catch a $75 price move, you'll gain 100%. A beginner looks at these numbers and exclaims, “where have I been all my life?” He thinks he's found a royal road to riches. But there is a catch. Before that market rises $75, it may dip $50. That meaningless blip will trigger a margin call and force a small speculator's account to go bust—despite his correct forecast. Easy margins attract adrenaline junkies who quickly go up in smoke. Futures are very tradable—but only if you follow strict money management rules and don't go crazy with easy margins. Professionals put on small initial positions and pyramid them if a trade moves in their favor. They keep adding new contracts while moving stops beyond breakeven.


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

An additional question should be posed to the original advisers on debt structuring, in terms of whether they have fully explained the “option value” being conceded by potentially allowing such a hold-out. Margin calls Similarly, borrowing against securities raises specific problems. These relate to the power given to a lender to divest the security under certain circumstances. The lender, under these circumstances, may only be concerned with making whole the original loan. This can result in inefficiently timed (and obviously so) sales of securities, at the worst possible terms for the borrower, who therefore experiences significant economic harm. As with the discussion on hold-out value, the borrower may have given away value without realising how significant it is, not appreciating the significant option value associated with decisions to sell (or buy) securities. In practice, the market can anticipate some major margin calls or defaults, and consequently the price of affected securities is likely to be adversely affected.

., 73 conflicts of interest in, 112–14 cardinal virtues, 37 Caritas in Veritate (Benedict), 6, 52 cash compensation, 132, 134 casino capitalism emergence of, 43 in investment banking, 3 speculative, 16, 93 categorical imperative, 34, 59, 69 Caterpillar, 48 Central Finance Board of the Methodist Church (CFB), 54, 59 chief executive officer (CEO), 116 Christianity, 52–4 Anglican Communion, 53 Methodist Church, 53 Roman Catholic Church, 53 Christian Old Testament, 34 Church Investors’ Group (CIG), 135 Church of England, 9, 53, 58 Citigroup, 19, 112 claiming credit, 134 clients confidential information, 120 conflicts of interest, 105–10 171 duty of care, 105 engagement letters, 122–3 fees, 115–18 financial restructuring, 119–20 hold-out value, 120–1 honesty, 101–5 margin-calls, 121 practical issues, 110–15 promises, 100–1 restructuring fees, 121–2 syndication, 118–22 truth, 101–5 Code of Ethics, 47–50, 147–51 for Goldman Sachs business principles, 46 in investment banking, 47–9 Revised, 47 collatoralised debt obligations (CDOs), 30, 42, 75 command economies, 13 commercial banking, 19–21, 25 communication within markets, 88 Companies Act 2006, 27 compensation cash, 132, 134 defined, 132 for employees, 135 internal issues on, 8 for junior bankers, 136 levels of, 132–3, 138 objectivity of, 144 political issues with, 6, 137 restrictions on, 10 competitors, 113 compliance corporate, 20 danger of, 20 frameworks for, 68, 146 regulatory, 18 requirements of, 6 confidential information, 120 conflicts of interest, 105–10, 158 with capital markets, 109–10 with corporate finance, 107–8 personal, 47 with pre-IPO financing, 110 with private equity, 110 172 Index conflicts of interest – continued reconciling, 68–70 of trusted advisers, 108–9 consequentialist ethics, 36–7, 42 corporate compliance, 20 Corporate/Compliance Social Responsibility (CSR), 7 corporate debt, 17 corporate entertainment, 128–9, 159 corporate finance, 107–8 Corporate Sustainability Committee, 152 Costa, Ken, 9 Cox, Christopher, 96–7 creative accounting, 12 credit crunch, 17 credit default swap (CDS), 71 credit downgrade, 17, 76 Credit Lyonnais, 12 creditors, restricted, 121 credit rating, 75–7 calculating, 76 inaccurate, 5 manipulating, 75, 156, 158 unreliability of, 17 credit rating agencies, 76 Crisis and Recovery (Williams), 53 culture, 46, 136, 151 customers, 69 Daily Telegraph, 84 Debtor in Possession finance (DIP finance), 80 debts bank, 82–3, 120 corporate, 17 junior, 118 rated, 77 senior, 118 sovereign, 17 deferred equity, 5 deferred shares, 133 Del Monte Foods Co., 107 deontological ethics, 34–6 stockholders, 41–2 trust, 40–1 derivative, 27, 30 dharma, 63–4 Dharma Indexes, 57 discounted cash flow (DCF), 27 discount rate, 27 discriminatory behaviour, 129–31 distribution, 15, 35, 66 Dodd–Frank Wall Street Reform and Consumer Protection Act, 25 dotcom crisis, 94 dotcom stocks, 17 Dow Jones, 55–6 downgrade credit, 17, 76 defined, 76 multi-notch, 17, 76 duties, see rights vs. duties duty-based ethics, 66–8 duty of care, 105 Dynegy, 8 Earnings Before Interest Tax Depreciation and Amortisation (EBITDA), 27 economic free-ride, 5, 21 economic reality, 137 effective tax rate (ETR), 140 emissions trading, 14 employees, compensation for, 135 Encyclical, 52 engagement letters, 122–3, 159 Enron, 8, 12, 17, 20, 76 enterprise value (EV), 27 entertainment adult, 56 corporate, 128–9, 159 sexist, 159 equity deferred, 5 private, 2–3, 12, 110 equity research, 88–9, 113–15 insider dealing and, 83–4 ethical behaviour, 38–9 Ethical Investment Advisory Group (EIAG), 53, 58 ethical investment banking, 145–7 ethical standards, 47 Index ethics consequentialist, 36–7, 42 deontological, 34–6 duty-based, 66–8 exceptions and, effects of, 89–90 financial crisis and, 4–8 in investment banking, 1 in moral philosophy, 1 performance and, 8–10 rights-based, 66–8 virtue, 37–8, 43–4 see also business ethics; Code of Ethics Ethics Helpline, 48 Ethics of Executive Remuneration: a Guide for Christian Investors, The, 135 European Commission, 89 European Exchange Rate Mechanism (ERM), 17 exceptions, 89 external regulations, 19, 31 fair dealing, 45 Fannie Mae, 43 Federal Home Loan Mortgage Corporation, 43 Federal National Mortgage Association, 43 fees, 115–18 advisory, 107, 116 restructuring of, 121–2 2 and 20, 13 fiduciary duties, 27–8 financial advisers, 109 Financial Conduct Authority (FCA), 26 financial crisis, business ethics during CDOs during, 90 CDSs during, 90 ethics during, 4–8, 12–34 investment banking and, necessity of, 14–15 market capitalism, 12–14 necessity of, 14–15 non-failure of, 21 positive impact of, 18 problems with, 15–17 reality of, 16 speculation in, 91 173 Financial Crisis Inquiry Commission, 76 Financial Policy Committee (FPC), 25 financial restructuring, 119–20 Financial Services Modernization Act, 19 Financial Stability Oversight Council, 25 firm price, 67 Four Noble Truths, 57 Freddie Mac, 43 free-ride defined, 26 economic, 5, 21 in investment banking, 24 FTSE, 55 Fuhs, William, 8 General Board of Pension and Health Benefits, 54, 59 German FlowTex, 12 Gift Aid, 141 Glass–Steagall Act, 19 Global Settlement, 113 golden parachute arrangements, 133 Golden Rule, 35, 150 Goldman Sachs, 7, 16, 45, 63 Business Principles, 45–6 charges against, 78 Code of Business Conduct and Ethics, 45, 68 Code of Ethics for, 47–8 Goldsmith, Lord, 27 government, 59 business ethics within, 60 guarantees of, 24 intervention by, 22–3 government bonds, 23 greed, 4–5 Green, Stephen, 8–9 gross revenues, 59 Hedge fund behaviour of, 12 failure of, 21 funds for, raising, 2 investment fund, as type of, 3 rules for, 133 174 Index Hennessy, Peter, 42 Her Majesty’s Revenue and Customs (HMRC), 140–1 high returns, 28, 110 Hinduism, 56–7 Hobbes, Thomas, 36 hold-out value, 120–1 honesty, see trust hospitality, 128–9 hot IPOs, 94 hot-stock IPOs, 94 HSBC, 9, 28, 152 Ijara, 55 implicit government guarantee, 22–3 Independent Commission on Banking, 25 inequitable rewards, 6 informal authorisation, 81, 98 Initial Public Offering (IPO), 7 of dotcom stocks, 17 hot, allocation of, 94 hot-stock, 94 insider dealings, 83–4, 155 equity research and, 83–4 ethics of, 66, 70 laws on, 84 legal prohibition on, 82 legal restrictions on, 10 legal status of, 82 legislation on, 74 restrictions on, 83 rules of, 82, 90 securities, 70 insider trading, 12 insolvency, 24–5 institutional greed, 4 integrated bank, 28 integrated investment banking, 2, 30, 67, 106, 108 interest payments, 59–60 interest rate, 60 internal ethical issues, 126–43 abuse of resources, 127–8 corporate entertainment, 128–9 discriminatory behaviour, 129–31 hospitality, 128–9 management behaviour, 131–2 remuneration, 132–9 tax, 139–41 internal review process, managing, 134 investment banking, 94 casino capitalism in, 3 Code of Ethics in, 47–9 commercial and, convergence of, 20–1 defined, 2 ethics in, 1 free-ride in, 24 integrated, 2, 30, 67, 108, 112 in market position, role of, 65–6 moral reasoning and, 38 necessity of, 14–15 non-failure of, 19–20 positive impact of, 18 recommendations in, 94–7 sector exclusions for, 58–9 investment banking adviser, 121 investment banking behaviours, 3 investment banking ethics committee, 151–3 investment bubbles, 95 investment fund, 3 investment grade bonds, 118 investment grade securities, 76 investment recommendations, 94 investments personal account, 128, 156 principal, 15, 28 proprietary, 29 IRS, 140 Islam, 54–5 Islamic banking, 6, 54–5 Jewish Scriptures, 34 Joint Advisory Committee on the Ethics of Investment (JACEI), 54 JP Morgan, 16 Judaism, 56 junior bankers, 139 junior debt, 118 junk bond, 118 “just war” approach, 38 Index Kant, Immanuel, 35, 69 karma, 57 Kerviel, Jérôme, 44, 80 Krishna, 57 Law Society, 19 Lazard International, 9 leading adviser, 41 Leeson, Nick, 12, 44, 81 legislative change, 25–6 Lehman Brothers, 5–6, 15, 21, 23, 31, 43, 76 lenders, 26, 131 lending, 59–60 leverage levels of, 25 over, 75, 80, 119 Levin, Carl, 17, 63–4, 68 light-touch regulations, 4 liquidity market, 95 orderly, 25 withdrawal of, 24 loan-to-own, 80 Locke, John, 34 London Inter-Bank Offered Rate (LIBOR), 23 London School of Economics, 43 London Stock Exchange, 65, 71, 84 long-term values, 147 Lords Grand Committee, 27 LTCM, 23 lying, 101 MacIntyre, Alasdair, 38 management behaviour, 131–2 margin-calls, 121 market abuse, 14, 70, 75, 86–8, 155 market announcements, 88 market behaviours, 74 market capitalism, 12–14 market communications, 88 market liquidity, 95 market maker defined, 65–7 investment bank as, 66 primary activities of, 65 175 market manipulation, 75 market position, role of, 104 market rate, 117 markets advisory, 73 capital, 73, 117–18, 158 communication within, 88 duties to support, 71–2 primary, 103 qualifying, 70, 82 secondary, 103 market trading, 41 Maxwell, Robert, 12 Meir, Asher, 56 mergers and acquisitions (M&As), 41, 79 Merkel, Angela, 93 Merrill Lynch, 8, 16 Methodism, 53 Methodist Central Finance Board, 59 Methodist Church, 54 Midrash, 56 Milken, Michael, 12 Mill, John Stuart, 36 Mirror Newspaper Group, 12 misleading behaviours, 86, 105 mis-selling of goods and services, 77–9, 155 modern capitalism, 54 moral-free zones, 31 moral hazard, 22, 70 moral philosophy, 1 moral reasoning, 38 moral relativism, 38–9, 49, 68 Morgan Stanley, 47 multi-notch downgrade, 17, 79 natural law, 34, 37 natural virtues, 37 necessity of investment banking, 14–15 New York Stock Exchange (NYSE), 65, 71 New York Times, 8 Noble Eightfold Path, 57 Nomura Group Code of Ethics, 47 normal market trading, 71 Northern Rock, 43 176 Index offer price, 64 off-market trading, 71–3, 90, 155 Olis, Jamie, 8 on-market trading, 70–1 oppressive regimes, 61 option value, 121 Orderly Liquidation Authority, 25 orderly liquidity, 25 out-of-pocket expenses, 127–8 over-leverage, 75, 80, 119, 158 overvalued securities, 155 patronage culture, 131, 142 Paulson, Henry M., 86 Paulson & Co., 78 “people-based” activity, 67 P:E ratio, 27 performance, 8–10 personal abuse, 159 personal account investments, 128, 156 personal account trading, 128 personal conflicts of interest, 45 pitching, 102, 159 Plato, 37 practical issues, 110–15 competitors, relationships with, 113 equity research, 113–15 pitching, 111 sell-side advisers, 111–13 pre-IPO financing, 110 prescriptive regulations, 31, 145 price tension, 79, 113 primary market, 103 prime-brokerage, 2 principal investment, 15, 28 private equity, 2–3, 12, 110 private trading, 94 Project Merlin, 133, 141 promises, 100–1 proprietary investment, 29 proprietary trading, 15, 25, 66, 150, 155 Prudential Regulation Authority (PRA), 26 public ownership, bonus pools in, 136–9 “pump and dump” strategy, 86 qualifying instruments, 70, 87 qualifying markets, 70, 82 quality-adjusted life year (QALY), 36 Quantitative Easing (QE), 23 Queen Elizabeth II, 42 Qu’ran, 54 rated debt, 77 rates attrition, 132 discount, 27 interest, 60 market, 117 tax, 140 rating agencies, 76 Rawls, John, 35, 136 recognised exchanges, 71 Regal Petroleum, 84 regulations banking, 16 compliance with, 28 external, 19, 31 light-touch, 4 prescriptive, 31, 145 regulatory changes and, 18–20 securities, 114 self, and impact on legislation, 19 regulatory compliance, 18 religion, business ethics in, 51–62 Buddhism, 56 Christianity, 52–4 Governments, 59 Hinduism, 56–7 interest payments, 59–60 Islam, 54–5 Judaism, 56 lending, 59–60 thresholds, 60 usury, 59–60 remuneration, 132–9 bonus pools in public ownership and, 136–9 claiming credit, 134 ethical issues with, 142–3 internal review process, managing, 134 1 Timothy 6:10, 135–6 Index research, 156 resources, abuse of, 127–8 restricted creditors, 120 restructuring of fees, 121–2 financial, 119–20 syndication and, 118–22 retail banks, 16 returns, 28, 156 Revised Code of Ethics, 47 right livelihood, 57 rights-based ethics, 66–8 rights vs. duties advisory vs. trading/capital markets, 73 conflict between, reconciling, 68–70 duty-based ethics, 66–8 off-market trading, ethical standards to, 71–2 on-market trading, ethical standards in, 70–1 opposing views of, 63–74 reconciling conflict between, 68–70 rights-based ethics, 66–8 Roman Catholic Church, 52 Royal Dutch Shell, 85 Sarbanes–Oxley Act, 20 Schwarzman, Stephen, 20 scope of ethical issues, 7–8 secondary market, 103 sector exclusions for investment banking, 58–9 securities investment grade, 76 issuing, 103–5 overvalued, 155 Securities and Exchange Commission (SEC), 7, 16 Goldman Sachs, charges against, 78 rating agencies, review by, 77 short-selling, review of, 96–7 securities insider dealing, 70 securities mis-selling, 77–9 securities regulations, 114 self-regulation, 19 sell recommendation, 115 177 sell-side advisers, 107, 111–13 Senate Permanent Subcommittee on Investigations, 46 senior debt, 118 sexist entertainment, 159 shareholders, 27–9 shares, deferred, 133 Shariah finance, 55 short-selling, 94–7, 154–5 Smith, Adam, 14, 35–6 social cohesion, 53 socially responsible investment (SRI), 56 Société Générale, 44, 80 solidarity, 53 Soros, George, 17 South Sea Bubble, 90 sovereign debt, 17 speculation, 91–4, 155 in financial crisis, 93 traditional views of, 91–3 speculative casino capitalism, 16, 91 spread, 21 stabilisation, 89 stock allocation, 94–7 stockholders, 41–2 stocks, dotcom, 17 Strange, Susan, 43 strategic issues with business ethics, 30–1 syndication, 119 and restructuring, 118–22 systemic risk, 24–5 Takeover Panel, 109 Talmud, 56 taxes, 139–41 tax optimisation, 158 tax rates, 140 tax structuring, 140 Terra Firma Capital Partners, 79, 112 Theory of Moral Sentiments, The (Smith), 14 3iG FCI Practitioners’ Report, 51 thresholds, 60 1 Timothy 6:10, 135–6 178 Index too big to fail concept, 21–7 ethical duties, and implicit Government guarantee, 22–3 ethical implications of, 26–7 in government, 22–3 insolvency, systemic risk and, 24–5 legislative change, 25–6 Lehman, failure of, 23 systemic risk, 24–5 toxic financial products, 5 trading abusive, 93 emissions, 14 insider, 12 market, 41 normal market, 71 off-market, 71–83, 90, 155 on-market, 70–1 personal account, 128 private, 94 proprietary, 15, 25, 66, 150, 155 unauthorised, 7 “trash and cash” strategy, 86 Travellers, 19 Treasury Select Committee, 26 Trinity Church, 53 Trouble with Markets, The (Bootle), 4 trust, 40, 53 trusted adviser, 108–9, 125 truth, 101–5 bait and switch, 102–3 misleading vs. lying, 101 securities, issuing, 103–5 2 and 20 fee, 13 UBS Investment Bank, 9 unauthorised trading, 7, 80–1, 155 unethical behaviour, 68 UK Alternative Investment Market, 89 UK Business Growth Fund, 133 UK Code of Practice, 141 UK Independent Banking Commission, 4, 22 United Methodist Church, 54, 59 United Methodist Investment Strategy Statement, 59 US Federal Reserve, 24, 25 US Financial Crisis Inquiry Commission, 4 US Open, 126 US Senate Permanent Subcommittee on Investigations, 64, 73 US Treasury Department, 132 universal banks, 2, 21, 28, 67 untoward movement, 85 usury, 59–60 utilitarian, 84 utilitarian ethics, 49, 84, 139 values, 9, 46, 119–21, 148 Vedanta, 57 victimless crime, 82 virtue ethics, 37–8, 43–4 virtues, 9, 34 virtuous behaviours, 37 Vishnu, 57 Volcker, Paul, 25 Volcker Rule, 2, 25 voting shareholders, 29 Wall Street, 12, 19, 53 Wall Street Journal, 20 Wealth of Nations, The (Smith), 14 Wesley, John, 53 Wharf, Canary, 18 Williams, Rowan, 53 Wimbledon, 127 WorldCom, 12, 17, 20, 76 write-off, 80 zakat, 55 zero-sum games, 118–22

., 107 deontological ethics, 34–6 stockholders, 41–2 trust, 40–1 derivative, 27, 30 dharma, 63–4 Dharma Indexes, 57 discounted cash flow (DCF), 27 discount rate, 27 discriminatory behaviour, 129–31 distribution, 15, 35, 66 Dodd–Frank Wall Street Reform and Consumer Protection Act, 25 dotcom crisis, 94 dotcom stocks, 17 Dow Jones, 55–6 downgrade credit, 17, 76 defined, 76 multi-notch, 17, 76 duties, see rights vs. duties duty-based ethics, 66–8 duty of care, 105 Dynegy, 8 Earnings Before Interest Tax Depreciation and Amortisation (EBITDA), 27 economic free-ride, 5, 21 economic reality, 137 effective tax rate (ETR), 140 emissions trading, 14 employees, compensation for, 135 Encyclical, 52 engagement letters, 122–3, 159 Enron, 8, 12, 17, 20, 76 enterprise value (EV), 27 entertainment adult, 56 corporate, 128–9, 159 sexist, 159 equity deferred, 5 private, 2–3, 12, 110 equity research, 88–9, 113–15 insider dealing and, 83–4 ethical behaviour, 38–9 Ethical Investment Advisory Group (EIAG), 53, 58 ethical investment banking, 145–7 ethical standards, 47 Index ethics consequentialist, 36–7, 42 deontological, 34–6 duty-based, 66–8 exceptions and, effects of, 89–90 financial crisis and, 4–8 in investment banking, 1 in moral philosophy, 1 performance and, 8–10 rights-based, 66–8 virtue, 37–8, 43–4 see also business ethics; Code of Ethics Ethics Helpline, 48 Ethics of Executive Remuneration: a Guide for Christian Investors, The, 135 European Commission, 89 European Exchange Rate Mechanism (ERM), 17 exceptions, 89 external regulations, 19, 31 fair dealing, 45 Fannie Mae, 43 Federal Home Loan Mortgage Corporation, 43 Federal National Mortgage Association, 43 fees, 115–18 advisory, 107, 116 restructuring of, 121–2 2 and 20, 13 fiduciary duties, 27–8 financial advisers, 109 Financial Conduct Authority (FCA), 26 financial crisis, business ethics during CDOs during, 90 CDSs during, 90 ethics during, 4–8, 12–34 investment banking and, necessity of, 14–15 market capitalism, 12–14 necessity of, 14–15 non-failure of, 21 positive impact of, 18 problems with, 15–17 reality of, 16 speculation in, 91 173 Financial Crisis Inquiry Commission, 76 Financial Policy Committee (FPC), 25 financial restructuring, 119–20 Financial Services Modernization Act, 19 Financial Stability Oversight Council, 25 firm price, 67 Four Noble Truths, 57 Freddie Mac, 43 free-ride defined, 26 economic, 5, 21 in investment banking, 24 FTSE, 55 Fuhs, William, 8 General Board of Pension and Health Benefits, 54, 59 German FlowTex, 12 Gift Aid, 141 Glass–Steagall Act, 19 Global Settlement, 113 golden parachute arrangements, 133 Golden Rule, 35, 150 Goldman Sachs, 7, 16, 45, 63 Business Principles, 45–6 charges against, 78 Code of Business Conduct and Ethics, 45, 68 Code of Ethics for, 47–8 Goldsmith, Lord, 27 government, 59 business ethics within, 60 guarantees of, 24 intervention by, 22–3 government bonds, 23 greed, 4–5 Green, Stephen, 8–9 gross revenues, 59 Hedge fund behaviour of, 12 failure of, 21 funds for, raising, 2 investment fund, as type of, 3 rules for, 133 174 Index Hennessy, Peter, 42 Her Majesty’s Revenue and Customs (HMRC), 140–1 high returns, 28, 110 Hinduism, 56–7 Hobbes, Thomas, 36 hold-out value, 120–1 honesty, see trust hospitality, 128–9 hot IPOs, 94 hot-stock IPOs, 94 HSBC, 9, 28, 152 Ijara, 55 implicit government guarantee, 22–3 Independent Commission on Banking, 25 inequitable rewards, 6 informal authorisation, 81, 98 Initial Public Offering (IPO), 7 of dotcom stocks, 17 hot, allocation of, 94 hot-stock, 94 insider dealings, 83–4, 155 equity research and, 83–4 ethics of, 66, 70 laws on, 84 legal prohibition on, 82 legal restrictions on, 10 legal status of, 82 legislation on, 74 restrictions on, 83 rules of, 82, 90 securities, 70 insider trading, 12 insolvency, 24–5 institutional greed, 4 integrated bank, 28 integrated investment banking, 2, 30, 67, 106, 108 interest payments, 59–60 interest rate, 60 internal ethical issues, 126–43 abuse of resources, 127–8 corporate entertainment, 128–9 discriminatory behaviour, 129–31 hospitality, 128–9 management behaviour, 131–2 remuneration, 132–9 tax, 139–41 internal review process, managing, 134 investment banking, 94 casino capitalism in, 3 Code of Ethics in, 47–9 commercial and, convergence of, 20–1 defined, 2 ethics in, 1 free-ride in, 24 integrated, 2, 30, 67, 108, 112 in market position, role of, 65–6 moral reasoning and, 38 necessity of, 14–15 non-failure of, 19–20 positive impact of, 18 recommendations in, 94–7 sector exclusions for, 58–9 investment banking adviser, 121 investment banking behaviours, 3 investment banking ethics committee, 151–3 investment bubbles, 95 investment fund, 3 investment grade bonds, 118 investment grade securities, 76 investment recommendations, 94 investments personal account, 128, 156 principal, 15, 28 proprietary, 29 IRS, 140 Islam, 54–5 Islamic banking, 6, 54–5 Jewish Scriptures, 34 Joint Advisory Committee on the Ethics of Investment (JACEI), 54 JP Morgan, 16 Judaism, 56 junior bankers, 139 junior debt, 118 junk bond, 118 “just war” approach, 38 Index Kant, Immanuel, 35, 69 karma, 57 Kerviel, Jérôme, 44, 80 Krishna, 57 Law Society, 19 Lazard International, 9 leading adviser, 41 Leeson, Nick, 12, 44, 81 legislative change, 25–6 Lehman Brothers, 5–6, 15, 21, 23, 31, 43, 76 lenders, 26, 131 lending, 59–60 leverage levels of, 25 over, 75, 80, 119 Levin, Carl, 17, 63–4, 68 light-touch regulations, 4 liquidity market, 95 orderly, 25 withdrawal of, 24 loan-to-own, 80 Locke, John, 34 London Inter-Bank Offered Rate (LIBOR), 23 London School of Economics, 43 London Stock Exchange, 65, 71, 84 long-term values, 147 Lords Grand Committee, 27 LTCM, 23 lying, 101 MacIntyre, Alasdair, 38 management behaviour, 131–2 margin-calls, 121 market abuse, 14, 70, 75, 86–8, 155 market announcements, 88 market behaviours, 74 market capitalism, 12–14 market communications, 88 market liquidity, 95 market maker defined, 65–7 investment bank as, 66 primary activities of, 65 175 market manipulation, 75 market position, role of, 104 market rate, 117 markets advisory, 73 capital, 73, 117–18, 158 communication within, 88 duties to support, 71–2 primary, 103 qualifying, 70, 82 secondary, 103 market trading, 41 Maxwell, Robert, 12 Meir, Asher, 56 mergers and acquisitions (M&As), 41, 79 Merkel, Angela, 93 Merrill Lynch, 8, 16 Methodism, 53 Methodist Central Finance Board, 59 Methodist Church, 54 Midrash, 56 Milken, Michael, 12 Mill, John Stuart, 36 Mirror Newspaper Group, 12 misleading behaviours, 86, 105 mis-selling of goods and services, 77–9, 155 modern capitalism, 54 moral-free zones, 31 moral hazard, 22, 70 moral philosophy, 1 moral reasoning, 38 moral relativism, 38–9, 49, 68 Morgan Stanley, 47 multi-notch downgrade, 17, 79 natural law, 34, 37 natural virtues, 37 necessity of investment banking, 14–15 New York Stock Exchange (NYSE), 65, 71 New York Times, 8 Noble Eightfold Path, 57 Nomura Group Code of Ethics, 47 normal market trading, 71 Northern Rock, 43 176 Index offer price, 64 off-market trading, 71–3, 90, 155 Olis, Jamie, 8 on-market trading, 70–1 oppressive regimes, 61 option value, 121 Orderly Liquidation Authority, 25 orderly liquidity, 25 out-of-pocket expenses, 127–8 over-leverage, 75, 80, 119, 158 overvalued securities, 155 patronage culture, 131, 142 Paulson, Henry M., 86 Paulson & Co., 78 “people-based” activity, 67 P:E ratio, 27 performance, 8–10 personal abuse, 159 personal account investments, 128, 156 personal account trading, 128 personal conflicts of interest, 45 pitching, 102, 159 Plato, 37 practical issues, 110–15 competitors, relationships with, 113 equity research, 113–15 pitching, 111 sell-side advisers, 111–13 pre-IPO financing, 110 prescriptive regulations, 31, 145 price tension, 79, 113 primary market, 103 prime-brokerage, 2 principal investment, 15, 28 private equity, 2–3, 12, 110 private trading, 94 Project Merlin, 133, 141 promises, 100–1 proprietary investment, 29 proprietary trading, 15, 25, 66, 150, 155 Prudential Regulation Authority (PRA), 26 public ownership, bonus pools in, 136–9 “pump and dump” strategy, 86 qualifying instruments, 70, 87 qualifying markets, 70, 82 quality-adjusted life year (QALY), 36 Quantitative Easing (QE), 23 Queen Elizabeth II, 42 Qu’ran, 54 rated debt, 77 rates attrition, 132 discount, 27 interest, 60 market, 117 tax, 140 rating agencies, 76 Rawls, John, 35, 136 recognised exchanges, 71 Regal Petroleum, 84 regulations banking, 16 compliance with, 28 external, 19, 31 light-touch, 4 prescriptive, 31, 145 regulatory changes and, 18–20 securities, 114 self, and impact on legislation, 19 regulatory compliance, 18 religion, business ethics in, 51–62 Buddhism, 56 Christianity, 52–4 Governments, 59 Hinduism, 56–7 interest payments, 59–60 Islam, 54–5 Judaism, 56 lending, 59–60 thresholds, 60 usury, 59–60 remuneration, 132–9 bonus pools in public ownership and, 136–9 claiming credit, 134 ethical issues with, 142–3 internal review process, managing, 134 1 Timothy 6:10, 135–6 Index research, 156 resources, abuse of, 127–8 restricted creditors, 120 restructuring of fees, 121–2 financial, 119–20 syndication and, 118–22 retail banks, 16 returns, 28, 156 Revised Code of Ethics, 47 right livelihood, 57 rights-based ethics, 66–8 rights vs. duties advisory vs. trading/capital markets, 73 conflict between, reconciling, 68–70 duty-based ethics, 66–8 off-market trading, ethical standards to, 71–2 on-market trading, ethical standards in, 70–1 opposing views of, 63–74 reconciling conflict between, 68–70 rights-based ethics, 66–8 Roman Catholic Church, 52 Royal Dutch Shell, 85 Sarbanes–Oxley Act, 20 Schwarzman, Stephen, 20 scope of ethical issues, 7–8 secondary market, 103 sector exclusions for investment banking, 58–9 securities investment grade, 76 issuing, 103–5 overvalued, 155 Securities and Exchange Commission (SEC), 7, 16 Goldman Sachs, charges against, 78 rating agencies, review by, 77 short-selling, review of, 96–7 securities insider dealing, 70 securities mis-selling, 77–9 securities regulations, 114 self-regulation, 19 sell recommendation, 115 177 sell-side advisers, 107, 111–13 Senate Permanent Subcommittee on Investigations, 46 senior debt, 118 sexist entertainment, 159 shareholders, 27–9 shares, deferred, 133 Shariah finance, 55 short-selling, 94–7, 154–5 Smith, Adam, 14, 35–6 social cohesion, 53 socially responsible investment (SRI), 56 Société Générale, 44, 80 solidarity, 53 Soros, George, 17 South Sea Bubble, 90 sovereign debt, 17 speculation, 91–4, 155 in financial crisis, 93 traditional views of, 91–3 speculative casino capitalism, 16, 91 spread, 21 stabilisation, 89 stock allocation, 94–7 stockholders, 41–2 stocks, dotcom, 17 Strange, Susan, 43 strategic issues with business ethics, 30–1 syndication, 119 and restructuring, 118–22 systemic risk, 24–5 Takeover Panel, 109 Talmud, 56 taxes, 139–41 tax optimisation, 158 tax rates, 140 tax structuring, 140 Terra Firma Capital Partners, 79, 112 Theory of Moral Sentiments, The (Smith), 14 3iG FCI Practitioners’ Report, 51 thresholds, 60 1 Timothy 6:10, 135–6 178 Index too big to fail concept, 21–7 ethical duties, and implicit Government guarantee, 22–3 ethical implications of, 26–7 in government, 22–3 insolvency, systemic risk and, 24–5 legislative change, 25–6 Lehman, failure of, 23 systemic risk, 24–5 toxic financial products, 5 trading abusive, 93 emissions, 14 insider, 12 market, 41 normal market, 71 off-market, 71–83, 90, 155 on-market, 70–1 personal account, 128 private, 94 proprietary, 15, 25, 66, 150, 155 unauthorised, 7 “trash and cash” strategy, 86 Travellers, 19 Treasury Select Committee, 26 Trinity Church, 53 Trouble with Markets, The (Bootle), 4 trust, 40, 53 trusted adviser, 108–9, 125 truth, 101–5 bait and switch, 102–3 misleading vs. lying, 101 securities, issuing, 103–5 2 and 20 fee, 13 UBS Investment Bank, 9 unauthorised trading, 7, 80–1, 155 unethical behaviour, 68 UK Alternative Investment Market, 89 UK Business Growth Fund, 133 UK Code of Practice, 141 UK Independent Banking Commission, 4, 22 United Methodist Church, 54, 59 United Methodist Investment Strategy Statement, 59 US Federal Reserve, 24, 25 US Financial Crisis Inquiry Commission, 4 US Open, 126 US Senate Permanent Subcommittee on Investigations, 64, 73 US Treasury Department, 132 universal banks, 2, 21, 28, 67 untoward movement, 85 usury, 59–60 utilitarian, 84 utilitarian ethics, 49, 84, 139 values, 9, 46, 119–21, 148 Vedanta, 57 victimless crime, 82 virtue ethics, 37–8, 43–4 virtues, 9, 34 virtuous behaviours, 37 Vishnu, 57 Volcker, Paul, 25 Volcker Rule, 2, 25 voting shareholders, 29 Wall Street, 12, 19, 53 Wall Street Journal, 20 Wealth of Nations, The (Smith), 14 Wesley, John, 53 Wharf, Canary, 18 Williams, Rowan, 53 Wimbledon, 127 WorldCom, 12, 17, 20, 76 write-off, 80 zakat, 55 zero-sum games, 118–22


pages: 258 words: 71,880

Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street by Kate Kelly

bank run, buy and hold, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Donald Trump, fixed income, housing crisis, index arbitrage, Long Term Capital Management, margin call, moral hazard, quantitative hedge fund, Renaissance Technologies, risk-adjusted returns, shareholder value, technology bubble, too big to fail, traveling salesman

True to its name, the fund attempted to goose, or enhance, returns by upping the amount of leverage it employed, borrowing about $10 for every $1 it had in cold, hard cash or collateral. That was less leverage than an average Wall Street firm employed, but more than many of the better-managed hedge funds. The riskier fund’s lenders were a who’s who of Wall Street, and now they smelled blood. A number of lenders, including J.P. Morgan, made margin calls on Cioffi’s funds, and when he couldn’t make good, they threw him into default. Hoping to monetize some of their assets, Cioffi and Tannin began a fire sale of the bonds they held, off-loading at least $8 billion into the markets in May and June. Still they couldn’t keep up with investor and lender demands. The housing market, now saddled with a growing number of late payments and borrowers in default, was in freefall.

Schwartz returned his attention to the management changes he was planning, which he intended to announce internally on March 25. Encouraged by the preliminary earnings results, he began preparing for the annual media conference, set to begin March 10 at the swanky Breakers hotel in Palm Beach, Florida. It was the week before Bear would fail, and worrisome signs were already appearing. Days prior, the London hedge fund Peloton Partners LLP had collapsed, unable to secure enough cash to meet a flurry of margin calls—demands for more cash or collateral—from lenders. Bad buzz was also encircling Carlyle Capital Corporation, a London-based unit of the Washington, D.C., private equity firm Carlyle Group, which was said to be having margin problems as well. Similar problems were besetting Thornburg Mortgage, a home-loan provider to customers with good credit. As a lender and holder of mortgages with tentacles reaching throughout the financial system, Bear stood to lose money from all three.

Cioffi’s pleas for clemency—delivered at a pair of meetings with creditors in June—made him for a time a laughingstock. Bear was the firm that refused to bail out Long-Term, whose CEO wouldn’t leave his office for a meeting and who would fight a rival firm over a turkey sandwich, much less an interest rate on a loan. Now one of Bear’s money managers had proven himself incompetent. The lenders felt it was absurd that Cioffi expected them to give him a break on collateral demands or a grace period on margin calls. So the curtain lowered on Cioffi’s funds, and soon, in short order, on Spector, Bear’s profitability, and Cayne himself. In August and September 2008, Ace Greenberg and Steve Meyer began arguing with Tom Marano over the size of his mortgage portfolio. They didn’t like his holdings, or his hedge—a huge short bet on financial firms like Wells Fargo and Wachovia that he referred to as “the chaos trade.”


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 late 1993 crude oil prices fell sharply and the oil forward curve moved into contango. This triggered large losses on MG’s hedge transactions, around $1 billion. The hedge losses were offset by unrealized gains on the forward sales to clients. Its margin between its sales contracts and oil purchases was broadly intact. MG’s hedges had worked – well, almost. MG needed to pay the exchange $1 billion in margin calls on its futures positions but it didn’t have the ready cash. The loss was covered by the profits on the oil products it had sold, the only problem being that the profits would arrive over five to ten years. MG needed the cash now. Metallgesellschaft reacted to the crisis decisively by hiring a raft of consultants who recommended closing out the hedges. It wasn’t clear why this was the best course of action.

Metallgesellschaft created a substantial industry: academics who had never traded now held forth at length on ‘issues’ such as whether MG’s positions were a ‘true’ hedge. What should have been done when the liquidity crisis occurred? Erudite, unending debate ensued. The hedges had not worked, there had been ‘basis’ risk, ‘trading‘ risk (the large size of the position) and ‘funding’ risk (MG had apparently forgotten that it needed money to make potential margin calls). MG had come close to collapse. Me too In 1999, Ashanti Goldfields set out to prove conclusively that hedging disasters were not the preserve of first world companies. Ashanti, a Ghanaian gold miner, hedged its gold production by entering into forward sales of gold. Through the late 1990s, central banks sold off their gold reserves, forcing the gold price lower. This triggered increasingly aggressive forward gold sales by gold miners (including Ashanti) trying to protect themselves from falling prices.

The hedge losses were offset by the increased value of physical gold sales at the higher prices when the contracts were closed out by delivery. But Ashanti’s contracts were cash ‘collateralized’. Ashanti, like MG, had to post cash to cover losses on its forward positions. Dealers were unprepared to take country risk on Ghana and counterparty risk on Ashanti. The losses triggered significant collateral calls; Ashanti was not able to meet the DAS_C04.QXP 8/7/06 98 8:39 PM Page 98 Tr a d e r s , G u n s & M o n e y unexpected margin calls. This necessitated the extensive restructuring of Ashanti, including the sale of a key Tanzanian mine, dilution of its equity shareholders and the restructuring of its hedge positions. Banks fête many companies as ‘sophisticated’ hedgers. There are flattering profiles in financial magazines about their operations. All that the accolades say is that the companies have provided a lot of business and profits for the banks.


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

A couple of days later, Henry Blodgett came out with his famous Amazon price target of $400 that sent all of the tech stocks flying.Amazon had been trading at $240 and immediately jumped to $290 after Blodgett’s call. Soon thereafter it went as high as $600. I was in Colombia at the time and got a call in my hotel room from my assistant informing me that I had received a margin call. I did not think it was possible and asked my assistant to verify it. Not only had I received a margin call on my short position, but to add insult to injury, I had also sold a bunch of calls on Amazon with strikes way out-of-the-money.The options were now in-the-money, exacerbating the margin call. It was a traumatic lesson in learning how to manage a portfolio—in this case my personal net worth, which immediately went down by 20 percent—but it was also a great lesson about the timing of a view.You can be right, but your timing can be totally wrong.

But, like all great investors, Keynes first had to learn some difficult lessons. He was not immune to blowups in spite of his superior intellect and understanding of global markets. In the early 1900s, he successfully speculated in global currencies on margin before switching to the commodity markets.Then, during the commodity slump of 1929, his personal account was completely wiped out by a margin call. After the 1929 setback, his greatest successes came from investing globally in equities but he continued to speculate in bonds and commodities. Skidelsky adds, “His investment philosophy . . . changed in line with his evolving economic theories. He learned a lot of his theory from his experience as an investor and this theory in turn modified his practice as an investor.” Keynes’ distaste of floating currencies (ironically his original vehicle of choice for speculating) eventually led him to participate in the construction of a global fixed currency regime at Bretton Woods in 1945.The post-World War II economic landscape, coupled with the ensuing Cold War–induced peace and the relative stability fostered by Bretton Woods, led to a boom in 500 450 Keynes 400 UK Broad Country Index Initial Base Value (100) 350 300 250 200 150 100 50 19 45 19 44 19 43 19 42 19 41 19 40 19 39 19 38 19 37 19 36 19 35 19 34 19 33 19 32 19 31 19 30 19 29 19 28 0 FIGURE 2.1 King’s College Cambridge Chest Fund and the UK Broad Country Equity Index Source: Motley Fool.

The Stock Market Crash of 1987 Although the U.S. stock market crash of October 1987 is now a mere blip on long-term stock market charts (see Figure 2.3), as indexes fully recov- THE HISTORY OF GLOBAL MACRO HEDGE FUNDS FIGURE 2.2 11 Major Global Macro Market Events since 1971 Source: DGA. ered only two years later, the intensity of Black Monday for traders who lived through it has certainly left its mark. Most notably, the notions of liquidity risk and fat tails were introduced to the wider investment community without mercy. Entire portfolios and money management businesses were obliterated on that day as margin calls went unfunded. Indeed, even so-called “portfolio insurance” hedges didn’t work as the futures and options markets became unhinged from the cash market. 1600 1400 S&P 500 Index 1200 1000 1987 U.S. Stock Market Crash 800 600 400 200 0 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 9 19 9 8 19 8 7 19 8 6 19 8 5 19 8 19 8 3 4 19 8 2 FIGURE 2.3 19 8 1 19 8 19 8 19 8 0 0 S&P 500 Index, 1980–2005 Source: Bloomberg. 12 INSIDE THE HOUSE OF MONEY FAT TAILS “Fat tails” are anomalies in normal distributions, whereby observed outcomes differ from those suggested by the distribution.


pages: 543 words: 157,991

All the Devils Are Here by Bethany McLean

Asian financial crisis, asset-backed security, bank run, Black-Scholes formula, Blythe Masters, break the buck, buy and hold, call centre, collateralized debt obligation, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Exxon Valdez, fear of failure, financial innovation, fixed income, high net worth, Home mortgage interest deduction, interest rate swap, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, market fundamentalism, Maui Hawaii, money market fund, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, shareholder value, short selling, South Sea Bubble, statistical model, telemarketer, too big to fail, value at risk, zero-sum game

The Bear team had made money on short positions they had placed on the ABX, but the volatility was worrisome. Because the higher-rated securities were supposed to be nearly riskless, the Bear Stearns hedge funds were highly leveraged: only about $1.6 billion of the $20 billion was equity. The rest was borrowed. Earlier in February, they’d started to get margin calls, meaning that their lenders were demanding more collateral. They’d met the margin calls, but their fears had not abated. Trying to calm the others, Cioffi told them about the time he and Warren Spector, Bear’s co-president, with whom Cioffi had risen through the ranks, had been caught with a big bond position way back when. They didn’t panic, and they ended up making a lot of money. Tannin commiserated with Van Solkema about how the stress made it hard to get any sleep.

The posting of $450 million, he wrote, was an effort “to get everyone to chill out.” But, he added, “this is not the last margin call we are going to debate.” Forster agreed. “I have heard several rumors now that gs is aggressively marking down asset types that they don’t own so as to cause maximum pain to their competitors,” he e-mailed back. “It may be rubbish, but it’s the sort of thing gs would do.”20 Unbeknownst to AIG, Goldman Sachs did something else to protect itself. Concluding that it could no longer trust AIG to pay off its swap contracts in full if the triple-A tranches started to default, Goldman began buying protection on AIG itself. Goldman would later claim that this was standard practice: it always bought protection on a counterparty if that counterparty was fighting margin calls. But it’s also true that Goldman, having done so many deals with AIG over the years and having served as AIG’s longtime investment banker, had a deeper understanding of AIG and all its foibles than anybody else.

New Century’s perpetual motion machine is grinding to a halt. Meanwhile, New Century is running low on cash. On August 17, CFO Patti Dodge sends an e-mail to Brad Morrice, the CEO: “We started the quarter with $400mm in liquidity and we are down to less than $50mm today,” she writes. In explaining the problem to the company’s board, Morrice cites “continued difficult secondary market conditions leading to warehouse line margin calls, higher investors kick outs [meaning that wary investors are refusing to purchase loans] and loan repurchases.” Internally, top management begins receiving a weekly report monitoring its problems. It is entitled “Storm Watch.” Does Wall Street know about New Century’s problems? Of course it does! One Wall Street banker tells New Century that its problems aren’t all that unusual, according to a report done later by a bankruptcy examiner.


When Free Markets Fail: Saving the Market When It Can't Save Itself (Wiley Corporate F&A) by Scott McCleskey

Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, break the buck, call centre, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, information asymmetry, invisible hand, Isaac Newton, iterative process, Long Term Capital Management, margin call, money market fund, moral hazard, mortgage debt, place-making, Ponzi scheme, prediction markets, risk tolerance, shareholder value, statistical model, The Wealth of Nations by Adam Smith, time value of money, too big to fail, web of trust

Leverage simply means borrowing money to invest, on the assumption that you will make more money from the investment than you will owe on the loan. A firm’s leverage is customarily expressed as a ratio of borrowed money to hard assets (that is, loan to collateral). It makes winning bets into huge winning bets, but can work just as powerfully in the other direction in case of a loss. Of course, losses happen all the time and so a mechanism is built into the process in order to protect the parties loaning the money. This is the margin call. A margin call requires the borrowing party to pony up more cash or other collateral to back up the loan if the investment bought with the borrowed money has dropped significantly in value (the investment is the initial collateral). So now view the Bear Stearns collapse from the point of view of the rest of the market. For some, the use of risky and difficult-to-price toxic assets will mean that you demand higher collateral, or that you simply cease to loan money to Bear Stearns at all.

See International Organization of Securities Commissioners (IOSCO) issuer-pays model, 85, 88, 97–98, 154 J Joint (House and Senate) Economic Committee, 101 K Kanjorski, Paul, 98–99 King, Governor Mervyn, 19 L Lehman Brothers, 8, 22, 25, 38, 77, 87, 134 leverage, 6, 16, 147, 159, 177–78, 184 lobbying, 92, 99–100, 104, 126, 131, 171 Long Term Capital hedge fund collapse, 11 Long Term Capital Management (LTCM), 16 M Madoff Investment Securities, 109 Malthus, Ricardo, xvii malus schemes, 50, 52, 153 margin call, 6 market abuse, 107, 113, 181 Markets in Financial Instruments Directive (MiFID), 136 Merrill Lynch, 4, 77, 87 MMFs. See Money Market Mutual Funds (MMFs) money laundering activity, 119, 151, 185–86 money market fund, 7–9, 11, 92 Money Market Mutual Funds (MMFs), 180 Moody’s, xi, 84, 86, 88–89, 94, 98 moral hazard AAA ratings of riskiest assets, 26 about, xxiv, 24–25 of businesses associated with the irresponsible firms, 28 clawback of previous compensation, 29 conclusion, 30 creditors as the other, 28–30 creditors should not be made whole, 30 as deciding factor in risk decisions, 26 emergency pool of funds trigger clawback in compensation and civil liability, 28 emergency pool of funds trigger government to dismiss any or all senior management or Board, 27 failures, provisions for, 29–30 federally insured deposits of individuals, 24 firms extending credit to irresponsible firms stand to lose their investment, 28 government bailout of AIG and Bear Stearns, 25 government bailout of financial institutions, 24 government can create, 27 government-sponsored enterprises (GSEs), 25 government support of failing banks prevents uncertainty, 28 government support of important institutions, 30 as life insurance, 26 moral suasion alone will not carry the day, 29 Plan B, 30 practice of, 26 punish or reward firm vs. the individual, 27 ‘‘punish the leaders, not the organization,’’ 27–28 regulatory debate on, 30 ‘‘risks are fully understood to be risky,’’ 26 risky behavior by firms too big to fail, 26 salary and incentive compensation, forfeiture of, 29 sanctions against senior management, 29–30 sanctions for individuals making risktaking decisions, 27 self-interest, 30 short-term funding contracts and exemption from haircuts, 28–29 systemic risk, need for new rules for, 25 theory of, 25–26 third-party, 28, 30 Morgan Stanley, 17, 78, 92, 104, 160, 175 N NASDAQ stock market, 113, 160, 168 National Bank Supervisor (NBS), 179 Nationally Recognized Statistical Rating Organization (NRSRO), 84–89, 94–97, 154 NBS.

See Self-Regulatory Organizations (SROs) Standard & Poor (S&P), 84, 88, 94 structured finance products, 32, 34–36, 73, 84, 88 Stuart, John, xvii–xviii subprime mortgages AAA rating for, 33–34 interest rates, rising, 86 investment bankers, xxi mortgage payments and, 34 pooled risk, 33 ratings, downgrading, xvii–xix, 88, 93 structured investments backed by, 37 as toxic assets, 32–34, 37 systemic risk and market meltdown about, 1 AIG and credit default swaps, 5 Bear Stearns, 2–6, 10, 13–14 borrowed money, short vs. long-term, 2 ‘‘breaking the buck,’’ 8 collateral damage, 6–7 conclusion, 12 economy is about connections, 1 economy is not the sum of its parts, 1 funding, day-to-day, 2–3 government intervention, 9–10, 12 hedge fund redemption, 6 investment practice, legal covenants governing, 4 Lehman repos, 8 leverage, 6 Long Term Capital hedge fund collapse, 11 loss of confidence, 3 margin call, 6 money market fund, 7–9, 11, 92 regulation to focus on firms vs. system as a whole, 12 regulatory reform proposals, 2, 12 repurchase agreement (repo), 3, 6–8, 13 risk of fluctuation in the overnight price of an asset, 3 rumor control and market psychology, 4 rumors, at the mercy of, 4–6 rumors, self-fulfilling nature of, 9 rumors and bank runs, 4 rumors cause a crisis, 4 run on the bank, institutional, 6 SEC regulations restricting what money market fund for investment, 7 six degrees of separation, 11 speculative (junk) bond status, 4 system collapse, why not before?


pages: 345 words: 86,394

Frequently Asked Questions in Quantitative Finance by Paul Wilmott

Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, buy and hold, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, lateral thinking, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

The initial margin is the amount deposited at the initiation of the contract. The total amount held as margin must stay above a prescribed maintenance margin. If it ever falls below this level then more money (or equivalent in bonds, stocks, etc.) must be deposited. The amount of margin that must be deposited depends on the particular contract. A dramatic market move could result in a sudden large margin call that may be difficult to meet. To prevent this situation it is possible to margin hedge. That is, set up a portfolio such that margin calls on one part of the portfolio are balanced by refunds from other parts. Usually over-the-counter contracts have no associated margin requirements and so won’t appear in the calculation. Crash (Platinum) hedging The final variety of hedging is specific to extreme markets. Market crashes have at least two obvious effects on our hedging.

Unfortunately, as you can probably imagine, and certainly as in this example, superhedging might give you prices that differ vastly from the market. Margin hedging Often what causes banks, and other institutions, to suffer during volatile markets is not the change in the paper value of their assets but the requirement to suddenly come up with a large amount of cash to cover an unexpected margin call. Examples where margin has caused significant damage are Metallgesellschaft and Long Term Capital Management. Writing options is very risky. The downside of buying an option is just the initial premium, the upside may be unlimited. The upside of writing an option is limited, but the downside could be huge. For this reason, to cover the risk of default in the event of an unfavourable outcome, the clearing houses that register and settle options insist on the deposit of a margin by the writers of options.

Second, normal market correlations become meaningless. Typically all correlations become one (or minus one). Crash or Platinum hedging exploits the latter effect in such a way as to minimize the worst possible outcome for the portfolio. The method, called CrashMetrics, does not rely on parameters such as volatilities and so is a very robust hedge. Platinum hedging comes in two types: hedging the paper value of the portfolio and hedging the margin calls. References and Further Reading Taleb, NN 1997 Dynamic Hedging. John Wiley & Sons Wilmott, P 2006 Paul Wilmott On Quantitative Finance, second edition. John Wiley & Sons What is Marking to Market and How Does it Affect Risk Management in Derivatives Trading? Short Answer Marking to market means valuing an instrument at the price at which it is currently trading in the market.


pages: 204 words: 58,565

Keeping Up With the Quants: Your Guide to Understanding and Using Analytics by Thomas H. Davenport, Jinho Kim

Black-Scholes formula, business intelligence, business process, call centre, computer age, correlation coefficient, correlation does not imply causation, Credit Default Swap, en.wikipedia.org, feminist movement, Florence Nightingale: pie chart, forensic accounting, global supply chain, Hans Rosling, hypertext link, invention of the telescope, inventory management, Jeff Bezos, Johannes Kepler, longitudinal study, margin call, Moneyball by Michael Lewis explains big data, Myron Scholes, Netflix Prize, p-value, performance metric, publish or perish, quantitative hedge fund, random walk, Renaissance Technologies, Robert Shiller, Robert Shiller, self-driving car, sentiment analysis, six sigma, Skype, statistical model, supply-chain management, text mining, the scientific method, Thomas Davenport

Charles Duhigg, The Power of Habit: Why We Do What We Do in Life and Business (New York: Random House, 2012). 5. Gary Loveman, “Foreword,” in Thomas H. Davenport and Jeanne G. Harris, Competing on Analytics: The New Science of Winning (Boston: Harvard Business School Press, 2007), x. 6. More context on the movie and the characters can be found at http://business-ethics.com/2011/11/23/0953-margin-call-a-small-movie-unveils-big-truths-about-wall-street/. 7. Margin Call, film with direction and screenplay by J. C. Chandor, 2011. 8. Liam Fahey, “Exploring ‘Analytics’ to Make Better Decisions: The Questions Executives Need to Ask,” Strategy and Leadership 37, no. 5 (2009): 12–18. 9. Information for this example came from several interviews with Anne Robinson; and Blake Johnson, “Leveraging Enterprise Data and Advanced Analytics in Core Operational Processes: Demand Forecasting at Cisco,” case study, Stanford University Management Science and Engineering Department. 10.

“Maybe you could consider a small but rigorous experiment on that concept.” You get the idea. If enough people around an organization constantly ask questions of this type, the culture will change quickly and dramatically. Quantitative people will often attempt to describe models and problems in highly technical terms. That doesn’t mean you have to listen or converse in the same terms. As a good illustration, the movie Margin Call dramatizes some of the events that led to the financial crisis of 2008–2009. The movie is based on an investment bank that resembles Lehman Brothers. The quant character in the plot, who has a PhD in propulsion engineering, comes up with a new algorithm for calculating the bank’s exposure to risk. When he shows the algorithm to the head of trading, played by Kevin Spacey, the blustery trading czar says, “You know I can’t read these things.


pages: 135 words: 26,407

How to DeFi by Coingecko, Darren Lau, Sze Jin Teh, Kristian Kho, Erina Azmi, Tm Lee, Bobby Ong

algorithmic trading, asset allocation, Bernie Madoff, bitcoin, blockchain, buy and hold, capital controls, collapse of Lehman Brothers, cryptocurrency, distributed ledger, diversification, Ethereum, ethereum blockchain, fiat currency, Firefox, information retrieval, litecoin, margin call, new economy, passive income, payday loans, peer-to-peer, prediction markets, QR code, reserve currency, smart contracts, tulip mania, two-sided market

For simplicity’s sake, we will separate the degrees of decentralization into three categories: centralized, semi-decentralized and completely decentralized. Centralized Characteristics: Custodial, uses centralized price feeds, centrally-determined interest rates, centrally-provided liquidity for margin calls Examples: Salt, BlockFi, Nexo and Celsius Semi-Decentralized (has one or more of these characteristics but not all) Characteristics: Non-custodial, decentralized price feeds, permissionless initiation of margin calls, permissionless margin liquidity, decentralized interest rate determination, decentralized platform development/updates Examples: Compound, MakerDAO, dYdX, bZx Completely Decentralized Characteristics: Every component is decentralized Examples: No DeFi protocol is completely decentralized yet.


pages: 466 words: 127,728

The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

Affordable Care Act / Obamacare, Asian financial crisis, asset allocation, Ayatollah Khomeini, bank run, banking crisis, Ben Bernanke: helicopter money, bitcoin, Black Swan, Bretton Woods, BRICs, business climate, business cycle, buy and hold, capital controls, Carmen Reinhart, central bank independence, centre right, collateralized debt obligation, collective bargaining, complexity theory, computer age, credit crunch, currency peg, David Graeber, debt deflation, Deng Xiaoping, diversification, Edward Snowden, eurozone crisis, fiat currency, financial innovation, financial intermediation, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, G4S, George Akerlof, global reserve currency, global supply chain, Growth in a Time of Debt, income inequality, inflation targeting, information asymmetry, invisible hand, jitney, John Meriwether, Kenneth Rogoff, labor-force participation, Lao Tzu, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market design, money market fund, money: store of value / unit of account / medium of exchange, mutually assured destruction, obamacare, offshore financial centre, oil shale / tar sands, open economy, plutocrats, Plutocrats, Ponzi scheme, price stability, quantitative easing, RAND corporation, reserve currency, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Satoshi Nakamoto, Silicon Valley, Silicon Valley startup, Skype, sovereign wealth fund, special drawing rights, Stuxnet, The Market for Lemons, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, too big to fail, trade route, undersea cable, uranium enrichment, Washington Consensus, working-age population, yield curve

They involve time-outs for the markets to allow traders to comprehend the situation and begin to see bargains they might buy. They also involve margin calls designed to cover mark-to-market losses and give the brokers a cushion against customers who default. Those mitigation techniques do not stop the financial warrior, because he is not looking for bargains or profits. The attacker can use the time-out to pile on additional sell orders in a second wave of attacks. Also, these safety techniques rely heavily on actual performance by the affected parties. When a margin call is made, it applies the brakes to a legitimate trader due to the need to provide cash. But the malicious trader would ignore the margin call and continue trading. For the malicious trader, there is no day of reckoning. The fact that the enemy might be discovered later is also no deterrent.

Examples include the 1987 stock market crash, when the Dow Jones Industrial Index fell over 22 percent in a single day, the 1994 Mexican peso collapse, the 1997–98 Asia-Russia-Long-Term Capital market panic, the 2000 tech stock collapse, the 2007 housing market collapse, and the Lehman-AIG financial panic of 2008. Panics are neither prevented nor caused by gold. Panics are caused by credit overexpansion and overconfidence, followed by a sudden loss of confidence and a mad scramble for liquidity. Panics are characterized by rapid declines in asset values, margin calls by creditors, dumping of assets to obtain cash, and a positive feedback loop in which more asset sales cause further valuation declines, which are followed by more and more margin calls and asset sales. This process eventually exhausts itself through bankruptcy, a rescue by solvent parties, government intervention, or a convergence of all three. Panics are a product of human nature, and the pendulum swings between fear and greed and back to fear. Panics will not disappear. The point is that panics have little or nothing to do with gold.


pages: 419 words: 130,627

Last Man Standing: The Ascent of Jamie Dimon and JPMorgan Chase by Duff McDonald

bank run, Blythe Masters, Bonfire of the Vanities, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Exxon Valdez, financial innovation, fixed income, G4S, housing crisis, interest rate swap, Jeff Bezos, John Meriwether, Kickstarter, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, money market fund, moral hazard, negative equity, Nelson Mandela, Northern Rock, profit motive, Renaissance Technologies, risk/return, Rod Stewart played at Stephen Schwarzman birthday party, Saturday Night Live, sovereign wealth fund, statistical model, Steve Ballmer, Steve Jobs, technology bubble, The Chicago School, too big to fail, Vanguard fund, zero-coupon bond, zero-sum game

The first fund was leveraged about 35 to one, and the second at a breathtaking 100 to one. At that level, a drop of 1 percent wipes out all the equity. When the housing market stalled, as it did in late 2006 and early 2007, that’s exactly what happened. Housing prices were not yet in free fall, but some securities had slipped to about 95 percent of their value by the spring. Cioffi took a huge paper loss and was unable to meet margin calls from his overnight lenders. (This is the lesson of leverage. If you pay only $1 for $100 worth of securities while borrowing the other $99, and those securities lose $5 in value, you’re not only out your original $1. You now owe $4 just to get back to breakeven. Multiply those numbers by several hundred million, and you can appreciate the pickle Cioffi found himself in.) In a move as brazen as it was cynical, Cioffi decided that the way out of the mess was to find a few patsies to take the toxic securities off his hands.

What would Everquest do? Overpay for Cioffi’s underwater securities. (The name of the company—“Everquest”—was classic Wall Street, both portentous and meaningless.) Unfortunately for Cioffi, a number of reporters at both the Wall Street Journal and Business Week sniffed out the scheme by early June, and he was forced to abort it. A total of $4 billion in securities had to be liquidated to satisfy redemptions and margin calls by the funds’ creditors. By this point, those creditors, including Merrill Lynch and JPMorgan Chase, were threatening to pull the plug and send both funds into default. In an attempt to head off the crisis, the copresident of Bear Stearns, Warren Spector, convened a meeting of the firm’s lenders, including Merrill Lynch, JPMorgan Chase, Goldman Sachs, and Bank of America, at the company’s offices at 383 Madison Avenue.

In an attempt to head off the crisis, the copresident of Bear Stearns, Warren Spector, convened a meeting of the firm’s lenders, including Merrill Lynch, JPMorgan Chase, Goldman Sachs, and Bank of America, at the company’s offices at 383 Madison Avenue. The gist of his message was that everything would be OK; Cioffi was an expert in such things, and just needed some breathing room to put the funds back on a solid footing. John Hogan, chief risk officer for JPMorgan Chase’s investment bank, attended. Hogan asked a question. Was Bear Stearns prepared to provide a capital infusion to help the funds meet their margin calls? When he was told the answer was no, he left the meeting and returned to the JPMorgan Chase headquarters. After being debriefed by Hogan, Steve Black picked up the phone and called Spector. “You guys are out of your mind if you think we’re not going to put you into default,” Black told him. Spector replied that Black and Hogan did not understand the business, and that JPMorgan Chase was the only bank that was giving Bear Stearns a hard time about the loans.


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

(The opposite amount is added or subtracted for a short futures position.) Any excess that builds up above the initial margin can be withdrawn by the investor. On the other hand, if the deposit drops below a certain level, called the maintenance margin, the clearing house will issue a margin call , requesting the investor to make a payment and restore the deposit to the level of the initial margin. A futures position can be closed at any time, in which case the deposit will be returned to the investor. In particular, the futures position will be closed immediately by the clearing house if the investor fails to respond to a margin call. As a result, the risk of default is eliminated. Example 6.1 Suppose that the initial margin is set at 10% and the maintenance margin at 5% of the futures price. The table below shows a scenario with futures prices f (n, T ).

The ‘payment’ column contains the amounts paid to top up the deposit (negative numbers) or withdrawn 136 Mathematics for Finance (positive numbers). n 0 1 2 3 4 f (n, T ) 140 138 130 140 150 cash flow opening: − 2 − 8 +10 +10 closing: margin 1 0 12 4 23 24 15 total: payment −14 0 − 9 + 9 + 9 +15 10 margin 2 14 12 13 14 15 0 On day 0 a futures position is opened and a 10% deposit paid. On day 1 the futures price drops by $2, which is subtracted from the deposit. On day 2 the futures price drops further by $8, triggering a margin call because the deposit falls below 5%. The investor has to pay $9 to restore the deposit to the 10% level. On day 3 the forward price increases and $9 is withdrawn, leaving a 10% margin. On day 4 the forward price goes up again, allowing the investor to withdraw another $9. At the end of the day the investor decides to close the position, collecting the balance of the deposit. The total of all payments is $10, the increase in the futures price between day 0 and 4.

Glossary of Symbols A B β c C C CA CE CE Cov delta div div0 D D DA E E∗ f F gamma Φ k K i m fixed income (risk free) security price; money market account bond price beta factor covariance call price; coupon value covariance matrix American call price European call price discounted European call price covariance Greek parameter delta dividend present value of dividends derivative security price; duration discounted derivative security price price of an American type derivative security expectation risk-neutral expectation futures price; payoff of an option; forward rate forward price; future value; face value Greek parameter gamma cumulative binomial distribution logarithmic return return coupon rate compounding frequency; expected logarithmic return 305 306 Mathematics for Finance M m µ N N k ω Ω p p∗ P PA PE PE PA r rdiv re rF rho ρ S S σ t T τ theta u V Var VaR vega w w W x X y z market portfolio expected returns as a row matrix expected return cumulative normal distribution the number of k-element combinations out of N elements scenario probability space branching probability in a binomial tree risk-neutral probability put price; principal American put price European put price discounted European put price present value factor of an annuity interest rate dividend yield effective rate risk-free return Greek parameter rho correlation risky security (stock) price discounted risky security (stock) price standard deviation; risk; volatility current time maturity time; expiry time; exercise time; delivery time time step Greek parameter theta row matrix with all entries 1 portfolio value; forward contract value, futures contract value variance value at risk Greek parameter vega symmetric random walk; weights in a portfolio weights in a portfolio as a row matrix Wiener process, Brownian motion position in a risky security strike price position in a fixed income (risk free) security; yield of a bond position in a derivative security Index admissible – portfolio 5 – strategy 79, 88 American – call option 147 – derivative security – put option 147 amortised loan 30 annuity 29 arbitrage 7 at the money 169 attainable – portfolio 107 – set 107 183 basis – of a forward contract 128 – of a futures contract 140 basis point 218 bear spread 208 beta factor 121 binomial – distribution 57, 180 – tree model 7, 55, 81, 174, 238 Black–Derman–Toy model 260 Black–Scholes – equation 198 – formula 188 bond – at par 42, 249 – callable 255 – face value 39 – fixed-coupon 255 – floating-coupon 255 – maturity date 39 – stripped 230 – unit 39 – with coupons 41 – zero-coupon 39 Brownian motion 69 bull spread 208 butterfly 208 – reversed 209 call option 13, 181 – American 147 – European 147, 188 callable bond 255 cap 258 Capital Asset Pricing Model 118 capital market line 118 caplet 258 CAPM 118 Central Limit Theorem 70 characteristic line 120 compounding – continuous 32 – discrete 25 – equivalent 36 – periodic 25 – preferable 36 conditional expectation 62 contingent claim 18, 85, 148 – American 183 – European 173 continuous compounding 32 continuous time limit 66 correlation coefficient 99 coupon bond 41 coupon rate 249 307 308 covariance matrix 107 Cox–Ingersoll–Ross model 260 Cox–Ross–Rubinstein formula 181 cum-dividend price 292 delta 174, 192, 193, 197 delta hedging 192 delta neutral portfolio 192 delta-gamma hedging 199 delta-gamma neutral portfolio 198 delta-vega hedging 200 delta-vega neutral portfolio 198 derivative security 18, 85, 253 – American 183 – European 173 discount factor 24, 27, 33 discounted stock price 63 discounted value 24, 27 discrete compounding 25 distribution – binomial 57, 180 – log normal 71, 186 – normal 70, 186 diversifiable risk 122 dividend yield 131 divisibility 4, 74, 76, 87 duration 222 dynamic hedging 226 effective rate 36 efficient – frontier 115 – portfolio 115 equivalent compounding 36 European – call option 147, 181, 188 – derivative security 173 – put option 147, 181, 189 ex-coupon price 248 ex-dividend price 292 exercise – price 13, 147 – time 13, 147 expected return 10, 53, 97, 108 expiry time 147 face value 39 fixed interest 255 fixed-coupon bond 255 flat term structure 229 floating interest 255 floating-coupon bond 255 floor 259 floorlet 259 Mathematics for Finance forward – contract 11, 125 – price 11, 125 – rate 233 fundamental theorem of asset pricing 83, 88 future value 22, 25 futures – contract 134 – price 134 gamma 197 Girsanov theorem 187 Greek parameters 197 growth factor 22, 25, 32 Heath–Jarrow–Morton model hedging – delta 192 – delta-gamma 199 – delta-vega 200 – dynamic 226 in the money 169 initial – forward rate 232 – margin 135 – term structure 229 instantaneous forward rate interest – compounded 25, 32 – fixed 255 – floating 255 – simple 22 – variable 255 interest rate 22 interest rate option 254 interest rate swap 255 261 233 LIBID 232 LIBOR 232 line of best fit 120 liquidity 4, 74, 77, 87 log normal distribution 71, 186 logarithmic return 34, 52 long forward position 11, 125 maintenance margin 135 margin call 135 market portfolio 119 market price of risk 212 marking to market 134 Markowitz bullet 113 martingale 63, 83 Index 309 martingale probability 63, 250 maturity date 39 minimum variance – line 109 – portfolio 108 money market 43, 235 no-arbitrage principle 7, 79, 88 normal distribution 70, 186 option – American 183 – at the money 169 – call 13, 147, 181, 188 – European 173, 181 – in the money 169 – interest rate 254 – intrinsic value 169 – out of the money 169 – payoff 173 – put 18, 147, 181, 189 – time value 170 out of the money 169 par, bond trading at 42, 249 payoff 148, 173 periodic compounding 25 perpetuity 24, 30 portfolio 76, 87 – admissible 5 – attainable 107 – delta neutral 192 – delta-gamma neutral 198 – delta-vega neutral 198 – expected return 108 – market 119 – variance 108 – vega neutral 197 positive part 148 predictable strategy 77, 88 preferable compounding 36 present value 24, 27 principal 22 put option 18, 181 – American 147 – European 147, 189 put-call parity 150 – estimates 153 random interest rates random walk 67 rate – coupon 249 – effective 36 237 – forward 233 – – initial 232 – – instantaneous 233 – of interest 22 – of return 1, 49 – spot 229 regression line 120 residual random variable 121 residual variance 122 return 1, 49 – expected 53 – including dividends 50 – logarithmic 34, 52 reversed butterfly 209 rho 197 risk 10, 91 – diversifiable 122 – market price of 212 – systematic 122 – undiversifiable 122 risk premium 119, 123 risk-neutral – expectation 60, 83 – market 60 – probability 60, 83, 250 scenario 47 security market line 123 self-financing strategy 76, 88 short forward position 11, 125 short rate 235 short selling 5, 74, 77, 87 simple interest 22 spot rate 229 Standard and Poor Index 141 state 238 stochastic calculus 71, 185 stochastic differential equation 71 stock index 141 stock price 47 strategy 76, 87 – admissible 79, 88 – predictable 77, 88 – self-financing 76, 88 – value of 76, 87 strike price 13, 147 stripped bond 230 swap 256 swaption 258 systematic risk 122 term structure 229 theta 197 time value of money 21 310 trinomial tree model Mathematics for Finance 64 underlying 85, 147 undiversifiable risk 122 unit bond 39 value at risk 202 value of a portfolio 2 value of a strategy 76, 87 VaR 202 variable interest 255 Vasiček model 260 vega 197 vega neutral portfolio volatility 71 weights in a portfolio Wiener process 69 yield 216 yield to maturity 229 zero-coupon bond 39 197 94


pages: 1,073 words: 302,361

Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan

asset-backed security, Bernie Madoff, business cycle, buttonwood tree, buy and hold, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, fear of failure, financial innovation, fixed income, Ford paid five dollars a day, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, John Meriwether, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, mega-rich, merger arbitrage, moral hazard, mortgage debt, Myron Scholes, paper trading, passive investing, Paul Samuelson, Ponzi scheme, price stability, profit maximization, risk tolerance, Ronald Reagan, Saturday Night Live, South Sea Bubble, time value of money, too big to fail, traveling salesman, value at risk, yield curve, Yogi Berra, zero-sum game

At the same time, AIOI Insurance, a Goldman client in Tokyo, let the Goldman traders know how upset the company was about Goldman’s marks and the margin call that resulted. According to Shigeru Akamatsu, a Goldman vice president, “Suzuki-san,” at AIOI, believed Goldman’s marks were “more than twice as bad as others,” that the margin call was “totally unaccepted,” and “warned that he will strongly protest against us.” Goldman’s opening salvo against AIG had been fired. The next day, Goldman asked AIGFP for $1.81 billion in collateral; Goldman also purchased $100 million of insurance—by buying CDS—against the possibility that AIG would default on its obligations. (Eventually Goldman’s CDS purchase against an AIG default would reach a peak of $3.2 billion.) On July 30, an AIG trader told Forster that “[AIG] would be in fine shape if Goldman wasn’t hanging its head out there.” The July 27 margin call was “something that hit out of the blue, and it’s a fucking number that’s well bigger than we ever planned for,” Forster said later.

On July 26, Andrew Davilman, at Goldman, wrote Frost an e-mail telling him Goldman was making its first collateral call. Frost was on vacation. “Sorry to bother you on vacation,” Davilman wrote. “Margin call coming your way. Want to give you a heads up.” “On what?” Frost wrote back, eighteen minutes later. “[$]20bb of supersenior,” Davilman replied, just over a minute later. Frost never replied to Davilman’s e-mail. Instead, AIGFP decided that Forster, not Frost, would deal with Goldman’s requests for collateral payments. Goldman’s marks—and the subsequent collateral call to AIGFP based on them—were, understandably, not welcome news at AIGFP. But the marks were also the subject of some controversy within Goldman itself. “The $2bn margin call is driven by a massive remarking by Goldman Sachs of the underlying [mortgage] securities (down from −6 pts to −20 to −25 pts in some cases), ahead of all other dealers in the [S]treet,” Goldman’s Nicholas Friedman wrote in an internal e-mail the day before the AIGFP collateral call.

“Sparks and the [mortgage] group are in the process of considering making significant downward adjustments to the marks on their mortgage portfolio esp[ecially] CDOs and CDO squared,” Craig Broderick, Goldman’s chief risk officer, wrote in a May 11, 2007, e-mail, referring to the lower values Sparks was placing on complex mortgage-related securities. “This will potentially have a big P&L impact on us, but also to our clients due to the marks and associated margin calls on repos, derivatives, and other products. We need to survey our clients and take a shot at determining the most vulnerable clients, knock on implications, etc. This is getting lots of 30th floor”—the executive floor at Goldman’s former headquarters at 85 Broad Street—“attention right now.” Broderick’s e-mail may turn out to be the unofficial “shot heard round the world” of the financial crisis.


pages: 403 words: 119,206

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

The bank’s governor, George Harrison, responding to criticism that he had exceeded his powers, said, “It is not at all unlikely that had we not bought governments so freely, thus supplementing the reserves built up by large additional discounts, the stock exchange might have had to yield to the tremendous pressure brought to bear on it to close on some of those very bad days in the last part of October.”15 During the next two weeks, tens of thousands of margin calls went out to investors whose stockholdings had declined in value to the point where they no longer provided sufficient collateral to cover the investors’ margin loans. Nonbank lenders cut their broker’s loans by $1.4 billion in the last two weeks of October, and non-New York banks recalled $800 million during this same period. The big New York commercial banks stepped into the breach, making $1 billion in additional loans available.

Unlike 1929, when a similar directive by the Fed to cease funding speculation was openly spurned by Charles Mitchell of First National City Bank, in 1980 the banking community quickly fell in line with Fed policy. It was generally assumed that the Fed was specifically targeting the Hunts; whatever the case, the effect of the new policy on the brothers was devastating. They could expect to borrow no more money from U.S. banks to meet future margin requirements. The price of silver continued to slide, and the Hunts, for the first time, found themselves unable to meet their margin calls. Bache, Halsey, Stuart, Shields put up some of the money for them, but even this additional margin was quickly consumed by falling prices. Worse still, Bache itself was now placed in a precarious financial position. Even though the Hunt brothers still possessed substantial assets that were not encumbered by loans, those assets were illiquid and could not be sold easily to raise cash. Because of Federal Reserve policy, banks would not lend to them.

As Leland put it, portfolio insurance was comparable to a “run with your winners, cut your losses” strategy.2 Leland and other apostles of “portfolio insurance” were quite successful in selling the idea; by 1987 close to $100 billion in institutional portfolio values was reportedly “insured.” Some observers expressed concern about the potential impact of these insurance strategies in a down market, in that the strategies called for selling more futures contracts as prices fell. This might exacerbate market weakness by creating even more selling pressure at the worst possible time, in much the same sense that margin-call selling accelerated the 1929 collapse. But little attention was paid to this possibility. Most portfolio insurance clients were quite happy with the protection they believed they had purchased. From the August 1982 lows, the stock market roared ahead over the next several years, propelled by a rapid economic recovery, declining interest rates, and rising corporate profits. The market was driven primarily by institutions, which accounted for approximately 70% of all trading volume.


pages: 992 words: 292,389

Conspiracy of Fools: A True Story by Kurt Eichenwald

Asian financial crisis, Burning Man, computerized trading, corporate raider, estate planning, forensic accounting, intangible asset, Irwin Jacobs, John Markoff, Long Term Capital Management, margin call, Negawatt, new economy, oil shock, price stability, pushing on a string, Ronald Reagan, transaction costs, value at risk, young professional

Given all the turmoil at Enron, the accountants there thought the idea of shredding records was crazy. They held on to everything. The fax from Bank of America arrived that same day. Lay’s decision in September to use his ten-million-dollar bonus to pay down debt had held off margin calls for a while. Now, with Enron’s share price collapsing, the banks were nipping at his heels again, demanding cash. In the fax, the bank said he had two days to meet the demands or it would take action. Lay and his advisers decided to pay back the Enron loan he had been carrying with company stock, then borrow from the line again, and use the cash to meet the margin call. Ray Bowen headed up to Whalley’s office to discuss the warning about Fastow he had given his boss in a voice mail the previous week. Whalley got right to the point. “Do you have specific facts that Andy did something wrong?”

“This is the troubling part,” Astin said. “As a practical matter, LJM has its investment back.” Still, that wasn’t something Enron wanted Vinson & Elkins to worry about. The firm was told not to bother retaining another accounting firm. There was no need to second-guess everybody on this. Just a fact-finding mission. The day after his meeting with Sherron Watkins, Ken Lay was hit with another margin call from his lenders. Enron’s stock price had fallen again with the announcement of Skilling’s departure, and the banks wanted more money. Beau Herrold took care of it. He borrowed from Enron for the cash, and then repaid it with company stock, just as they had arranged. Every penny went to pay down debt. Fastow was in a rage. Word had finally gotten around to him that, in response to this letter to Lay challenging the Raptors, the company was bringing in lawyers to dig into his work.

“And we will look back a couple of years from now and see the great opportunity that we have.” Employees should spread the good word, he said. The company was sound, its balance sheet strong, its liquidity never better. When asked why more senior executives weren’t buying stock, Lay assured the questioner that plenty were, including himself. He mentioned nothing of his tens of millions of dollars in stock sales to the company to help meet his margin calls. Lay’s soothing words were exactly what the troops needed to hear. Everything would be fine. September 28, 2001, the day that would forever change Nancy Temple’s life, began normally enough for her. Temple was a young lawyer in Arthur Andersen’s Chicago office, having joined the previous year from the law firm Sidley & Austin. This morning her supervisor, Donald Dreyfus, came by to talk about a new assignment.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

"Robert Solow", Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Blythe Masters, Bretton Woods, British Empire, business cycle, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, different worldview, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Kickstarter, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

Given the near impossibility of predicting the future, investing based on the calculation of cash flows and other economic fundamentals “is so difficult to-day as to be scarcely practicable.” Furthermore, many professional investors operate on borrowed money. When the market takes a tumble, as it invariably does from time to time, investors who hold on to their positions in the belief that they are fundamentally sound face the prospect of margin calls from their lenders. If they can’t raise the cash to meet these demands, their positions are liquidated. Finally, and perhaps most important, there is peer pressure. The genuine long-term investor who eschews fads and tries to seek out real value will run into criticism from his colleagues and bosses, Keynes said: “For it is the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion.

To be sure, if you have a long enough time horizon, this won’t necessarily be a problem. You could maintain your short position until Amazon’s price finally tumbles, which it did in 2000. Patient hedge fund managers, or even mutual fund managers, are a rarity. Most of them get judged every three months. If they have a bad quarter, they can face a slew of investor redemptions. Moreover, most hedge funds operate on leverage, which makes them subject to margin calls if their trades go wrong. As Keynes pointed out, the difficulty of financing a losing position is a significant disincentive to speculating on the basis of fundamentals. Shleifer elucidated this point: “This risk comes from the unpredictability of the future resale price or, put differently, from the possibility that the mispricing gets worse before it disappears,” he wrote. “[E]ven an arbitrage that looks nearly perfect from the outside is in reality quite risky and therefore likely to be limited.”

With trading in many mortgage securities halted, banks, investment banks, hedge funds, mutual funds, university endowments, pension funds, and other financial institutions were holding countless pieces of paper that previously had been immensely valuable but that were now of indeterminate worth. There simply weren’t any buyers. This shock to the system caused all sorts of problems. Some highly leveraged investors faced demands for more collateral and were forced to reduce their positions. Margin calls and forced selling is the classic recipe for a market blow-up, but this wasn’t a 1987-style crash. Instead of spiraling down, the mortgage securities market had simply frozen up. Banks and other lenders had no way to estimate how exposed to it other financial institutions might be. Rather than extending credit to a rival firm that could turn out to be insolvent, they had opted to hoard their capital, forcing the European Central Bank and the Fed to step in as the lenders of last resort.


pages: 432 words: 127,985

The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry by William K. Black

accounting loophole / creative accounting, affirmative action, Andrei Shleifer, business climate, cognitive dissonance, corporate governance, corporate raider, Donald Trump, fear of failure, financial deregulation, friendly fire, George Akerlof, hiring and firing, margin call, market bubble, money market fund, moral hazard, offshore financial centre, Ponzi scheme, race to the bottom, Ronald Reagan, short selling, The Market for Lemons, transaction costs

REPO loans are collateralized by high-quality fixed-rate bonds. When interest rates increase, those bonds lose value and the REPO contract imposes a “margin call” that requires the borrower to immediately post enough new high-quality bonds to protect the lender against any loss. This means that American Savings faced a double whammy: the increase in interest rates both reduced the value of its huge bond portfolio by over $2 billion and produced repetitive margin calls that created a severe liquidity problem. This same dynamic later caused Orange County’s bankruptcy. Wall and his top advisors met one weekend that fall. American Savings would collapse on Monday when it could not meet its margin calls. That was inevitable. Wall’s staff was in emergency meetings with the Federal Reserve to try to get large amounts of cash in order to fend off any runs that might be triggered by closing the nation’s largest S&L in a liquidity-and-solvency crisis.

The FHLBSF was suddenly (and temporarily) back in Wall’s good graces. I was leading an emergency effort to prepare the legal and factual grounds for a takeover. Wall faced imminent disgrace. Then Monday came—“Black Monday,” October 19, 1987. The largest stock market loss in American history occurred that day. Frightened investors sold stocks and bought bonds, which caused interest rates to fall. American Savings did not have to meet any margin calls, and over half the losses on its interest-rate-risk gamble were made good. Black Monday brought gloom worldwide, except in a tiny pocket at the Bank Board’s headquarters, which found renewed faith in God. It was the miracle on 1700 G Street. Proposed as a movie plot, the story would be rejected as too contrived.7 WRIGHT ATTEMPTS TO GET WALL TO FIRE ME After the February 10, 1987, meeting, and after my criticisms of the Speaker began appearing in the press, he added me to his “to fire” list.


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

When the market is in backwardation, producers will be less inclined to hedge their anticipated forward output, because they would be locking in a price below the current price. Even more critical, if cash price levels remain unchanged or go higher, forward short hedge positions will generate large margin calls as their prices rise to meet the cash level with the approach of the contract expiration date. The combination of reduced hedge selling and especially producer short covering, as it becomes too expensive to meet margin calls, can cause a price advance to become near vertical. In this sense, besides merely acting as a barometer of supply tightness, widening spreads between nearby and forward prices can exert a direct bullish market impact. Figure 2.4 shows the price spread between three-month forward and 27-month forward copper.

Treasury bills types of Hedge funds investment about advantages of hidden risk managed futures perception vs. reality rationale for single fund risk Hedge selling Hedgers Hedging Hidden risk Hidden risk evaluation qualitative assessment quantitative measures High-water mark Housing bubble (mid-2000s) Hseigh, David Hulbert Financial Digest Human emotions Idiosyncratic risk Illiquid portfolio Illiquid trades Illiquidity risk Incentive fees Index funds Indicators contrarian credit quality of differentiation of diversification of future performance futures market as interest rates merger arbitrage past as past returns return levels risk volatility Inflation Information availability efficient use of Initial public offerings (IPO) Insider trading Institutional investors Interest rates Internet bubble In-the-money options Inverse correlated fund Inverse relationship Investment analysis Investment decisions Investment durations Investment insights correlation diversification hedge fund of funds hedge funds leverage managed accounts past performance portfolio allocations portfolio considerations portfolio rebalancing pro-forma statistics track records volatility Investment principle Investment size, maximum Investment strategies Investment timing Investor behavior Investor fees Investor requirements IPO price Irrational behavior Irrational choices Jones, Alfred Winslow Junk bonds Kahneman, Daniel Knowledge use Kudlow, Larry Lack, Simon Lagged shifts in supply Leverage about danger from investor performance and and risk Leverage risk Leveraged EFTs Leveraged/rebalanced funds Liar loans Life, Liberty and Property (Jones) Limit orders Linear relationships Liquidation selling Liquidations Liquidity of futures Liquidity crunch Liquidity risk Lockups London interbank offered rate (LIBOR) London Metal Exchange Long bias position Long only hedge funds Long-Term Capital Management (LTCM) Long-term investment Look-back period Loomis, Carol J. Lowenstein, Roger Luck Mad Money Madoff scandal Managed accounts advantages of vs. funds in hedge funds individual vs. indirect management objections to Managed futures Management fees Manager performance Managers hedge funds vs. CTA risk taking vs. skill MAR. See Minimum acceptable return (MAR) ratio Marcus, Michael Margin Margin calls Marginal production loss Market bubbles Market direction Market neutral fund Market overvaluation Market panics Market price delays and inventory model of Market price response Market pricing theory Market psychology Market risk Market sector convertible arbitrage hedge funds and CTA funds hidden risk long-only funds market dependency past and future correlation performance impact by strategy Market timing skill Market-based risk Maximum drawdown (MDD) Mean reversion Mean-reversion strategy Merger arbitrage funds Mergers, cyclical tendency Metrics Minimum acceptable return (MAR) ratio and Calmar ratio Mispricing Mocking Monetary policy Mortgage standards Mortgage-backed securities (MBSs) Mortgages Multifund portfolio, diversified Mutual fund managers, vs. hedge fund managers Mutual funds National Futures Association (NFA) Negative returns Negative Sharpe ratio, and volatility Net asset valuation (NAV) Net exposure New York Stock Exchange (NYSE) Newsletter recommendation NINJA loans Normal distribution Normally distributed returns Notional funding October 1987 market crash Offsetting positions Option ARM Option delta Option premium Option price, underlying market price Option timing Optionality Out-of-the-money options Outperformance Pairs trading Palm Palm IPO Palm/3 Com Past high-return strategies Past performance back-adjusted return measures evaluation of going forward with incomplete information visual performance evaluation Past returns about and causes of future performance hedge funds high and low return periods implications of investment insights market sector past highest return strategy relevance of sector selection select funds and sources of Past track records Performance-based fees Portfolio construction principles Portfolio fund risk Portfolio insurance Portfolio optimization past returns volatility as risk measure Portfolio optimization software Portfolio rebalancing about clarification effect of reason for test for Portfolio risks Portfolio volatility Price aberrations Price adjustment timing Price bubble Price change distribution The price in not always right dot-com mania Pets.com subprime investment Pricing models Prime broker Producer short covering Professional management Profit incentives Pro-forma statistics Pro-forma vs. actual results Program sales Prospect theory Puts Quantitative measures beta correlation monthly average return Ramp-up period underperformance Random selection Random trading Random walk process Randomness risk Rare events Rating agencies Rational behavior Redemption frequency notice penalties Redemption liquidity Relative velocity Renaissance Medallion fund Return periods, high and low long term investment S&P performance Return retracement ratio (RRR) Return/risk performance Return/risk ratios vs. return Returns comparison measures relative vs. absolute objective Reverse merger arbitrage Risk assessment of for best strategy and leverage measurement vs. failure to measure measures of perception of vs. volatility Risk assessment Risk aversion Risk evaluation Risk management Risk management discipline Risk measurement vs. no risk measurement Risk mismeasurement asset risk vs. failure to measure hidden risk hidden risk evaluation investment insights problem source value at risk (VaR) volatility as risk measure volatility vs. risk Risk reduction Risk types Risk-adjusted allocation Risk-adjusted return Risk/return metrics Risk/return ratios Rolling window return charts Rubin, Paul Rubinstein, Mark Rukeyser, Louis S&P 500, vs. financial newsletters S&P 500 index S&P returns study of Sasseville, Caroline Schwager Analytics Module SDR Sharpe ratio Sector approach Sector funds Sector past performance Securities and Exchange Commission (SEC) Select funds, past returns and Selection bias Semistrong efficiency Shakespearian monkey argument Sharpe ratio back-adjusted return measures vs.


pages: 279 words: 87,875

Underwater: How Our American Dream of Homeownership Became a Nightmare by Ryan Dezember

activist fund / activist shareholder / activist investor, Airbnb, business cycle, call centre, Cesare Marchetti: Marchetti’s constant, cloud computing, collateralized debt obligation, coronavirus, corporate raider, COVID-19, Credit Default Swap, credit default swaps / collateralized debt obligations, Donald Trump, Home mortgage interest deduction, housing crisis, interest rate swap, margin call, McMansion, mortgage debt, mortgage tax deduction, negative equity, rent control, rolodex, sharing economy, sovereign wealth fund, transaction costs

Selling assets to repay the banks meant dumping these complex mortgage-backed securities into the market and pushing prices even lower. Representatives from the troubled funds’ lenders were given an eleven-page handout when they arrived for the meeting with Bear Stearns executives. The handout detailed the funds’ troubles and listed the margin calls it faced from lenders. Bear wasn’t going to bail out the funds. Instead, the investment bank asked creditors to impose a sixty-day moratorium on margin calls while the situation was straightened out. Attendees were stunned. They wanted their money back before there wasn’t any left. A risk management executive from JPMorgan Chase & Co. raised his hand. “With all due respect,” he told the men from Bear, “I think you’re underestimating the severity of the situation.” A few days later, Bear had a change of heart and said it would bail out the older of its ailing funds with a $3.2 billion loan to stop the bleeding.

Icahn, Carl income, wealth ratios to Industrial Revolution insurance costs interest-only mortgages Interstate Land Sales Full Disclosure Act inventory control investments first-lien mortgages and foreclosures and home density for in homeownership private-equity properties for in real estate second-lien mortgage bonds in in toll roads Invitation Homes Island Tower It’s a Wonderful Life (film) Jacobs, Geoff James, Fob James, Tim condo deposits taken by Foley Beach toll bridge and sentencing speech of Joe Raley Builders JPMorgan Chase & Co Kavana, Jordan Kay, Martin Kennon, Tony Kinloch Partners KKR (corporate buyout firm) Kleros Real Estate CDO III Kuhn, Moritz land purchase landlords Leatherbury, Greg Lehman Brothers Holdings Levin’s Bend Levitt, William Lewis, Michael Lighthouse condominiums loans Alt-A home NINA piggyback refinance lower-income households Macquarie Group Mandalay Beach Marchetti Constant margin calls Martinez, Ruben Marx, Karl material costs Mattei, Jim McAleer, Mac McCarron, Joe McLaughlin, Jeff McLaughlin, Shannon McNeilage, Bruce houses sold by Mr. Bruce Needs His Money made by neighbors as leads to promotional borrowing rates to rental properties of tenants of mega-developments Merrill Lynch middle-class Million Dollar Club Mobile Bay Mobile Register money borrowing easy The Money Game (Goodman) Moon, Jeff Moore, Roy Morgan Stanley Mortgage Forgiveness Debt Relief Act (2007) mortgage-backed securities mortgage-interest tax deduction mortgages.


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

On August 17, 1998, the Russian government, under the teetering leadership of Boris Yeltsin, declared a debt moratorium and defaulted on its GKO bonds, the Russian equivalent of Treasury bills. This default caused a global “flight to quality”—investors dumped risky investments by the billions in favor of safety and liquidity, which widened credit spreads in markets around the world. Unfortunately, it was precisely those widening spreads that LTCM’s analysts had predicted would narrow. September 1998 saw an escalating cycle of margin calls at LTCM. Its ability to secure financing dried up, while its large size now proved an obstacle to get out of its positions. By September 21, 1998, LTCM had virtually no capital left to meet its obligations.29 Unlike smaller collapses at smaller funds, the unwinding of LTCM’s gargantuan portfolio threatened the safety of the global fi nancial system. These very highly leveraged positions made LTCM’s role in the financial system analogous to a “keystone species” in a biological ecosystem, a species whose interactions with other species in the ecology make it disproportionately more important than its physical size or number of individuals might suggest.

The large losses in our simulated portfolio from Tuesday, August 7, through Thursday, August 9, implied that at least one large statarb portfolio was liquidated quickly during this time. It must have been large to have registered such a big impact on our simulated portfolio, and it must have been liquidated quickly given that the losses lasted only through Thursday. This was most likely a forced liquidation, made under great duress, perhaps by a large commercial bank that needed to raise cash quickly in response to margin calls on its losing mortgage- and credit-related positions (recall that the summer of 2007 was when subprime mortgages and mortgagerelated securities began their downward spiral). The reason for this guess is that even after the significant loss on Tuesday, our simulated strategy continued to lose even more on Wednesday. Only desperation would motivate a statarb manager to continue unwinding in the face of mounting losses.

Second, few commercial banks were involved in statarb in 1998, but because of the relatively low-risk/high-return performance of Shaw, Renaissance, and other statarb managers, and the growing need for higher yielding assets in the declining-yield environment of the early 2000s, these banks started to take an interest. By 2007, all of the major banks were running statarb portfolios of their own, which meant that sufficiently severe losses to their subprime mortgage holdings could force them to liquidate their statarb portfolios to raise cash for margin calls. This link between fixed-income credit markets and statarb strategies didn’t exist in 1998, as our simulations showed, but clearly existed in 2007. Finally, an additional channel linking the mortgage crisis and statarb was the growing popularity of funds of hedge funds (funds that invest in a broadly diversified portfolio of other hedge funds) and multistrategy funds (funds that employ many different types of strategies).


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 1998, they placed an enormous bet—we’re talking about leveraging up 70-to-1—on the turbulent Russian financial market. Yet something unexplained happened along the way to the forum. In August of 1998, the Russian government decided that it could not meet its debt obligations and started to devalue the Russian ruble. As Russian bond prices cratered, traders around the world began to scramble and sold the bonds and other securities to create liquidity and to meet margin calls. Despite the mathematical purity of their assumptions and their analysis, the überconfident LTCMers were caught off guard. They were in an untenable position. When the Russian government defaulted in 1998, LTCM blew up, losing millions and millions of dollars a day. As Warren Buffett says, “You only find out who is swimming naked when the tide goes out.” Fearful that LTCM’s collapse would signal a more widespread hedge fund fire, the Federal Reserve board intervened and orchestrated a $3.65-billion bailout—with the help of 14 other financial institutions.

This overly simplistic description also neglects to account for external market forces that may dampen the short seller’s quest for alpha. What often happens is that others discover what a manager is shorting, and they start buying the stock aggressively in an effort to make the price go up. Effectively, they “squeeze” the manager out of the position. If he is not able to meet his collateral margin call, he will be forced out by his prime broker and suffer a big loss. (Remember, as the price of the stock goes up the manager has to post higher collateral at the prime broker so this will increase buying pressure on the manager if momentum takes over.) Let’s face it, no one grows up (or mostly no one) learning the game from the short side. So, the best way to think about it is in a few different parts. 1.


pages: 381 words: 101,559

Currency Wars: The Making of the Next Gobal Crisis by James Rickards

Asian financial crisis, bank run, Benoit Mandelbrot, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, borderless world, Bretton Woods, BRICs, British Empire, business climate, buy and hold, capital controls, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Fall of the Berlin Wall, family office, financial innovation, floating exchange rates, full employment, game design, German hyperinflation, Gini coefficient, global rebalancing, global reserve currency, high net worth, income inequality, interest rate derivative, John Meriwether, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, Network effects, New Journalism, Nixon shock, offshore financial centre, oil shock, one-China policy, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, private sector deleveraging, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, Ronald Reagan, sovereign wealth fund, special drawing rights, special economic zone, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, time value of money, too big to fail, value at risk, War on Poverty, Washington Consensus, zero-sum game

They trade and invest within networks of exchanges, brokers, automated execution systems and information flows. Interdependence is also characteristic of markets. When the subprime mortgage crisis struck in early August 2007, stocks in Tokyo fell sharply. Some Japanese analysts were initially baffled about why a U.S. mortgage crisis should impact Japanese stocks. The reason was that Japanese stocks were liquid and could be sold to raise cash for margin calls on the U.S. mortgage positions. This kind of financial contagion is interdependence with a vengeance. Finally, traders and investors are nothing if not adaptive. They observe trading flows and group reactions; learn on a continuous basis through information services, television, market prices, chat rooms, social media and face-to-face; and respond accordingly. Capital and currency markets exhibit other indicia of complex systems.

The dollar quickly moves outside its previous trading range and begins to hit new lows relative to the leading indices. Traders with preassigned stop-loss limits are forced to sell as those limits are hit, and this stop-loss trading just adds to the general momentum forcing the dollar down. As losses accumulate, hedge funds caught on the wrong side of the market begin to sell U.S. stocks to raise cash to cover margin calls. Gold, silver, platinum and oil all begin to surge upward. Brazilian, Australian and Chinese stocks start to look like safe havens. As bank and hedge fund traders perceive that a generalized dollar collapse has begun, another thought occurs to them. If an underlying security is priced in dollars and the dollar is collapsing, then the value of that security is collapsing too. At this point, stress in the foreign exchange markets immediately transfers to the dollar-based stock, bond and derivatives markets in the same way that an earthquake morphs into a tsunami.

One by one officials close the Asian and European stock exchanges to give markets a chance to cool down and to give investors time to reconsider valuations. But the effect is the opposite of the one intended. Investors conclude that exchanges may never reopen and that their stock holdings have effectively been converted into illiquid private equity. Certain banks close their doors and some large hedge funds suspend redemptions. Many accounts cannot meet margin calls and are closed out by their brokers, but this merely shifts the bad assets to the brokers’ accounts and some now face their own insolvencies. As the panic courses through Europe for the second day, all eyes slowly turn to the White House. A dollar collapse is tantamount to a loss of faith in the United States itself. The Fed and the Treasury have been overwhelmed and now only the president of the United States can restore confidence.


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

In this case, illiquid markets allow unexpected price movements on small volume to force large numbers of investors to behave irrationally as they liquidate assets (defining rational as an investor who tries to maximize wealth). Price movements can trigger a large number of actions that can exacerbate market crashes or other panics. These actions may be mandated by regulators or firm management giving traders no ability to override these actions. Some of the items that can create risk when combined with mark to market accounting are: ■ ■ ■ ■ Margin Calls. Margin is a good faith deposit. Large price movements can force market participants to margin calls. This can trigger panic selling to raise the necessary cash. Risk Limits. Traders often have risk limits that constrain the size of their portfolios. If these limits are exceeded, trading firms may have a policy of forced liquidations. Hedging Requirements. Many trading strategies, particularly options portfolios, might require the trader to keep a balanced book at all times.

The trade would also not be considered a forced or distressed sale since the firm voluntarily decided to make the trade. As a result, because of mark‐to‐market accounting, the final price of the day will be used for everyone in the market. Even investors who were not transacting on that day will be required to use the mark‐to‐market price to value their books. This can have a cascading effect on the market. For example, a large loss in value of an asset might trigger a margin call for other traders holding that asset. Needing to raise money, those traders would then be required to sell assets or reduce their positions. As more assets start being sold to cover losses, the sell‐off could cross several markets and snowball into a market crash. MARKET PRICE Two of the most important risks facing investors, market risk and credit risk, depend on being able to price securities.


pages: 571 words: 105,054

Advances in Financial Machine Learning by Marcos Lopez de Prado

algorithmic trading, Amazon Web Services, asset allocation, backtesting, bioinformatics, Brownian motion, business process, Claude Shannon: information theory, cloud computing, complexity theory, correlation coefficient, correlation does not imply causation, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, G4S, implied volatility, information asymmetry, latency arbitrage, margin call, market fragmentation, market microstructure, martingale, NP-complete, P = NP, p-value, paper trading, pattern recognition, performance metric, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, Silicon Valley, smart cities, smart meter, statistical arbitrage, statistical model, stochastic process, survivorship bias, transaction costs, traveling salesman

First, label per a varying threshold , estimated using a rolling exponentially weighted standard deviation of returns. Second, use volume or dollar bars, as their volatilities are much closer to constant (homoscedasticity). But even these two improvements miss a key flaw of the fixed-time horizon method: the path followed by prices. Every investment strategy has stop-loss limits, whether they are self-imposed by the portfolio manager, enforced by the risk department, or triggered by a margin call. It is simply unrealistic to build a strategy that profits from positions that would have been stopped-out by the exchange. That virtually no publication accounts for that when labeling observations tells you something about the current state of the investment literature. 3.3 Computing Dynamic Thresholds As argued in the previous section, in practice we want to set profit taking and stop-loss limits that are a function of the risks involved in a bet.

These are just a few basic errors that most papers published in journals make routinely. Other common errors include computing performance using a non-standard method (Chapter 14); ignoring hidden risks; focusing only on returns while ignoring other metrics; confusing correlation with causation; selecting an unrepresentative time period; failing to expect the unexpected; ignoring the existence of stop-out limits or margin calls; ignoring funding costs; and forgetting practical aspects (Sarfati [2015]). There are many more, but really, there is no point in listing them, because of the title of the next section. 11.3 Even If Your Backtest Is Flawless, It Is Probably Wrong Congratulations! Your backtest is flawless in the sense that everyone can reproduce your results, and your assumptions are so conservative that not even your boss could object to them.

CHAPTER 15 Understanding Strategy Risk 15.1 Motivation As we saw in Chapters 3 and 13, investment strategies are often implemented in terms of positions held until one of two conditions are met: (1) a condition to exit the position with profits (profit-taking), or (2) a condition to exit the position with losses (stop-loss). Even when a strategy does not explicitly declare a stop-loss, there is always an implicit stop-loss limit, at which the investor can no longer finance her position (margin call) or bear the pain caused by an increasing unrealized loss. Because most strategies have (implicitly or explicitly) these two exit conditions, it makes sense to model the distribution of outcomes through a binomial process. This in turn will help us understand what combinations of betting frequency, odds, and payouts are uneconomic. The goal of this chapter is to help you evaluate when a strategy is vulnerable to small changes in any of these variables. 15.2 Symmetric Payouts Consider a strategy that produces n IID bets per year, where the outcome Xi of a bet i ∈ [1, n] is a profit π > 0 with probability P[Xi = π] = p, and a loss − π with probability P[Xi = −π] = 1 − p.


Britannia Unchained: Global Lessons for Growth and Prosperity by Kwasi Kwarteng, Priti Patel, Dominic Raab, Chris Skidmore, Elizabeth Truss

Airbnb, banking crisis, Carmen Reinhart, central bank independence, clockwatching, creative destruction, Credit Default Swap, demographic dividend, Edward Glaeser, eurozone crisis, fear of failure, glass ceiling, informal economy, James Dyson, Kenneth Rogoff, knowledge economy, long peace, margin call, Mark Zuckerberg, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, Neil Kinnock, new economy, North Sea oil, oil shock, open economy, paypal mafia, pension reform, price stability, profit motive, Ronald Reagan, Sand Hill Road, Silicon Valley, Stanford marshmallow experiment, Steve Jobs, Walter Mischel, wealth creators, Winter of Discontent, working-age population, Yom Kippur War

Discounting all other factors, a top male student from an ethnic minority is more likely to read engineering or maths than an equally high achiever who happens to be white.50 At the top it remains acceptable not to understand science. The spirit of Yes Minister, where everyone in the room can discuss the Greek Aorist but are clueless about chemistry, is still strong in British boardrooms. In the recent financial crisis, problems were caused by owners not understanding managers and managers not understanding the rocket scientists working for them. The film Margin Call portrays the chaos in an investment bank where a mistake in an equation threatens to wipe out the firm’s market capitalisation. When the analysts try to bring the impending disaster to the attention of the banks CEO, his response is one of incomprehension. ‘Speak to me in plain English or as you would to a young child or golden retriever. It wasn’t brains that got me here’, he tells his subordinates.

(1967) 9 favelas (Brazilian shantytowns) 101–4 drug lords 102–3 entrepreneurial spirit 103–4 feed-in tariffs 85 Ferguson, Niall 21, 66, 91 First Care Products 79 fiscal rules 25, 27, 29, 30, 31, 33 see also Golden Rule Flaherty, Jim 35 Flikr 95 Frankel, Jeffrey 29 fuel prices 62 Furedi, Frank 87 139 geek culture 48–51 General Motors 92 Germany birth rate 107 economic growth 8 educational reform 41 high-tech industry 52 and PISA results 40–1, 57 welfare reform 4 Giffords, Gabrielle 78, 79–80 Gladwell, Malcolm 86 Global Competitiveness Report 2011/12 88 global financial crisis (2007–08) 2–3, 4, 9–10, 31–2 responses to 13–14 globalisation 4, 54 Golden Rule 28, 29 Google 60, 81, 93 Gou, Terry 105 Gove, Michael 38 Greece 3 Griffin, John 62 Haddock, Richard 64 Harford, Tim 92 Hari, Johann 19 Harper, Stephen 35, 36 Harvard University Harvard Institute of Economic Research 68, 69 and New Keynesianism 25, 26 Hasan, Medhi 19 Hawke, Bob 32 Heath, Edward 8, 9, 114 Henderson, Sir Nicholas 7, 8 Heritage Foundation 36 Hernández, Daniel, Jr 78 Hewlett Packard 81, 93 Higher Education Policy Institute 57 Hinduja brothers 72–3 Hodge, Margaret 43 Hoffman, Reid 97 Hong Kong 5, 36, 66, 113 Howard, John 33 Human Rights Act 74 140 Britannia Unchained Hutton, Will 26 hyperinflation 21, 83, 104, 105 IBM 81 ICQ (instant messaging programme) 81 Imperial College 58 India 4–5, 100, 113, 115 attitudes to science and technology 44, 46, 49–51 Institutes of Technology 51, 53 work ethic 57, 72–3 innovation 5, 93–4, 97, 98–9, 105, 114 and informal economy 88–9 and necessity 86, 91 patent applications 81, 82, 95–7 and risk 91–2 see also entrepreneurship; Israeli entrepreneurial culture; venture capital instant messaging 81 Intel 68, 81 intellectual capital 52, 53, 112 intellectual property law 55, 89 International Indicators of Educational Systems (INES) project (OECD) 39 International Monetary Fund (IMF) 34, 114 internet 55, 81, 88, 99, 108–9 Intuit 92 Iraq War (2003) 10 Isagba, Beau 1 Isenberg, Daniel 83, 94, 95–6 ‘Israeli bandage’ 78–80 Israeli entrepreneurial culture 78–86 government support for 83–6 and Jewish immigrants from Soviet Union 86 technology sector 80–1, 86 and venture capital 5, 80, 84–5, 94 Italy 3, 52 Ive, Jonathan 91 Jackson, Tim 10 Jain, Nitin 50 Japan aging population 106–7 education 40, 43, 55 work ethic 106 Jebel Ali Free Zone (Dubai) 88 Jefferson, Thomas 90 Jobs, Steve 89 Jobseeker’s Allowance 74 John-Baptiste, Ashley 45–6 Johnson, Samuel 98 Jones, Peter 97 Katz, Lawrence 25 Katzir , Ephraim 83 Keating, Paul 32 Keegan, William 26, 28 Kennedy, John F. 23–4 Keynes, John Maynard 20 Keynesian economics 14–15, 20, 24, 28 Kinnock, Neil 28 Kissinger, Henry 9 Krugman, Paul 19 Kumar, Manmohan S. 22 Laski, Harold 14 Last.fm 55, 98 Le Dang Doanh 89 Leavis, F.R. 46 Lehman Brothers 92 leverage 35 Li, David 47–8 Liberal Party (Canada) 16–18, 35 The Limits to Growth 9 LinkedIn 95, 97, 98 London tube-drivers 63 Lopes, Antonio Francisco Bonfim (‘Nem’) 103 Loughner, Jared Lee 78 Lula da Silva, Luiz Inácio 100–1 M-Systems Ltd 81 Macaulay, Thomas 19, 21 Macmillan, Harold 114 Major, John 28 Malaysia, women and tech careers 50 Index Mandelson, Peter 94, 115 Manpower Talent Shortage Survey 73 Margin Call (film) 47 Marland, Jonathan, Baron 85 Marshall, Alfred 52 marshmallow test 71–2 Martin, Paul 16–18, 35, 36 Massé, Marcel 18 Mayer, Marissa 48 meritocracy, in emerging economies 49 Merkel, Angela 46 Mexico debt default 22 education 44, 55 Peso Crisis (1994) 16 women and tech careers 50 Michau, Jean-Baptiste 70 Michel, Harald 107 Microsoft 68, 81 miners’ strike (1983–84) 114–15 Mirabilis 81 Mischel, Walter 71 Mittal, Lakshmi 73 mobile phones, dual-sim-card 89 Moo.com 55 Moody’s 47 Mossbourne Academy (Hackney) 59 Motorola 81 Mulroney, Brian 15–16, 36 NAFTA (North American Free Trade Agreement) 15 NASDAQ 80, 94 A Nation at Risk, report on US education system 39, 40 National Commission on Excellence in Education 38–9 National Employment Savings Trust Scheme (UK) 87 National Health Service (NHS) 28, 29, 31 Netanyahu, Binyamin 86 Neuwirth, Robert 89 New Keynesianism 25, 26 New Labour 24, 25 and growing deficit 29–33 141 inaccuracy of budget forecasts 29 investment in public services 12, 28–9 macroeconomic framework 27–30 tax increases 28–9 North Korea 36 North Sea oil 9, 37 Obama, Barack 100 ‘Occupy London’ protests 10 O’Donnell, Gus 27, 30 OECD, comparing school systems 31, 38–41 Ofsted 59, 71, 73 Old Age Pensions Act (1908) 69 Oliveira, Silvinha 103 Olympic Games in Brazil 101–2, 103 London tube drivers pay 63 Paypal 93, 95 Pedro II, Emperor of Brazil 104 pensions 3, 32, 63, 69–70, 110 pension age 69 Peston, Robert 28 PISA tests see Programme for International Student Assessment (PISA) ‘The Poles are Coming’ 63–4 poll tax riots (1990) 69, 115 The Population Bomb, (1968) 9 Postlethwaite, T.


pages: 1,202 words: 424,886

Stigum's Money Market, 4E by Marcia Stigum, Anthony Crescenzi

accounting loophole / creative accounting, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Black-Scholes formula, Brownian motion, business climate, buy and hold, capital controls, central bank independence, centralized clearinghouse, corporate governance, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, disintermediation, distributed generation, diversification, diversified portfolio, financial innovation, financial intermediation, fixed income, full employment, high net worth, implied volatility, income per capita, intangible asset, interest rate derivative, interest rate swap, large denomination, locking in a profit, London Interbank Offered Rate, margin call, market bubble, market clearing, market fundamentalism, money market fund, mortgage debt, Myron Scholes, offshore financial centre, paper trading, pension reform, Ponzi scheme, price mechanism, price stability, profit motive, Real Time Gross Settlement, reserve currency, risk tolerance, risk/return, seigniorage, shareholder value, short selling, technology bubble, the payments system, too big to fail, transaction costs, two-sided market, value at risk, volatility smile, yield curve, zero-coupon bond, zero-sum game

He could, for example, do a swap in which he would receive 1-year fixed and pay 3-month LIBOR. The forward IMM swap is a great speculative vehicle—an ideal trading instrument. There is no cost of carry on an IMM swap provided the trader 10 The risk in variation margin calls is not one that a trader should treat lightly. Often, a trader will do an arb using one or more positions in futures in which he reasons: “Rates are out of whack; A exceeds B; but, as time passes, A must come to equal B.” That this is true is no protection against A and B getting further out of whack in the short run and the trader having, consequently, to meet huge variation margin calls. Should this occur, the risk to the trader is that he will exhaust his funds before A and B move into line. A scenario of rates getting more, not less, out of whack over the short run has caused sleepless nights for—even emptied the pockets of—more than a few professional traders.

Repos, Reverses, and Safekeeping Several things were done by the Treasury and the SEC in their regulations to pare the risks associated with repos and reverses. In particular, both the Treasury and the SEC imposed complex capital charges on repos and reverses. One purpose of these requirements was to create incentives to encourage dealers doing repos and reverses to operate as follows: collateral is to be reasonably priced; the amount of money that changes hands is to be a reasonable percentage of the collateral’s market value; and, finally, margin calls are to be made if significant changes occur in that market value. Also, the new regulations required that a dealer, before doing repo with a customer, send to the customer a written agreement that includes a specifically worded disclosure regarding the dealer’s right to substitute collateral. A dealer must also send to a customer confirmations on all transactions, including repos and reverses.

First, a small commission must be paid on the futures trade. Second, if bill rates rise sharply over the holding period, variation margin in the form of investable dollars will be paid into the trader’s margin account, which—assuming he invests these dollars—will raise his return on the trade. Our trader’s 26-bp profit spread would conversely be threatened by a rally in bills, which would result in margin calls that he would have to meet in cash. How much of a threat do potential margin TABLE 15.5 Calculating the profit on a $10 million cash-and-carry trade if rates were those shown in Table 15.4 and the term repo rate were 8.25 calls pose to our trader? Relatively little. Even in the unlikely event that bills rallied by 100 bp on the day the trade settled (October 28, 1982), the extra margin he would have to put up over 56 days would, assuming a 8.25 financing rate, cost him only 2¼ bp of his profit spread.


pages: 354 words: 105,322

The Road to Ruin: The Global Elites' Secret Plan for the Next Financial Crisis by James Rickards

"Robert Solow", Affordable Care Act / Obamacare, Albert Einstein, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bayesian statistics, Ben Bernanke: helicopter money, Benoit Mandelbrot, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, bitcoin, Black Swan, blockchain, Bonfire of the Vanities, Bretton Woods, British Empire, business cycle, butterfly effect, buy and hold, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, cellular automata, cognitive bias, cognitive dissonance, complexity theory, Corn Laws, corporate governance, creative destruction, Credit Default Swap, cuban missile crisis, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, debt deflation, Deng Xiaoping, disintermediation, distributed ledger, diversification, diversified portfolio, Edward Lorenz: Chaos theory, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, fiat currency, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, Fractional reserve banking, G4S, George Akerlof, global reserve currency, high net worth, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Isaac Newton, jitney, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, large denomination, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, mutually assured destruction, Myron Scholes, Naomi Klein, nuclear winter, obamacare, offshore financial centre, Paul Samuelson, Peace of Westphalia, Pierre-Simon Laplace, plutocrats, Plutocrats, prediction markets, price anchoring, price stability, quantitative easing, RAND corporation, random walk, reserve currency, RFID, risk-adjusted returns, Ronald Reagan, Silicon Valley, sovereign wealth fund, special drawing rights, stocks for the long run, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transfer pricing, value at risk, Washington Consensus, Westphalian system

If LTCM was holding spread trades with embedded gains, those potential gains would only increase as spreads widened. Why throw a lifeline to a drowning man when you can wait for him to drown and collect the life insurance? Soros could afford to wait; desperate sellers only get more desperate. By August 31, losses at LTCM were $2 billion, 50 percent of our original capital. It seemed surreal that we were still standing, still meeting margin calls, and still operating every day. The reason was our contracts did not give counterparties a way out. LTCM consistently refused to sign termination clauses with subjective criteria such as “material adverse change.” We insisted on a numeric trigger of $500 million of remaining capital for an early termination of contract. At that level, counterparties could cancel trades and take collateral. This made sense in 1994 when capital was $1 billion; the $500 million trigger equaled a 50 percent decline.

The PWG consisted of the president of the United States, Federal Reserve chairman, treasury secretary, SEC chairman, and the chairman of the Commodity Futures Trading Commission. PWG’s purpose was to put banking, securities, and commodities regulators in one place to deal with crises. The 1987 crash involved complex interactions between the stock market, regulated by the SEC, and Chicago futures markets, regulated by the CFTC. The crisis then spread to the bank payments system because billion-dollar margin calls were required between the New York and Chicago markets. Banks were hesitant to initiate wire transfers to Chicago futures brokers for fear that they would not receive incoming wires from New York stockbrokers. The system started to freeze up. Noncoordination among securities, futures, and bank regulators made crisis resolution difficult. The PWG was intended to prevent those problems in the future.

Arbitrage can be applied to other categories of cheap and rich assets, although the less the similarity between the two, the greater the risk that perceived spreads do not converge as expected. To the extent two instruments in an arbitrage trade have low volatility and credit risk, the trade may be regarded as relatively risk-free and amplified with leverage to synthesize S&P volatility with a higher expected return. The flaw in this neat theory of risk-free arbitrage is that in a panic, price spreads can widen before they converge. A leveraged player will be bled dry with margin calls on mark-to-market losses before reaching the promised land of convergence. Success at arbitrage also derives from market timing. In fact, all alpha results from market timing, and the only consistent source of successful market timing is inside information. This was demonstrated by the Nobelist Robert C. Merton in an obscure 1981 paper, “On Market Timing and Investment Performance. I. An Equilibrium Theory of Value for Market Forecasts.”


pages: 554 words: 168,114

Oil: Money, Politics, and Power in the 21st Century by Tom Bower

addicted to oil, Ayatollah Khomeini, banking crisis, bonus culture, corporate governance, credit crunch, energy security, Exxon Valdez, falling living standards, fear of failure, forensic accounting, index fund, interest rate swap, kremlinology, LNG terminal, Long Term Capital Management, margin call, Mikhail Gorbachev, millennium bug, MITM: man-in-the-middle, Nelson Mandela, new economy, North Sea oil, offshore financial centre, oil shale / tar sands, oil shock, passive investing, peak oil, Piper Alpha, price mechanism, price stability, Ronald Reagan, shareholder value, short selling, Silicon Valley, sovereign wealth fund, transaction costs, transfer pricing, zero-sum game, éminence grise

“No one will want the oil when the prices get too high.” Hall’s argument, carefully based on Hubbert and his disciples, won Rubin’s support. “No one paid any attention to the economist,” said Hall on his return to Connecticut. “I hate going to New York.” Hall had mastered the commodity and the market, read the literature, spoken to the right people, and was ready to stake about $1 billion in margin calls. He would buy oil two to five years in advance. Since the market was in backwardation, oil was cheaper in the future than on the instant “spot” market. Holding 90 percent of Phibro’s “book,” or positions, he wanted to bet against the world, particularly the banks, rather than the oil majors. Speculating about oil prices had been transformed by the major players. The growing popularity of “swaps” and over-the-counter (OTC) contracts, developed during the 1990s to reduce and spread the risk assumed by energy providers, merchants and traders, had become frustrated by the limitations of trading and pricing through reporters and the existing exchanges.

In effect, “swaps” were trades in price, not in oil itself, and were used by both speculators and traders to protect or hedge their positions, reducing or spreading the risk. The final price would be calculated against Nymex’s. In 1990, traders demanded that regulatory authorities acknowledge that the trade was legitimate and their agreements were enforceable. Responding to those demands for unhindered growth, the CFTC agreed in 1991 that complex derivatives could be bought and sold using borrowed money or on margin calls. Under pressure from the traders and bankers, in 1993 Wendy Gramm, the head of the CFTC, announced that the regulator would not exercise its authority over the “spot” trade or over swaps or “forwards” on the OTC market, the equivalent of Nymex’s “futures.” As the trade expanded, the OTC traders speculated on the price of oil, natural gas and electricity free of any controls, and simultaneously expressed dissatisfaction with Nymex.

Authorized by the Commodity Exchange Act, ICE’s traders were required to keep records, but were exempt from the CFTC’s supervision. To guarantee payment and cover any losses, traders deposited funds in a clearinghouse. Every day the clearinghouse collected the “margin” or losses on each contract from the exposed traders. If necessary, the “losing” trader was then required to deposit more money, or to increase the margin call to cover any future loss, protecting both parties from default. Haphazardly, the unregulated OTC market using ICE and the futures trade on Nymex converged, and, unseen, was exploited by Enron’s traders, harming the integrity of the whole market. The rising price of oil and the ease of investing in it through swaps and ICE attracted the managers of savings and hedge funds, who after 2000 became disenchanted with shares.


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 developed economies, subsistence level is not really linked to starvation or other causes of physical extinction, but to the (still painful) loss of the standard of living one is accustomed to. Despite this caveat, to me the insight that people or institutions become more risk averse when they become poorer captures something essential in investor behavior. In an institutional setting, breaching a subsistence level might have an analogue in the institution’s bankruptcy, a trader reaching his or her terminal stop-loss limit or the point of an unaffordable margin call, a pension fund’s minimum acceptable funding ratio, or a financial intermediary’s binding capital constraint. The presence of a broadly defined subsistence level makes investors’ relative risk aversion vary with their wealth level and prompts them to act like someone trading a portfolio insurance strategy. When people feel wealthy (have a high cushion over the subsistence level) they can afford to take large risks.

The agency relation means that end-customers are more likely to withdraw capital just when mispricing trades have moved maximally against the arbitrageur. End-customers assess an arbitrageur’s ability by studying performance track records; and widening mispricing normally implies deteriorating performance for the arbitrageur. To compound the arbitrageurs’ problems when they are facing losses, creditors may make margin calls if leverage is employed, stop-loss rules or risk managers can require position reductions, and vanishing liquidity may reinforce the downward spiral. All these considerations push arbitrageurs toward short time horizons and constrain their position sizes. There are also transaction costs and model uncertainty to consider. Trading costs on leveraged strategies can be significant. Barring remarkable hubris, no arbitrageur can be completely confident that his model or view is correct.

I review the four most prominent models:• DeLong et al. (1990) developed the first formal model that predicted both short-term momentum and long-term reversal. The model focused on the interaction of noise traders and arbitrageurs. The study simply posits that noise traders follow positive-feedback strategies (buying recent winners and selling recent losers), which could reflect extrapolative expectations, stop-loss orders, margin calls, portfolio insurance, or wealth-dependent risk aversion or sentiment. Arbitrage need not always be stabilizing; it may be rational for arbitrageurs to jump on the bandwagon and push prices further away from fundamental values. Positive-feedback trading clearly creates short-term momentum and price overreaction. The eventual return toward fundamental values creates long-term price reversal. Subsequent studies present more detailed behavioral motivations as to why investors follow positive-feedback strategies


pages: 435 words: 127,403

Panderer to Power by Frederick Sheehan

"Robert Solow", Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, British Empire, business cycle, buy and hold, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, inflation targeting, interest rate swap, inventory management, Isaac Newton, John Meriwether, margin call, market bubble, McMansion, Menlo Park, money market fund, mortgage debt, Myron Scholes, new economy, Norman Mailer, Northern Rock, oil shock, Paul Samuelson, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, rolodex, Ronald Reagan, Sand Hill Road, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, stocks for the long run, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War, zero-sum game

On January 31, 1994, before the Joint Economic Committee, he stated “Short-term interest rates are abnormally low in real terms”30 It was no secret that the borrow short and lend long strategy had refinanced the banking system. By early 1994, banks were liquid and lending. The Fed raised the funds rate from 3.0 percent to 3.25 percent on February 4. This was the first of several increases, the consequence of which was the most traumatic financial convulsion since the 1987 crash. Margin calls drove prices lower, prompting more margin calls and more selling. Longterm Treasury yields rose from 6.3 percent in January to 8.0 percent in December 1994. Greenspan may not have anticipated how derivatives had leveraged the financial system. Still, he could not have been completely surprised by the deleveraging. At the December 1993 FOMC meeting, Federal Reserve Governor Lawrence Lindsey warned: “[W]e all agree that the 3 percent [funds] rate is unsustainable.

., 189 Kosinski, Jerzy, 75, 119 Kraft, Joseph, 55, 56 Kravis, Henry, 317, 321, 357 Kroszner, Randall, 334 L LaWare, John, 136 LBOs (see Leveraged buyouts) Leasco, 35, 351 Le Figaro (France), 341 Lehman Brothers, 272, 274, 275, 301, 310, 315, 317, 321, 347n.48, 354 Leland, Hayne, 110 Leland O’Brien Rubinstein Associates (LOR), 110–112 Leuthold, Steve, 150 Leverage: in 2006, 313 in 2007, 303 in housing market, 272–273 and LTCM failure, 185–186 and recovery from 1990s recession, 124–126 Leveraged buyouts (LBOs, leveragedbuyout firms), (see also privateequity firms), 80, 116–117, 317–319 Levitt, Arthur, 223 Lewis, Ken, 333 “Liar’s loans,” 330 Lidsky, Betti, 295 Lidsky, Carlos, 295 Liman, Arthur, 90 Lincoln Savings and Loan Association (Irvine, California), 6–7, 85–93, 100, 165, 274 Lindley, David, 109 Lindner, Carl, 80, 87–90, Lindsey, Lawrence “Larry,” 128–129, 161–162, 166, 238–240, 251–257, 259, 266, 365 warns Greenspan about ’irrational exuberance’, 240 warns Greenspan about consumer debt and longterm social cost, 258 warns Greenspan about actions not matching words, 162 Ling, James Joseph, 35, 351 Ling-Temco-Vought, 35 Liquidity, 116–117, 302, 325, 331, 363 Lockhart, James, 270 LongTerm Capital Management (LTCM), 181–187, 190 Longterm investment, 350–351 LOR (Leland O’Brien Rubinstein Associates), 110–112 LTCM (see LongTerm Capital Management) Los Angeles, California, 36, 117, 291, 319, 320 Los Angeles Times: “L.A. Land blog,” 347 Lucent, 207 Luckman, Charles, 23 M Madrick, Jeff, 59–60 Maestro (Bob Woodward), 171, 236 Mahar, Maggie, 210 Mailer, Norman, 74 Maisel, Sherman, 40 Malle, Louis, 75 Major, John, 323 Mankiw, Greg, 147–148 Manufacturing: 1980s decline in, 78 from 1998 to 2003, 291 from 2000 to 2004, 307–308 in mid-century, 23 overseas plants for, 44 profits from, 2–3 Margin calls, 128 Margin requirements, 104, 105, 161, 175, 219–220, 223, 230 Maricopa, Arizona, 357 Markey, Ed, 223 Martin, Justin, 17, 195–196 Martin, Steve, 353 Martin, William McChesney, Jr., 4, 20–21, 23–24, 26, 27, 32 n.6, 33–34, 39–41, 44, 65, 66, 115, 126, 201, 287, 300, 305, 350, 351, 362 Mayer, Martin, 4, 21, 88, 90 McCabe, Thomas B., 20n.5 McCain, John, 85, 215 McCulley, Paul, 245 McDonough, William, 186, 187, 247 McNamara, Robert, 29, 75 McTeer, Robert, 206, 247 Meany, George, 43–44 Measuring Business Cycles (Arthur Burns), 12 Media, stock market and, 248–249 Meeker, Mary, 233, 244 Mercury Finance Corporation, 165 Meriwether, John, 183, 187 Merrill, Dina, 74 Merrill Lynch, 116, 131, 144, 232–233, 272, 332, 333, 347n.48, 358 Merton, Robert, 183, 187 Mexico, bailout of, 135–136 Meyer, Laurence, 138, 139 Miami, Florida, 89, 295 Michaelcheck, William, 125 Micron Technology, 207 Microsoft Corporation, 177, 207, 216 Middle class, 252–253, 355 Milken, Michael, 7, 80, 81, 86, 87, 89, 90, 117 Miller, G.


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

The new twist was that he had invested $5 billion buying oil futures in the month leading up to the election with the objective of souring the stock market, the economy, and general voter sentiment prior to the election. If he also believed oil was going higher, it was not inconceivable that he would take a gigantic position. Soros has never been reluctant to use his wealth to throw his weight around.The chatter was that with this sharp break he was getting margin calls and was liquidating his position. I didn’t believe the rumor. Soros is far too smart and dispassionate to mix business with politics.While recognizing that it takes courage to be a pig, we decided that, after all the travail we had suffered, it was the better part of valor to cover about a third of our short.We bought it in at a little over 42.The trade had been unsuccessful, but at least we had a measure of redemption.

He has a house in London and a coffee plantation in Kenya.This is an intriguing question:Why does Tim run money in this extremely stressful, highly concentrated, massively leveraged way? Why does he travel endlessly to places like Japan, Russia, and India, which are not exactly luxury locations? He has no partner with whom to share the anxiety, and his performance swings are so immense it must be nervewracking even for an impervious persona. From time to time, one hears wild stories that Tim is facing huge margin calls and is about to be carried out. Of course it is never true. The only answer I can come up with is that he loves high-octane investing, and I know that he thinks it’s the right way to manage money. He must like to travel. This quiet, austere, gentle man must thrill to the adrenaline rush of spectacular successes and be able to live with the big downs. As an investor in hedge funds, what would you rather have over five years?

Keynes’ wealth, accumulated over the 1920s, was hit hard by the Crash, but not because he owned U.S. stocks. By the late 1920s he had been speculating for a number of years quite successfully in commodities and had become a reasonably rich man. In early 1929, he was long rubber, corn, cotton, and tin when suddenly prices collapsed. His commodity losses forced him initially to sell stocks into a falling market to meet margin calls.Then commodities fell further, and he suffered grievous wounds. By the end of 1929 he had nothing left but some tag ends and a massive position in the Austin Motor Company, which had collapsed to 5s from 21s earlier in the year. His net worth had plunged 75% from its high and fell even more in 1930. Keynes fared much better with the hedge fund he then was running. Once again he was in partnership with Falk, but they had divided their investors’ capital in two, finding that doing so focused and sharpened their judgments.


pages: 421 words: 128,094

King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone by David Carey

activist fund / activist shareholder / activist investor, asset allocation, banking crisis, Bonfire of the Vanities, business cycle, carried interest, collateralized debt obligation, corporate governance, corporate raider, credit crunch, diversification, diversified portfolio, fixed income, Gordon Gekko, margin call, Menlo Park, mortgage debt, new economy, Northern Rock, risk tolerance, Rod Stewart played at Stephen Schwarzman birthday party, Sand Hill Road, sealed-bid auction, Silicon Valley, sovereign wealth fund, The Predators' Ball, éminence grise

Blackstone was now worth as much as Lehman Brothers, where Peterson and Schwarzman had launched their banking careers, and a third as much as Goldman Sachs. Blackstone had arrived. Eleven days later, on July 3, KKR filed to go public, but Kravis’s firm was too late. The very day that Blackstone units began trading, Bear Stearns announced that it would lend $3.2 billion to a hedge fund it managed that was facing margin calls as the value of its mortgage-backed securities tumbled, and the bank said it might have to bail out a second, larger hedge fund. It was an omen. By mid-July, the credit markets were in full retreat and it was hard to muster financing for big LBOs. The growing losses on mortgage securities were unnerving hedge funds and other investors, and buyout debt looked a little too similar, so banks could no longer raise money through CLOs to make buyout loans.

But soon the default rates were so high that they threatened even senior tranches that had top credit ratings and were supposed to be insulated from mortgage defaults. In the cascade of unforeseen consequences, the jump in defaults in turn threatened to bring down the bond insurers that had sold protection on the senior layers, figuring there was a one-in-a-million chance that the damage would ever penetrate that far. As each month went by, more mortgage companies failed, and several steps down the financial chain, more margin calls were issued to investors who had borrowed to buy mortgage-backed securities that were no longer worth enough to suffice as collateral for the loans. Eventually the elaborately engineered mortgage securities that Wall Street had invented came home to roost, inflicting losses at the source—the banks. There was the collapse of the two Bear Stearns hedge funds the week of Blackstone’s IPO in June.

The push by some firms like Apollo, KKR, and Carlyle to diversify away from LBOs into other asset classes by launching business development companies and publicly traded debt funds also proved calamitous. A $900 million mortgage debt fund that Carlyle raised on the Amsterdam exchange, shortly after KKR launched its $5 billion equity fund, was leveraged with more than $22 billion of debt and capsized in 2008 when its lenders issued margin calls and seized all its assets. It was a complete wipeout. KKR Financial, a leveraged mortgage and corporate debt vehicle in the United States, had to be propped up by KKR and barely survived. Its shares sank from more than $29 in late 2007 to less than 50 cents in early 2009. Apollo Investment Corporation, the business development company that Apollo created in 2004, beating Blackstone and others to the punch, took huge write-downs.


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

For example, a European investment banking holding a large quantity of Japanese yen and wanting euros, might ask several foreign exchange spot traders to sell the yen rather than putting it all through one trade. 6.3 LEVERAGE When a spot trader buys aluminium he pays in full on the settlement day as depicted in Table 6.1. Whatever happens to the price of aluminium, there is no additional payment 77 Liquidity, Price and Leverage TABLE 6.1 Leverage on various trades Trade type Buyer Seller Spot Future No leverage Leverage partially offset by margin call Leveraged No leverage on trade but leveraged counterparty risk No leverage on trade but leveraged counterparty risk No leverage Leverage partially offset by margin call Leveraged Leveraged Forward Option Insurance such as credit derivative Leveraged required to meet his obligations arising from the trade. We say that spot trades are not leveraged. When a bank sells a put option, it receives the premium and pays nothing. If the trade is exercised, it will have to pay the difference between the strike and spot price at exercise.

A common technique in handling many of the possible changes is to use a diary. The diary may consist of events, the trades and underlyings they relate to and the action to be taken. Each day the diary is opened and all events for that day are processed. Table 8.3 shows example actions common to both middle office and back office, but in reality there would be separate reports for each business function. When events occur every day (such as margin calls or the possibility of a credit event) they can be given their own process. When there is no predicted date such as for a trade amendment, a process will need to be undertaken on demand and cannot be diarised. 110 THE TRADE LIFECYCLE TABLE 8.3 Example diary entries for one day Trade(s) Event Underlying Action T110 T304, T30 T737,T373 T167 T35, T36, T37 T22 T772 Coupon payment date Averaging date Swap fixing Settlement date Ex-dividend date Maturity date Close to knock-out Bond: BRD2020 Nymex WTexas Oil LIBOR CHF Fix/Float GBP Segro PLC Expect receipt Fix Fix Settle Record Process expiry Check market EUR/JPY Risks Changes to a trade or its assets cause risks to the institution holding the trade.


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

Our giddy investor loses his entire equity and his broker issues a margin call: Pay off the loan—which is now more than $9 million—or be sold out. As stock prices rose in 1929, investors leveraged themselves in this way to buy more, driving prices higher. The positive feedback loop led to an average total return on large-company stocks of 193 percent from the end of 1925 to the end of August 1929. A purchase of $100 on no borrowing grew to $293, and our 10 percent down investor who pyramided might have doubled his money more than ten times, gaining more than a thousand times his original investment. However, as prices eased in September and October 1929, the equity of the most highly leveraged investors vanished. When they were unable to meet margin calls, their brokers sold their stock. These sales drove prices down, wiping out investors who hadn’t been quite as leveraged, triggering a new round of margin calls and sales, driving prices down further.

These sales drove prices down, wiping out investors who hadn’t been quite as leveraged, triggering a new round of margin calls and sales, driving prices down further. As the equity bubble burst, the greatest stock market decline in history began. Large-company stocks eventually dropped by 89 percent, to one-ninth of their earlier peak prices. As waves of leveraged investors were ruined, bank and brokerage firms, saddled with bad debts, were wiped out, in turn ruining other institutions to whom they owed money. As the contagion spread, economic activity declined sharply, US unemployment reached 25 percent, and a worldwide depression ensued. It was only in January 1945—after more than fifteen years and most of World War II—that, on a month-end basis, large-company stocks finished above their August 1929 all-time high.


pages: 77 words: 18,414

How to Kick Ass on Wall Street by Andy Kessler

Andy Kessler, Bernie Madoff, buttonwood tree, call centre, collateralized debt obligation, family office, fixed income, hiring and firing, invention of the wheel, invisible hand, London Whale, margin call, NetJets, Nick Leeson, pets.com, risk tolerance, Silicon Valley, sovereign wealth fund, time value of money, too big to fail, value at risk

This is, uh, discouraged these days. But it will happen. How do you become a good or even great trader? By sensing what those on the other side of the trade are thinking. Are they building a huge position so a stock is going to keep going up or just tweaking around the edges? Are they dumping a stock because they know something is wrong? Are they panic selling, puking out a position at all costs because of a margin call which means the stock is about to bottom. Traders are often facilitating a trade for clients. That’s their job. But even with the Volker Rule being implemented, firms trade for their own account. They call it something else, hedging global risk, but you can make money for the firm. Great way to generate good will and cash bonuses. But even the smartest traders get fooled. Maybe the smartest get fooled the most.


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 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. Cash must then be added to the margin account to reach the level of 50% of the amount needed to close the short, i.e., to buy one share of stock at the current price of the asset, or the short is closed by the broker on your behalf. 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.


pages: 274 words: 81,008

The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything by Jason Kelly

activist fund / activist shareholder / activist investor, barriers to entry, Berlin Wall, call centre, carried interest, collective bargaining, corporate governance, corporate raider, Credit Default Swap, diversification, Fall of the Berlin Wall, family office, fixed income, Goldman Sachs: Vampire Squid, Gordon Gekko, housing crisis, income inequality, late capitalism, margin call, Menlo Park, Occupy movement, place-making, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Rubik’s Cube, Sand Hill Road, shareholder value, side project, Silicon Valley, sovereign wealth fund

A lawsuit filed after the collapse said Carlyle marketed the fund as aiming for leverage of around 19 times, meaning Carlyle would borrow up to $19 for each dollar of equity. The lawsuit said the actual leverage was more than 30 times.8 In such situations, such a bet goes wrong if the price of the underlying assets fall so much that lenders can make margin calls, and that’s just what happened. Carlyle pressed the lenders, which included huge banks like Citigroup and Deutsche Bank, to refinance the debt. Those negotiations, which Carlyle described at the time as “exhaustive,” failed. And so did Carlyle Capital, which had to be liquidated to meet those margin calls. The Carlyle Capital collapse in March foretold a coming storm far beyond the firm, predicted ominously in coverage at the time. “Carlyle won’t be the end of it,” Greg Bundy, executive chairman of Sydney-based merger advisory firm InterFinancial Ltd. told Bloomberg News at the time.


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

Daily % Returns 1.23% Largest Winning Trade 480,563 Average Expectation Value 20.33 Largest Losing Trade 141,900 Expectation 32.79% DU Area / DD Area 1.21 Percent New Highs 6.61% Average Winning Trade 56,223 Average Losing Trade 26,497 Max Consecutive Wins Max Consecutive Losses Trades Trades Rejected 576 85 Wins 245 Losses 331 Percent Wins Avg $Win to Avg $Loss 42.53% 2.12 8 15 Days Winning 1,350 Days Losing 1,176 Number of Margin Calls 0 $ Largest Margin Call 0 391 Appendix F • Trading System Example from Mechanica Average Days in Winning Trade 37 Size Adjustments 0 Average Days in Losing Trade 15 Size Adjusted Items 0 Total Slippage + Commission 0 Start Date 19910102 End Date 20001231 Max Items Held Total Items Traded 588 PSR run time (H:M:S) 18,879 To see how our equity curve looked in relationship to our drawdown, we can chart the logarithmic equity curve (see Chart F.4).

He feeds off panic, making short-term bets when prices get frothy. He condemns the common strategy of trend following, which helped make his buddy George Soros super-rich. “A delusion,’’ he declares.60 “In my dream, I am long IBM, or priceline.com, or worst of all, Krung Thai Bank, the state owned bank in Thailand that fell from $200 to pennies while I held in 1997. The rest of the dream is always the same. My stock plunges. Massive margin calls are being issued. Related stocks jump off cliffs in sympathy. Delta hedges are selling more stocks short to rebalance their positions. The naked options I am short are going through the roof. Millions of investors are blindly following the headlines. Listless as zombies, they are liquidating their stocks at any price and piling into money market funds with an after tax yield of –1 percent. ‘Stop you fools!’


pages: 665 words: 146,542

Money: 5,000 Years of Debt and Power by Michel Aglietta

bank run, banking crisis, Basel III, Berlin Wall, bitcoin, blockchain, Bretton Woods, British Empire, business cycle, capital asset pricing model, capital controls, cashless society, central bank independence, collapse of Lehman Brothers, collective bargaining, corporate governance, David Graeber, debt deflation, dematerialisation, Deng Xiaoping, double entry bookkeeping, energy transition, eurozone crisis, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, forward guidance, Francis Fukuyama: the end of history, full employment, German hyperinflation, income inequality, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invention of writing, invisible hand, joint-stock company, Kenneth Arrow, Kickstarter, liquidity trap, margin call, means of production, money market fund, moral hazard, Nash equilibrium, Network effects, Northern Rock, oil shock, planetary scale, plutocrats, Plutocrats, price stability, purchasing power parity, quantitative easing, race to the bottom, reserve currency, secular stagnation, seigniorage, shareholder value, special drawing rights, special economic zone, stochastic process, the payments system, the scientific method, too big to fail, trade route, transaction costs, transcontinental railway, Washington Consensus

Methodical confidence emerges within market practices on account of the repeated realisation of business relations between the same partners. It operates in various different ways: in the mutual respect of agreements, in the group mentality that facilitates loss-sharing and collective support in situations of vulnerability, and in the acceptance of regulation that limits risk exposure (position limits and margin calls on the markets). In short, in all of the practices that go against the liberal doxa of transparency and maximum competition. Such practices are based on the same logic: that of confidence in the objectivated rule, which conceals the authority that enunciates this rule. The objectivation of the rule puts it out of reach, creating the perception that it is a natural reality. Methodical confidence thus relies on the regularity of transactions and can be characterised in terms of a loss of distrust that stems from the repetition of acts and relations which can be assumed to be secure.

Crises in Developed Countries Banks always play a crucial role in propagating crises, even when they are not at their origin. In stock market crises, the contagion results from worries over market liquidity after an initial fall in prices. Thus, on 19 October 1987, the Wall Street market fell 22.6 percent under the weight of sales orders concerning some 600 million securities. The collapse rebounded on the Chicago futures market, producing a mass of margin calls. For the stock market to continue to function, arbitrageurs – securities firms – had to advance enormous credits to their clients to enable them to maintain their positions. Thus, as the market opened on 20 October, there was extreme tension over liquidity. Kidder Peabody and Goldman Sachs had to advance $1.5 billion in two hours! Here we can grasp the crucial role of these market markers. They themselves need enormous amounts of liquidity in order to finance their counterparty positions for the avalanche of sales orders, such that a floor price can be found.

These positions were financed by short-term credits. Since short-term loans were the debt levers that financed the acquisition of long-term securities, there was a massive exposure to rate risks, owing to the discordant maturity dates on the US bond markets. When the Fed raised its policy rate, investors hurried to close their positions in order not to have to renew their debts at higher rates, and to avoid extra margin calls. The result was a massive sale of bonds that raised long rates by 300 base points in a few weeks. Once again, this phenomenon resulted from a deterioration of market liquidity on account of the capital losses that followed the price rebound. The markets’ international interconnections played an essential role in propagating the crisis. The proliferation of risk-management tools created more fragile markets.


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

I used the analogy when I started here: was there a cheetah hunting down a weak member of the herd? … I am trying to get to this very issue of was a first domino pushed over? Or did someone light a fuse here? Another FCIC commissioner put it to Cassano this way: “Was Goldman out to get you?” Angelides during the testimony referred to Goldman’s aggressiveness in making collateral calls to AIG. At one point he quotes an AIGFP official who says that a July 30 margin call from Goldman “hit out of the blue, and a fucking number that’s well bigger than we ever planned for.” He called Goldman’s numbers “ridiculous.” Cassano that day refused to point a finger at Goldman, and Goldman itself, through documents released to the FCIC later in the summer of 2010 and via comments by Chief Operating Officer Gary Cohn (“We are not pushing markets down through marks”), denied that it had intentionally hastened AIG’s demise by being overaggressive with its collateral demands.

Most notably, it reported that Goldman had very nearly gone out of business in the wake of the AIG disaster: As the market continued to plunge and Goldman’s stock price nosedived, people inside the firm “were freaking out,” says a former Goldman executive who maintains close ties to the company. Many of the partners had borrowed against their Goldman stock in order to afford Park Avenue apartments, Hamptons vacation homes, and other accoutrements of the Goldman lifestyle. Margin calls were hitting staffers up and down the offices. The panic was so intense that when the stock dipped to $47 in intraday trading, Blankfein and Gary Cohn, the chief operating officer, came out of the executive suite to hover over traders on the floor, shocking people who’d rarely seen them there. They didn’t want staffers cashing out of their stock holdings and further destroying the share price.


High-Frequency Trading by David Easley, Marcos López de Prado, Maureen O'Hara

algorithmic trading, asset allocation, backtesting, Brownian motion, capital asset pricing model, computer vision, continuous double auction, dark matter, discrete time, finite state, fixed income, Flash crash, High speed trading, index arbitrage, information asymmetry, interest rate swap, latency arbitrage, margin call, market design, market fragmentation, market fundamentalism, market microstructure, martingale, natural language processing, offshore financial centre, pattern recognition, price discovery process, price discrimination, price stability, quantitative trading / quantitative finance, random walk, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, Tobin tax, transaction costs, two-sided market, yield curve

March 2011 yen appreciation Early in the morning of March 17, 2011, in the days following the Fukushima Daiichi earthquake, the USD/JPY declined by 300 pips, from around 79.50 to below 76.50 in just 25 minutes, between 05h55 and 06h20 Tokyo time (16h55–17h20 New York time on March 16, 2011). This price movement was triggered by stop-loss trades of retail FX margin traders (Bank for International Settlements 2011). The margin calls that the retail aggregators executed on behalf of their traders set off a wave of USD selling in a thin market. Many banks withdrew from market making and others widened their spreads so much that their bids were far below the last prevailing market price. This created a positive feedback loop of USD/JPY falling and leading to even more stop-losses until the pair hit 76.25 at around 06h20. 78 i i i i i i “Easley” — 2013/10/8 — 11:31 — page 79 — #99 i i HIGH-FREQUENCY TRADING IN FX MARKETS The exchange rate recovered in the next 30 minutes to 78.23 as hedge funds and new retail investors began to build up fresh long positions.

In other scenarios, HF traders can also destabilise price action, because they may be forced to close out positions all of a sudden, thus triggering an avalanche. In the next section, we shall discuss how organised exchanges can improve price discovery and reduce the likelihood of a “flash crash”. ALTERNATIVE LIMIT ORDER BOOK Price action in financial markets is at times erratic, because secondby-second transaction volume is a mere trickle, and minor market orders can trigger a price spike that can set off a large price move due to margin calls. Price movements are spurious and respond in a nonlinear fashion to imbalances of demand and supply. A temporary reduction in liquidity can easily result in significant price moves, triggering stop losses and cascades of position liquidations. Highfrequency traders now account for a large share of total transaction volume; if these traders are taken by surprise and close out their positions in one go, then this can trigger a massive sell-off, akin to the May 6, 2010, Flash Crash. 80 i i i i i i “Easley” — 2013/10/8 — 11:31 — page 81 — #101 i i HIGH-FREQUENCY TRADING IN FX MARKETS In response to the Flash Crash and other similar events, regulators have introduced several rules to ensure orderly functioning of capital markets.


Deep Value by Tobias E. Carlisle

activist fund / activist shareholder / activist investor, Andrei Shleifer, availability heuristic, backtesting, business cycle, buy and hold, corporate governance, corporate raider, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, fixed income, intangible asset, joint-stock company, margin call, passive investing, principal–agent problem, Richard Thaler, riskless arbitrage, Robert Shiller, Robert Shiller, Rory Sutherland, shareholder value, Sharpe ratio, South Sea Bubble, statistical model, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tim Cook: Apple

As it was possible for a gap to open up between the price of the mutual fund unit and the underlying value of the portfolio, it was also possible for that gap to widen. When it did so, an investor who had bought the units of the fund and sold short the underlying portfolio endured short-term, unrealized losses until the market closed the gap. In the worst-case scenario, the investor could be forced to realize those losses if the gap continued to widen and he or she couldn’t hold the positions, which could occur if he or she failed to meet a margin call or was required to cover the short position. Unwilling to rely on the market to close the gap, Icahn and Kingsley would often take matters into their own hands. Once they had established their position, they contacted the manager and lobbied to have the fund liquidated. The manager either acquiesced, and Icahn and Kingsley closed out the position for a gain, or the mere prospect of the manager liquidating caused the gap to wholly or partially close.

At some stage he figured out that he could trick the inspectors into believing he owned more soybean oil than he actually did, and so began to substitute seawater for soybean oil. De Angelis got so good at fooling the inspectors that he eventually controlled more soybean oil than there was in existence.14 The ruse was discovered when the market moved violently against him, and he was unable to meet margin calls from his broker. De Angelis was immediately wiped out. The position was so big that it also sent his broker into bankruptcy. Facing a fraudulent De Angelis and his bankrupt broker, De Angelis’s lenders naturally went looking for some deep pockets to sue. They found American Express, the company that had actually issued the warehouse receipts certifying the soybean oil existed. The sum sought was $175 million—more than 10 times American Express’s earnings in 1964— and it wasn’t clear that American Express could survive an award of that magnitude.


Trade Your Way to Financial Freedom by van K. Tharp

asset allocation, backtesting, Bretton Woods, buy and hold, capital asset pricing model, commodity trading advisor, compound rate of return, computer age, distributed generation, diversification, dogs of the Dow, Elliott wave, high net worth, index fund, locking in a profit, margin call, market fundamentalism, passive income, prediction markets, price stability, random walk, reserve currency, risk tolerance, Ronald Reagan, Sharpe ratio, short selling, transaction costs

If you ask the average person, “How will you get out of a bad trade if it really goes against you?” he or she has no answer. Most people just don’t have the backup protection they should have. More importantly, they trade at way too high a level. If you have $50,000 and are trading five or more different futures contracts simultaneously, then you are probably trading at too high a risk level. If you are a day trader and you get margin calls, then your risk level is way too high. That risk level may get you high rates of return, but it will eventually bankrupt your account. Think about the protection bias. Paying attention to this bias alone could preserve much of the equity that you currently have in your account. BIASES THAT AFFECT HOW YOU TRADE YOUR SYSTEM Let’s assume that you have gone through a system, thoroughly tested it, and determined it to be something you can trade.

You’ll only be comfortable trading a system that is compatible with your beliefs about stops. NOTES 1. John Sweeney, Campaign Trading: Tactics and Strategies to Exploit the Markets (New York: Wiley, 1996). 2. This kind of trading is difficult due to the very large commissions charged even by discount stockbrokers. However, discount Internet trading has changed that. 3. The stock exchange promotes this by having margin calls at only 50 percent and teaching people that they could lose it all. Furthermore, they are justified in doing so because most people don’t have a plan to trade and are psychologically wired to lose money. 4. Suggested by J. Welles Wilder in New Concepts in Technical Trading Systems (Greensboro, N.C.: Trend Research, 1978). 5. Refer to Sweeney, Campaign Trading, for more details about maximum adverse excursion (MAE). 6.

Thus, if you have a system that produces an average profit of 80R after 100 trades, you could expect to make 80 percent (or more with compounding) using a 1 percent risk model. Comparison of Models Table 14.4 shows the same 55-/21-day breakout system with a position-sizing algorithm based upon risk as a percentage of equity. The starting equity is again $1 million. Notice that the best reward-to-risk ratio occurs at about 25 percent risk per position, but you would have to tolerate an 84 percent drawdown in order to achieve it. In addition, margin calls (which are set at current rates and are not historically accurate) start entering the picture at 10 percent risk. If you traded this system with $1 million and used a 1 percent risk criterion, your bet sizes would be equivalent to trading the $100,000 account with 10 percent risk. Thus, Table 14.4 suggests that you probably should not trade this system unless you have at least $100,000, and then you probably should not risk more than about 0.5 percent per trade.


pages: 342 words: 99,390

The greatest trade ever: the behind-the-scenes story of how John Paulson defied Wall Street and made financial history by Gregory Zuckerman

1960s counterculture, banking crisis, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, index fund, Isaac Newton, Long Term Capital Management, margin call, Mark Zuckerberg, Menlo Park, merger arbitrage, mortgage debt, mortgage tax deduction, Ponzi scheme, Renaissance Technologies, rent control, Robert Shiller, Robert Shiller, rolodex, short selling, Silicon Valley, statistical arbitrage, Steve Ballmer, Steve Wozniak, technology bubble, zero-sum game

Banks and others now owed Paulson an amount of money that rivaled any sum owed in a financial trade. Some of them balked at forking all that cash over to Paulson before the CDS contracts were ended. Pellegrini and his team insisted, though, citing terms of their agreements, and the money was handed over. One bank dared Paulson to cause a default but ultimately backed down and posted the required collateral, a huge reverse margin call. The amateurs were putting the screws to the pros. Paulson sold a bit of his CDS protection, to lock in some profits, but he clung to most of it, convinced that much worse was ahead for housing. The trade had become much riskier, however. When the cost of mortgage insurance was dirt cheap, Paulson was able to pay very little for protection, limiting his risk. But now that the ABX had tumbled from 100 to 60, Paulson had a lot more to lose—--the index easily could snap back to 100.

Greene had about $100 million of other assets, but a few years of failure with his trade threatened to eat much of that up, too. Indeed, Greene had committed to pay $14 million a year to buy CDS protection on $1 billion of subprime mortgages. And he put up about $60 million with the brokers to allow him to do the trade. Greene owned so much protection, and put so little down, that when subprime-mortgage prices rose just slightly in late 2006, he received margin calls from Merrill Lynch, forcing him to fork over several million dollars from other accounts just to keep his brokerage firm from closing out his trade. Greene had bragged to friends and business associates about his moves and how they would pay off. His very reputation and sense of self-worth seemed tied up with the trade. But Greene’'s investments weren’'t moving, and he couldn’'t figure out why.


pages: 447 words: 104,258

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues by Alain Ruttiens

algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, discrete time, diversification, fixed income, implied volatility, interest rate derivative, interest rate swap, margin call, market microstructure, martingale, p-value, passive investing, quantitative trading / quantitative finance, random walk, risk/return, Satyajit Das, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond

Figure 5.9 Diagram of a CFD contract The counterparty can contract as the buyer or the seller of the CFD. There is no maturity on such a contract, even for the (short) seller. This is probably the most prominent feature of CFDs, with respect to traditional forwards and futures. CFDs contracts involve a kind of future margining system (cf. Chapter 7, Section 7.1), settled on a daily basis, that is: the counterparty must open an account with an initial margin, called a deposit; the size of the deposit depends on the underlying, that is, its volatility and liquidity, plus a commission for the market maker (or broker); the daily profit or loss due to the underlying daily price change is charged on the margin account; the counterparty must maintain a minimum margin level. The deposit is also affected on a daily basis by the financing of the opened position.

For a nominal of; say, €4 million, the trader sells The initial deposit margin is or $82 656, @ 1.2300 (initial spot rate), that is, a leverage of about 60: 125 000 / 2100. At inception, the (mid) spot is $1.2300 and the (mid) future is quoted $1.2385. By next 1st of March, the trader is unwinding his position, buying back the futures @ 1.2011, with a corresponding spot of 1.1950. The trading profit is Without taking account of possible margin call costs, the trading profit is or, relative to the underlying nominal of $4 290 000 (@ 1.2300): 7.7 FUTURES ON (NON-FINANCIAL) COMMODITIES 7.7.1 Introduction Commodities futures, the most ancient future contracts, significantly differ by many aspects from financial futures. Historically, they were physically settled, given the nature of the underlying, but today, to facilitate the speculative trading, most of the contracts allow for a cash settlement.


pages: 366 words: 109,117

Higher: A Historic Race to the Sky and the Making of a City by Neal Bascomb

buttonwood tree, California gold rush, Charles Lindbergh, Everybody Ought to Be Rich, hiring and firing, margin call, market bubble, Ralph Waldo Emerson, transcontinental railway, Works Progress Administration

The New York Times financial editor Alexander Noyes compared the present market circumstances to those of the panic in 1907 and warned of catastrophic consequences. The market had continued a slow downward spiral until September 24, when another serious break in share prices further darkened the mood. Investors by the thousands were selling off their portfolios. Gangsters in Chicago threatened their brokers if they dared make a margin call. The president of the New York Yankees, Ed Barrow, even held a special meeting to tell his players to abandon the market. Raskob understood the danger of this mood. He stared into the eyes of each of his lunch guests as he slowly walked around the table. One of his guests grumbled that bankers were becoming too cautious. Another said that the previous day’s brief rally, led by U.S. Steel, was evidence that Wall Street still thought the economy had legs.

At least to the press, the truth was a commodity to be bargained with as freely as a penny stock, and all the race’s participants traded it freely. Down on Wall Street, the ticker tape revealed that Raskob’s call to his friends to support the market hadn’t worked. Trading was heavy, and despite a few rallies over the previous two weeks, many of the market’s leading stocks were trending downward. A few investors had already lost everything, and rather than face their margin calls, they took their own lives. The unease that hung over Wall Street’s brokers continued, despite statements from Charles Mitchell, a director of the Federal Reserve Bank in New York, that recent declines were a healthy correction that had played itself out. Nonetheless, the Empire State, Inc., board pressed ahead with their business. The wreckers had already hauled away tons of the former Waldorf-Astoria, including much of its marble and gold fixtures, and the board needed to resolve the skyscraper’s plans in order to arrange for the steel and submit a loan application to the Metropolitan Life Insurance Company.


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

If the portfolio suffers a credit event, the issuer must pay losses, which, beyond a given level, are passed to investors. If the buyer of CDOs fails to meet margin calls on funds it borrowed to invest in them, the lender may seek to sell the collateral for the loan, which consists of the CDOs. Higher margin requirements could lead to forced selling of CDOs or investor redemptions. By mid-2007, investment banks that lend money to hedge funds to buy CDOs had been raising the margin requirements. At about this time Floridabased United Capital Asset Management suspended redemption in its Horizon funds, which were significantly invested in US sub-prime mortgage assets. Two hedge funds owned by US bank Bear Stearns came close to collapse because they failed to meet margin calls on CDOs made up of risky US subprime mortgages. Some banks that were their creditors threatened to sell off at auction the underlying sub-prime mortgages that they had held as collateral but it became clear that a quick sale would fetch poor returns.


pages: 398 words: 111,333

The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham by Joe Carlen

Albert Einstein, asset allocation, Bernie Madoff, Bretton Woods, business cycle, business intelligence, discounted cash flows, Eugene Fama: efficient market hypothesis, full employment, index card, index fund, intangible asset, invisible hand, Isaac Newton, laissez-faire capitalism, margin call, means of production, Norman Mailer, oil shock, post-industrial society, price anchoring, price stability, reserve currency, Robert Shiller, Robert Shiller, the scientific method, Vanguard fund, young professional

Graham, who enjoyed a close relationship with his brothers and was always eager to help them out, invested his profits in an Upper West Side phonograph store to be run and co-owned by his audiophile brother Leon. When overall security prices took a steady drop throughout 1917, Graham's Tassin account was “called in for margin”48 (when the price of a particular security, or group thereof, declines below a certain point, a margin call is made, at which point the account holder must either deposit additional funds or sell off assets). The problem was that Graham, who had anticipated better results for both the Tassin account and what proved to be a difficult (and ultimately short-lived) music retail enterprise, did not have the funds to meet the shortfall. This put Graham in the extraordinarily awkward position of having to inform a friend (one who had put his trust in Graham's investment skill and moral integrity) that he was unable to cover his share of the loss.

., 70, 73, 76, 109 Keynes, John Maynard, 185, 204, 216, 293–94 Kidder Peabody, 248 Kilpatrick, Andrew, 227 Knapp, Tom, 244, 249 Kreeger, David, 285 Krugman, Paul, 216 Lehman Brothers, 290 leverage, and the market, 52, 141 Levy, Gus, 156 Levy, Guy, 181–82 Lewine, Jerome, 148 Li Lu/Himalaya Capital Partners, 257 liquidity, defined, 209 Longleaf Partners, 257 losses, avoidance and minimization of, 50 Lowe, Janet, 198, 230 Lowenstein, Roger, 159, 267 Lynch, Peter, 138 Madoff, Bernard “Bernie,” 290 Mailer, Norman, 65 management integrity, 54 margin call, 114 margin of safety, 34–56 Marie Louise “Malou” Amigues, 237, 270–79, 301 marketable securities, 131 market analysts, 40 “market basket” or “commodity-unit” currency, 203–19 market corrections, 56, 156 market fluctuations, 167 buffer against, 39 market index, 94 market price, 40 “market psychology,” 174 market timing, 45 market volatility, 45, 174 Marks, Howard, 52, 54, 167–68 Marony, Bob, 143 Martin, William McChesney, 184, 207 Marx, Harpo, 131, 138 Maslow, Abraham, 65 Maxwell examinations, 59 Mead, Joseph, 207 mean reversion, 130 Menger, Carl, 210 Merck & Company, Ltd., 44 Meredith, Spencer B., 82, 96, 189 Messing, Estelle “Etsey” (Graham), 196 Michael Price/Franklin Templeton/MFP Investors, 257 micromovement of stock quotes, 128 microprofit trades, 128 Miki, Junkichi, 113 Miller, Alda, 75 Millman, Gregory, 127–28 Milne, Robert, 53, 109 minority stockholder, 131 “Mr.


pages: 113 words: 37,885

Why Wall Street Matters by William D. Cohan

Apple II, asset-backed security, bank run, Bernie Sanders, Blythe Masters, bonus culture, break the buck, buttonwood tree, corporate governance, corporate raider, creative destruction, Credit Default Swap, Donald Trump, Exxon Valdez, financial innovation, financial repression, Fractional reserve banking, Gordon Gekko, greed is good, income inequality, Joseph Schumpeter, London Interbank Offered Rate, margin call, money market fund, moral hazard, Potemkin village, quantitative easing, secular stagnation, Snapchat, South Sea Bubble, Steve Jobs, Steve Wozniak, too big to fail, WikiLeaks

He noted correctly that unlike the bank runs that typified the 1930s, when small depositors lined up to get their money out, in 2008 it was the institutions that ran for the exits without having to line up at all. They got out simply by—literally—pushing a button on their computers. What happened next, Tarullo explained, was that the Wall Street banks, “lacking enough liquidity to repay all the counterparties who declined to roll over their investments,” were forced “into fire sales that further depressed asset prices, thereby reducing the values of assets held by many other intermediaries, raising margin calls, and leading to still more asset sales.” Better-capitalized firms, he continued, tended “to hoard” their financial resources “in light of their uncertainty as to whether their balance sheets might come under greater stress and their reluctance to catch the proverbial falling knife by purchasing assets whose prices were plummeting with no obvious floor.” Tarullo’s postcrisis effort to “protect financial stability” remains focused on regulating “runnable securities.”


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

The bulk of the loss was in Europe, approaching $900 million. To a large extent, the losses at Salomon were the result of inexperience and faintheartedness on the part of the new Travelers-based management. The financial markets were not in ruin; there was no reason for the incredible drop in prices. It was a classic liquidity-driven market crisis. LTCM was cash-strapped; Meriwether had daily margin calls and needed to sell off his portfolio to come up with the cash; Salomon Smith Barney did not. With its deep pockets, Salomon/Citigroup could have weathered the storm, but a sense of panic pushed senior management to reduce positions almost in lockstep with LTCM. Still, for all of its losses, Salomon came out relatively unscathed. The firm had no Russian positions at the time of the default, and little in the way of counterparty commitments and related credit overhang to LTCM, and had limited its exposure with a decision to close the U.S. proprietary trading group in early July.

Though vilified and demonized by many, hedge funds and other speculative traders are not gamblers or financial parasites. In the aggregate, by supplying capital to hold risky securities, traders and hedge funds serve to reduce market volatility and improve prices for both buyers and sellers. 219 ccc_demon_207-242_ch10.qxd 2/13/07 A DEMON 1:47 PM OF Page 220 OUR OWN DESIGN For the investor who must liquidate because of a margin call, or the bank that finds itself hitting risk limits that force it to sell in a declining market, the cumulative impact of the hedge funds and speculators can be the difference between staying in business and facing default. And, as can be appreciated against the backdrop of the crises discussed earlier, this impact can extend to the overall market: The liquidity supply afforded by hedge funds and speculators will often make the difference between a market closing down only a few percentage points on the day and the market sliding abruptly into a crisis.


pages: 457 words: 125,329

Value of Everything: An Antidote to Chaos The by Mariana Mazzucato

"Robert Solow", activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Airbnb, bank run, banks create money, Basel III, Berlin Wall, Big bang: deregulation of the City of London, bonus culture, Bretton Woods, business cycle, butterfly effect, buy and hold, Buy land – they’re not making it any more, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, cleantech, Corn Laws, corporate governance, corporate social responsibility, creative destruction, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, European colonialism, fear of failure, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, full employment, G4S, George Akerlof, Google Hangouts, Growth in a Time of Debt, high net worth, Hyman Minsky, income inequality, index fund, informal economy, interest rate derivative, Internet of things, invisible hand, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour market flexibility, laissez-faire capitalism, light touch regulation, liquidity trap, London Interbank Offered Rate, margin call, Mark Zuckerberg, market bubble, means of production, money market fund, negative equity, Network effects, new economy, Northern Rock, obamacare, offshore financial centre, Pareto efficiency, patent troll, Paul Samuelson, peer-to-peer lending, Peter Thiel, profit maximization, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, rent control, rent-seeking, Sand Hill Road, shareholder value, sharing economy, short selling, Silicon Valley, Simon Kuznets, smart meter, Social Responsibility of Business Is to Increase Its Profits, software patent, stem cell, Steve Jobs, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Tobin tax, too big to fail, trade route, transaction costs, two-sided market, very high income, Vilfredo Pareto, wealth creators, Works Progress Administration, zero-sum game

These lenders benefited from a seemingly virtuous circle in which additional lending raised financial asset prices, which strengthened their balance sheets, giving them the scope to borrow and lend more within existing minimum capital ratios, the amount of capital banks had to retain relative to their lending. As well as lending more to one another and to retail clients, over the past three decades banks began to target their loans at riskier prospects offering higher rates of return. This is the part of the story that most people now understand, having been well covered in the media and popular culture, in books and films such as Inside Job, Margin Call and The Big Short. Banks felt they needed to take more risks because, with governments trying to balance budgets and reduce public borrowing requirements, the yields on low-risk assets (such as US and European government debt) had fallen very low. Banks also believed that they had become much better at handling risk: by configuring the right portfolio, insuring themselves against it (especially through credit default swaps -CDSs - that would pay out if a borrower didn't pay back), or selling it on to other investors with a greater risk appetite.

The former might include ‘public goods' like basic research, which the government needs to fund when the private sector doesn't (because it's hard to make profits), while the latter could involve the costs of pollution which companies do not include in their regular cost-accounting, so government might have to add that cost through a carbon tax.43 So while Public Choice theorists worry more about government failures and neo- Keynesians more about market failures, in the end their debates about policy intervention have not seriously challenged the primacy of marginal utility theory. Taken to its extreme, Public Choice theory, which derives from marginalism, calls for government to intervene as little as possible in the economy in order to minimize the risk of government failure. The public sector should be insulated from the private sector, for example to avoid agency capture - when a regulatory body grows too close to the industry it is meant to regulate. Fear of government failure has convinced many governments that they should emulate the private sector as far as they can.


pages: 706 words: 206,202

Den of Thieves by James B. Stewart

corporate raider, creative destruction, discounted cash flows, diversified portfolio, fixed income, fudge factor, George Gilder, index arbitrage, Internet Archive, Irwin Jacobs, margin call, money market fund, Ponzi scheme, rolodex, Ronald Reagan, shareholder value, South Sea Bubble, The Predators' Ball, walking around money, zero-coupon bond

The traders rolled into action, frantically calling West Coast market-makers such as Jeflferies & Co. to try to find buyers for some of the huge Boesky position or to try to hedge the position. Then an announcement came clattering over the ticker, confirming the worst: Gulf was pulling out! All buying interest evaporated. Boesky was stuck with a huge stake that had just plummeted in value. Worse, margin calls were already pouring in, demanding full repayment of the money borrowed to buy the shares. Boesky Corporation was in dire straits. It had nowhere near the cash to meet the margin calls, even if it liquidated all its other stock holdings. Worse, Boesky had $20 million in unsecured loans from banks: $5 million each from Chase Manhattan and Chemical banks, and $10 million from two European banks. The loans were callable, for any reason, and the banks would almost certainly get wind of Boesky's crisis.

He had Seema get on an extension and Lessman repeated it. On Monday morning. Cities Service stock didn't open for trading because of an "order imbalance"; there were too many sellers and no buyers. The New York Stock Exchange specialists, who make markets in the listed stocks, weren't going to open trading until they knew they had a price that would attract buyers. That price depended, in large part, on what Boesky would do. Would margin calls force a massive liquidation of his position, driving the ultimate price even lower? At Boesky's offices, the suspense was palpable. Every position except for Cities Service was liquidated. Then everyone hovered around the ticker and watched their computer screens waiting for an opening price. Opening price "indications" dropped steadily, from $50 to $45, then even lower. Anything below $30 a share, they knew, would probably wipe them out.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, business cycle, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

That security, in turn, depends on two things: that we can establish a daily market-clearing price for the derivative and that the price doesn’t change in any day more than the amount of initial margin required. Accurate, transparent prices and smooth price changes are both features of liquidity. Futures markets often have daily price change limits; the price is not allowed to move more than a certain amount in a day. That doesn’t solve the problem of large price movements, however; it only gives participants some extra time to meet large margin calls. Using derivatives, in principle, individuals can contract to exchange future goods and services directly, with no intermediation of paper money. Some people might choose portfolios that involve current or future inflows or outflows of cash, but in that respect cash is just like any other asset. In practice, cash is the accounting unit used to price everything, just as early paper money was denominated in terms of gold or silver.

Lehman’s Treasury desk would look at the entire net position of the firm in Treasuries, the billions of bonds owned (but lent out) and owed, as well as all the other complex Treasury-related products. If it decided it had a net exposure it didn’t want, it would offset it using a financial derivative. Second, Lehman’s margin operations department looked at all the customer accounts. If any had too little equity given the riskiness of the positions, the firm issued a margin call to either increase the equity or cut the risk of positions. Note that cash had nothing to do with this—all that mattered was the total value of all the positions in the account and the total risk of all those positions. Derivative Money Lehman’s Treasury business was not entirely virtual. In addition to the cash accounts, there were other reasons some transactions needed real, physical settlement.


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

The blockchain is considered immutable, as any change would change the hashes and be immediately evident. Key: a number which works like the PIN of a Bitcoin address. This is the one secret thing you must control if you “have” a bitcoin. 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.


pages: 209 words: 53,175

The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel

"side hustle", airport security, Amazon Web Services, Bernie Madoff, business cycle, computer age, coronavirus, discounted cash flows, diversification, diversified portfolio, Donald Trump, financial independence, Hans Rosling, Hyman Minsky, income inequality, index fund, invisible hand, Isaac Newton, Jeff Bezos, Joseph Schumpeter, knowledge worker, labor-force participation, Long Term Capital Management, margin call, Mark Zuckerberg, new economy, Paul Graham, payday loans, Ponzi scheme, quantitative easing, Renaissance Technologies, Richard Feynman, risk tolerance, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Stephen Hawking, Steven Levy, stocks for the long run, the scientific method, traffic fines, Vanguard fund, working-age population

Investor Mohnish Pabrai once asked Buffett what happened to Rick. Mohnish recalled: [Warren said] “Charlie and I always knew that we would become incredibly wealthy. We were not in a hurry to get wealthy; we knew it would happen. Rick was just as smart as us, but he was in a hurry.” What happened was that in the 1973–1974 downturn, Rick was levered with margin loans. And the stock market went down almost 70% in those two years, so he got margin calls. He sold his Berkshire stock to Warren—Warren actually said “I bought Rick’s Berkshire stock”—at under $40 a piece. Rick was forced to sell because he was levered.¹⁸ Charlie, Warren, and Rick were equally skilled at getting wealthy. But Warren and Charlie had the added skill of staying wealthy. Which, over time, is the skill that matters most. Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two different things: the first requires the second.


pages: 590 words: 153,208

Wealth and Poverty: A New Edition for the Twenty-First Century by George Gilder

"Robert Solow", affirmative action, Albert Einstein, Bernie Madoff, British Empire, business cycle, capital controls, cleantech, cloud computing, collateralized debt obligation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversified portfolio, Donald Trump, equal pay for equal work, floating exchange rates, full employment, George Gilder, Gunnar Myrdal, Home mortgage interest deduction, Howard Zinn, income inequality, invisible hand, Jane Jacobs, Jeff Bezos, job automation, job-hopping, Joseph Schumpeter, knowledge economy, labor-force participation, longitudinal study, margin call, Mark Zuckerberg, means of production, medical malpractice, minimum wage unemployment, money market fund, money: store of value / unit of account / medium of exchange, Mont Pelerin Society, moral hazard, mortgage debt, non-fiction novel, North Sea oil, paradox of thrift, Paul Samuelson, plutocrats, Plutocrats, Ponzi scheme, post-industrial society, price stability, Ralph Nader, rent control, Robert Gordon, Ronald Reagan, Silicon Valley, Simon Kuznets, skunkworks, Steve Jobs, The Wealth of Nations by Adam Smith, Thomas L Friedman, upwardly mobile, urban renewal, volatility arbitrage, War on Poverty, women in the workforce, working poor, working-age population, yield curve, zero-sum game

In the mortgage case they did so by actually looking at the mortgages underlying the AAA mortgage bonds that would bust the banks. They looked and they were appalled. In the great banks meanwhile, any actual knowledge of the details of the securities they held and the risks they ran was entirely divorced from the administrative and bureaucratic power at the top. The most poignant, revealing, and realistic moment in the film Margin Call, about the collapse of a Lehman-like bank, is the belated descent from on high of the bank’s CEO. Unable to grasp what his quant advisors were telling him about the crucial algorithms governing his portfolio, he implores, “Speak as you would to a young child or a golden retriever.” The great divorce of knowledge and power, information and finance, entrepreneurial realities on the ground and cantilevered paper towers in the sky was complete and cataclysmic.

Arthur liberals and liberalism, attitudes toward poor and blacks moral hazards of licensing Light, Ivan Likud Party Limits to Growth (Club of Rome) Lincoln, Abraham linear or homogeneous time Lippman, Greg Lippmann, Walter liquidity liquidity preference Lithuania loan guarantees Loeb Award London School of Economics Long, Russell longbow Los Angeles (California) Lovell, Arnold Macaulay, Thomas Babinton Maccoby, Eleanor macroeconomics Madoff, Bernie Making It (Norman Podhoretz) Malpass, David Mandelbaum, Michael marginal efficiency of capital Margin Call market sector marriage Marsden, Keith Marshall, Alfred Marx, Karl Marxism Massachusetts mass retailing materialist fallacy material progress material resources durable wealth vs. Mauss, Marcel McCarthy, Cormac McClelland, David McGovern, George McGraw Hill McKinney, Stuart McKinley, Vern McTigue, Maurice Mead, Margaret means tests media medicaid medical science medicare melting pot men, group leadership aptitude of provider, role of mercantilism meritocracy Merrill, Charles Merrill Lynch Mexico Miami (Florida) Michigan microbiology microcomputers microeconomics microprocessors Microsoft Midas middle-class values Midland, Archer Daniels Milken, Michael Mill, John Stuart millionaires Minard, Lawrence Minarek, Joseph minimum wage minority workers Mises, Ludwig von Mississippi MIT monetarism money, social pressures of supply of taboo money illusion Money (John Kenneth Galbraith) money market funds monopolies monopoly capitalism Moore, Gordon Moore, Stephen The Moral Basis of a Backward Society (Edward Banfield) moral hazards definition of of liberalism More Equality (Herbert J.


pages: 519 words: 148,131

An Empire of Wealth: Rise of American Economy Power 1607-2000 by John Steele Gordon

accounting loophole / creative accounting, bank run, banking crisis, Bretton Woods, British Empire, business cycle, buttonwood tree, California gold rush, clean water, collective bargaining, Corn Laws, corporate governance, cuban missile crisis, disintermediation, double entry bookkeeping, failed state, financial independence, Frederick Winslow Taylor, full employment, global village, imperial preference, informal economy, interchangeable parts, invisible hand, Isaac Newton, Jacquard loom, James Hargreaves, James Watt: steam engine, joint-stock company, joint-stock limited liability company, lone genius, Louis Pasteur, margin call, Marshall McLuhan, means of production, Menlo Park, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, new economy, New Urbanism, postindustrial economy, price mechanism, Ralph Waldo Emerson, RAND corporation, rent control, rent-seeking, reserve currency, rolodex, Ronald Reagan, spinning jenny, The Wealth of Nations by Adam Smith, trade route, transaction costs, transcontinental railway, undersea cable, Yom Kippur War

Known as the “Babson break,” it was like a slap across the face of a hysteric, and the mood of Wall Street changed abruptly from “the sky’s the limit” to “every man for himself.” Over the next six weeks the market trended downward, with occasional plunges followed by more modest recoveries. Then, on October 23, a wave of selling swept the market on the second highest volume on record. A mountain of margin calls went out that night, and sell orders by the thousands piled up at brokerage houses across the country. The next day, Thursday, October 24, soon known as Black Thursday, was the most frantic in the history of the New York Stock Exchange up to that time, as stocks plunged, generating more margin calls, which caused more stock to be sold at any price, as the averages spiraled downward. Meanwhile, short sellers added to the downward pressure on stocks in bear raids. A group of the Street’s leading bankers met at J. P. Morgan and Company, across Broad Street from the exchange, to decide what to do.


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

As such, this value is much more than the actual investment, which was in the range of $15 trillion at the cusp of the global credit crisis in 2007–2008 and the Great Recession that became most obvious by 2008–2009. These highly leveraged speculations generate great profits when things go well. However, highly leveraged derivatives trading also implies that an unexpected systemic shock of only a few percentage points can wipe out one’s investment and force margin calls that require speculators to cover even greater losses. It was the inability of a few large insurance companies, most notably American International Group (AIG), Citibank, the Bank of America, Wells Fargo, and a few others, to cover a decline that was greater than expected that plunged the world into the worst recession since the Great Depression. When such a displacement occurs on such a grand scale, there are literally riots in the streets and demonstrations on Wall Street.


pages: 272 words: 19,172

Hedge Fund Market Wizards by Jack D. Schwager

asset-backed security, backtesting, banking crisis, barriers to entry, beat the dealer, Bernie Madoff, Black-Scholes formula, British Empire, business cycle, buy and hold, Claude Shannon: information theory, cloud computing, collateralized debt obligation, commodity trading advisor, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, Edward Thorp, family office, financial independence, fixed income, Flash crash, hindsight bias, implied volatility, index fund, intangible asset, James Dyson, Jones Act, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, money market fund, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, quantitative easing, quantitative trading / quantitative finance, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Rubik’s Cube, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve

So you started shorting almost a year and a half too early. [The market didn’t peak until August 1987.] Yes, and a lot of times before the market cracks, the lower-quality stocks zoom. I remember being on the tennis courts with my friends in the summer of 1987 [he begins a tremulous laugh that betrays an undertone of pain], and I was losing so much money that I had to call my mother to get a loan to meet the margin call. She was the only one I could call. There is no way my dad would have loaned me the money. Did you stay short all the way through until the crash? I did. So even though the market kept moving against you, you just . . . I just hung in there. You never second-guessed yourself? Sure I did. In fact, when I was playing tennis that day, I told my buddies that I was a failure, and that I was going to lose all my money.

I was short these fly-by-night companies, some of which were probably manipulated. I think there were only two stocks that were up on October 19, 1987, and I was short one of them. It eventually cratered. I have always tried to be long and short in things that I really believed in for the longer term—situations in which I felt that the fundamental underpinnings of the company were completely different from the way it was being priced. In 1987, you went from margin calls to windfall profits. Did the 1987 experience influence you in any way? 1987 was the first year I made more money in the market than I did in my job. That was an eye-opener for me. And every year after that, I made more money in the market than in my job. How did you go from a career as a chemical engineer and the manager of European operations for a chemical company to being a portfolio manager?


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

Leading online brokerage firms paid Tradeworx 10 cents anytime one of their clients clicked on one of the tools. The limit-order calculator was used more than 20 million times in its first six months on the Internet. Tradeworx had dozens of similarly unique and innovative tools. The SEC purchased some of them for its Web site for a few years, including a margin-risk calculator that would compute the odds of a portfolio receiving a margin call and recommending specific trades to reduce the odds by 10% to 20%. As was the case with most dot-com startups, Tradeworx’s expenses outstripped its revenues in the early years. When the 9/11 attacks occurred and the capital markets shut down, Tradeworx could not find additional sources of venture capital. Narang decided that he had to use the company’s technology to make money in the market to keep the young company afloat.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, business cycle, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, George Santayana, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, Kickstarter, liquidity trap, London Interbank Offered Rate, long peace, margin call, market clearing, mass immigration, money market fund, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, plutocrats, Plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the new new thing, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

A margin loan allows you to buy a share of stock with the broker’s money paying for most of it. During the bull market of the twenties, it was possible to buy $1000 of stock for ten or twenty dollars. When stocks keep going up, this is a great way to turn a little money into a lot of money. If stocks plunge, the borrower is asked to put up more ‘‘margin,’’ cash to cover the difference between the loan and the value of the stock. If customers can meet these margin calls, fine. If they can’t, banks could find themselves with a $1000 loan the borrower cannot possibly pay by selling stock. Borrowers walk away, leaving the bank with trash stocks. With their paper wealth wiped out, these same borrowers began defaulting on mortgages and other loans. Banks began to call in loans to raise cash, sending more customers into the tank. Soon, banks began to fail in large numbers, triggering more bank runs.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, Thales of Miletus, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

Nesta, “Banking on Each Other,” April 25, 2013, http://www.nesta.org.uk/publications/banking-each-other-rise-peer-peer-lending-businesses. 3. “Withering Away,” Economist, May 19, 2012. 4. Harry DeAngelo and René Stulz, “Why High Leverage Is Optimal for Banks” (NBER Working Paper 19139, August 2013). NOTES TO CHAPTER 8 1. Victor Stango, “Are Payday Lending Markets Competitive?” Regulation (Fall 2012); “National Survey of Unbanked and Underbanked Households” (Federal Deposit Insurance Corporation, 2011). 2. “Margin Calls,” Economist, February 16, 2013. 3. Meta Brown et al., “The Financial Crisis at the Kitchen Table: Trends in Household Debt and Credit,” Current Issues in Economics and Finance 19 (2013). 4. Atif Mian and Amir Sufi, “The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis” (NBER Working Paper 13936, April 2008). 5. Brown et al., “Financial Crisis at the Kitchen Table.” 6.


pages: 1,336 words: 415,037

The Snowball: Warren Buffett and the Business of Life by Alice Schroeder

affirmative action, Albert Einstein, anti-communist, Ayatollah Khomeini, barriers to entry, Bob Noyce, Bonfire of the Vanities, Brownian motion, capital asset pricing model, card file, centralized clearinghouse, Charles Lindbergh, collateralized debt obligation, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, Donald Trump, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, global village, Golden Gate Park, Haight Ashbury, haute cuisine, Honoré de Balzac, If something cannot go on forever, it will stop - Herbert Stein's Law, In Cold Blood by Truman Capote, index fund, indoor plumbing, intangible asset, interest rate swap, invisible hand, Isaac Newton, Jeff Bezos, John Meriwether, joint-stock company, joint-stock limited liability company, Long Term Capital Management, Louis Bachelier, margin call, market bubble, Marshall McLuhan, medical malpractice, merger arbitrage, Mikhail Gorbachev, money market fund, moral hazard, NetJets, new economy, New Journalism, North Sea oil, paper trading, passive investing, Paul Samuelson, pets.com, plutocrats, Plutocrats, Ponzi scheme, Ralph Nader, random walk, Ronald Reagan, Scientific racism, shareholder value, short selling, side project, Silicon Valley, Steve Ballmer, Steve Jobs, supply-chain management, telemarketer, The Predators' Ball, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, transcontinental railway, Upton Sinclair, War on Poverty, Works Progress Administration, Y2K, yellow journalism, zero-coupon bond

Then, when the market crashed on October 29, he had to forget his pregnant wife and the loss of every cent he’d ever made in order to navigate the horror his clients now faced. He and his colleagues stayed up until five a.m. calling their accounts. Almost without exception, they, too, had traded on borrowed money. At first the clients came up with the cash to repay their loans. Market seers and government officials kept saying stocks would quickly rebound. They got the velocity right but the direction all wrong. With each succeeding wave of “margin” calls, half of Davidson’s remaining clients were wiped out, unable to pay their debts, forfeiting their accounts. Davidson, who had been pocketing an incredible $100,000 a year in commissions before the crash,23 was soon making about $100 a week selling bonds—and considering himself well off. “It was a pretty sorry sight,” he recalled of those Depression years, “to see an old friend, married with children, very successful, and now he has to work to get a nickel for an apple” selling fruit at the corner of Wall and Broad.

The partners had spent a week talking to everybody in their well-connected database, trying to raise money before they had to report this dire news to their investors on August 31. No dice. Now they agreed that Larry Hilibrand—the superrationalist whose sobriquet on Wall Street was still “the $23 million man,” for the outsize bonus that had set Mozer off on his tear—would make a pilgrimage to Omaha and reveal what Long-Term owned. The next day the Dow dropped four percent in what the Wall Street Journal referred to as a “global margin call,” with investors panicking and selling. Buffett picked up Hilibrand at the airport and drove him back to Kiewit Plaza. The modesty of Buffett’s smaller office, staffed by a handful of people and piled with Coca-Cola memorabilia, contrasted markedly with Long-Term’s enormous digs in Greenwich, which featured two pool tables and a three-thousand-square-foot gym staffed by a full-time trainer. Hilibrand had gone deep into debt to pump up his personal investment in the firm, leveraging the leverage with which Long-Term had already leveraged itself.

It owed money to people who owed money to people who owed money to Berkshire. “Derivatives are like sex,” Buffett said. “It’s not who we’re sleeping with, it’s who they’re sleeping with that’s the problem.” As Buffett headed to Seattle that Friday to meet the Gateses and embark on a thirteen-day “Gold Rush” trip from Alaska to California, he called a manager and told him, “Accept no excuses from anyone who doesn’t post collateral or make a margin call. Accept no excuses.”30 He meant that if the Howie-equivalents out there paid the rent one day late, then seize their farms. The next morning he, Susie, the Gateses, and three other couples flew to Juneau to helicopter over the ice fields. They cruised up the fjords to view huge blue icebergs and waterfalls cascading over three-thousand-foot cliffs. But as Buffett sat politely through a slide presentation on glaciology on board the ship that evening, his mind wandered to whether Goldman Sachs would be able to put together a bid for Long-Term.


pages: 278 words: 82,069

Meltdown: How Greed and Corruption Shattered Our Financial System and How We Can Recover by Katrina Vanden Heuvel, William Greider

Asian financial crisis, banking crisis, Bretton Woods, business cycle, buy and hold, capital controls, carried interest, central bank independence, centre right, collateralized debt obligation, conceptual framework, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, declining real wages, deindustrialization, Exxon Valdez, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, full employment, housing crisis, Howard Zinn, Hyman Minsky, income inequality, information asymmetry, John Meriwether, kremlinology, Long Term Capital Management, margin call, market bubble, market fundamentalism, McMansion, money market fund, mortgage debt, Naomi Klein, new economy, offshore financial centre, payday loans, pets.com, plutocrats, Plutocrats, Ponzi scheme, price stability, pushing on a string, race to the bottom, Ralph Nader, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, sovereign wealth fund, structural adjustment programs, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, wage slave, Washington Consensus, women in the workforce, working poor, Y2K

When they crashed—for example, in the savings-and-loan and junk-bond debacles of the 1980s, the Long-Term Capital Management collapse of 1998 and the Enron and dot-com crashes of the early 2000s—the government cleaned up the mess with taxpayers’ money and let them go back to the bar. So here we go again. When subprime homeowners stopped paying, the prices of the mortgage-backed securities used as collateral fell. Banks demanded that their borrowers pay up or cover their margins. Panicked selling by borrowers further lowered the securities’ prices, triggering more margin calls and more defaults. Massive losses piled up at places like Citigroup, Coun-trywide, Merrill Lynch and Morgan Stanley, and cascaded back into the insurance companies. At the end of February, the huge insurer American International Group reported the largest quarterly loss, $5 billion, since the company started in 1919. After some delay, the Federal Reserve Board last summer started lowering interest rates on loans to the banks.


pages: 287 words: 81,970

The Dollar Meltdown: Surviving the Coming Currency Crisis With Gold, Oil, and Other Unconventional Investments by Charles Goyette

bank run, banking crisis, Ben Bernanke: helicopter money, Berlin Wall, Bernie Madoff, Bretton Woods, British Empire, Buckminster Fuller, business cycle, buy and hold, California gold rush, currency manipulation / currency intervention, Deng Xiaoping, diversified portfolio, Elliott wave, fiat currency, fixed income, Fractional reserve banking, housing crisis, If something cannot go on forever, it will stop - Herbert Stein's Law, index fund, Lao Tzu, margin call, market bubble, McMansion, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, oil shock, peak oil, pushing on a string, reserve currency, rising living standards, road to serfdom, Ronald Reagan, Saturday Night Live, short selling, Silicon Valley, transaction costs

Today’s credit crisis and the compounding debt were implicit in those events. Now challenges to American global economic hegemony, bailouts, stimulus packages, and the recession and its accompanying deficits are driving the trend to a climax. The development of ETFs has made these commodity investments accessible in a way that they have not been before. We are using ETFs so that we can invest in these markets without the leverage, margin calls, or emotional toll of second-to-second price changes. You do not have to be mesmerized by price fluctuations on a screen. You do not have to give up your real job to become a day trader the way so many did in the dot-com bubble. You do not have to have perfect timing to enter and exit the market. You are not generating commissions by trading in and out of commodities. You are simply investing in real things and getting them in exchange for “magic” money that was created by Washington wizards.


pages: 286 words: 87,401

Blitzscaling: The Lightning-Fast Path to Building Massively Valuable Companies by Reid Hoffman, Chris Yeh

activist fund / activist shareholder / activist investor, Airbnb, Amazon Web Services, autonomous vehicles, bitcoin, blockchain, Bob Noyce, business intelligence, Chuck Templeton: OpenTable:, cloud computing, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, database schema, discounted cash flows, Elon Musk, Firefox, forensic accounting, George Gilder, global pandemic, Google Hangouts, Google X / Alphabet X, hydraulic fracturing, Hyperloop, inventory management, Isaac Newton, Jeff Bezos, Joi Ito, Khan Academy, late fees, Lean Startup, Lyft, M-Pesa, Marc Andreessen, margin call, Mark Zuckerberg, minimum viable product, move fast and break things, move fast and break things, Network effects, Oculus Rift, oil shale / tar sands, Paul Buchheit, Paul Graham, Peter Thiel, pre–internet, recommendation engine, ride hailing / ride sharing, Sam Altman, Sand Hill Road, Saturday Night Live, self-driving car, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Skype, smart grid, social graph, software as a service, software is eating the world, speech recognition, stem cell, Steve Jobs, subscription business, Tesla Model S, thinkpad, transaction costs, transport as a service, Travis Kalanick, Uber for X, uber lyft, web application, winner-take-all economy, Y Combinator, yellow journalism

McClendon acted as though his blitzscaling strategy was guaranteed to succeed, and Chesapeake was hit hard by the global recession of 2008. After peaking at $62.40 in June 2008, its stock price has declined sharply, falling as low as $2.61 in early 2016 (in 2017, it traded between $4 and $8 per share). McClendon had taken on a lot of risk in his personal finances as well, borrowing money to buy Chesapeake stock. A margin call in 2008 forced him to sell 94 percent of his Chesapeake stock at a massive loss. McClendon was eventually forced to step down from his position as CEO of Chesapeake in 2013, but remained a resolute blitzscaler. At the time of his death in 2016, McClendon was running American Energy Partners, a company he founded after his departure from Chesapeake, and for which he had raised $15 billion from investors.


pages: 348 words: 83,490

More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) by Michael J. Mauboussin

Albert Einstein, Andrei Shleifer, Atul Gawande, availability heuristic, beat the dealer, Benoit Mandelbrot, Black Swan, Brownian motion, butter production in bangladesh, buy and hold, capital asset pricing model, Clayton Christensen, clockwork universe, complexity theory, corporate governance, creative destruction, Daniel Kahneman / Amos Tversky, deliberate practice, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, dogs of the Dow, Drosophila, Edward Thorp, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, fixed income, framing effect, functional fixedness, hindsight bias, hiring and firing, Howard Rheingold, index fund, information asymmetry, intangible asset, invisible hand, Isaac Newton, Jeff Bezos, Kenneth Arrow, Laplace demon, Long Term Capital Management, loss aversion, mandelbrot fractal, margin call, market bubble, Menlo Park, mental accounting, Milgram experiment, Murray Gell-Mann, Nash equilibrium, new economy, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative finance, random walk, Richard Florida, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, statistical model, Steven Pinker, stocks for the long run, survivorship bias, The Wisdom of Crowds, transaction costs, traveling salesman, value at risk, wealth creators, women in the workforce, zero-sum game

The press sounds a lot like a split-brain patient making up a cause for an effect, and we investors lap it up because the link satisfies a very basic need. EXHIBIT 34.1 Top 30 S&P 500 Index Moves, 1941-1987 DatePercent ChangeExplanation 10/19/1987 —20.47 Worry over dollar decline and trade deficit; fear of U.S. not supporting dollar 10/21/1987 9.10 Interest rates continue to fall; deficit talks in Washington; bargain hunting 10/26/1987 —8.28 Fear of budget deficits; margin calls; reaction to falling foreign stocks 9/3/1946 —6.73 “No basic reason for the assault on prices” 5/28/1962 —6.68 Kennedy forces rollback of steel price hike 9/26/1955 —6.62 Eisenhower suffers heart attack 6/26/1950 —5.38 Outbreak of Korean War 10/20/1987 5.33 Investors looking for “quality stocks” 9/9/1946 —5.24 Labor unrest in maritime and trucking industries 10/16/1987 —5.16 Fear of trade deficit; fear of higher interest rates; tension with Iran 5/27/1970 5.02 Rumors of change in economic policy.


pages: 268 words: 81,811

Flash Crash: A Trading Savant, a Global Manhunt, and the Most Mysterious Market Crash in History by Liam Vaughan

algorithmic trading, backtesting, bank run, barriers to entry, Bernie Madoff, Black Swan, Bob Geldof, centre right, collapse of Lehman Brothers, Donald Trump, Elliott wave, eurozone crisis, family office, Flash crash, high net worth, High speed trading, information asymmetry, Jeff Bezos, Kickstarter, margin call, market design, market microstructure, Nick Leeson, offshore financial centre, pattern recognition, Ponzi scheme, Ralph Nelson Elliott, Ronald Reagan, sovereign wealth fund, spectrum auction, Stephen Hawking, the market place, Tobin tax, tulip mania, yield curve, zero-sum game

Convinced the authorities would never let that happen, Corzine quietly bought up $7 billion of the distressed securities, using them as collateral for a complicated so-called “repo” trade that served the dual purpose of keeping the instruments off the firm’s balance sheet and allowing it to declare its expected profits straightaway. It was the kind of bold, outside-the-box play that had catapulted Corzine from the family farm in Illinois to the Bilderberg Group. Unfortunately, this time the former high school quarterback had badly misjudged his Hail Mary pass. As the crisis deepened and the value of sovereign debt fell, the counterparties on the repo trades began issuing what are known as margin calls, forcing MF Global to hand over additional cash to cover potential losses. In October 2011, rating agencies downgraded the firm’s credit rating to “junk,” sparking the equivalent of a bank run, with customers calling up and demanding to withdraw their funds and lenders closing credit lines. In the frenzied final hours, a middle-ranking executive dipped into what should have been sacrosanct, segregated client funds to plug the gaps.


pages: 335 words: 94,657

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

For most people the most difficult part of the process is acquiring the habit of saving. Clear that one hurdle, and the rest is easy. What's that? You want an investment system where you don't have to save and can get rich quickly? Dream on. Sure, you can buy stocks on margin by putting as little as 20 percent down. But what if their value goes down? Are you prepared to come up with the cash to cover a margin call? In 1929 a lot of investors ran into that very problem. The consequences ushered in the historic stock market crash and the Great Depression. To our way of thinking, buying on margin isn't a prudent risk. Bogleheads are investors, not speculators. Investing is about buying assets, holding them for long periods of time, and reaping the harvest years later. Sure, it requires taking risks, but only when the odds are in your favor.


pages: 307 words: 90,634

Insane Mode: How Elon Musk's Tesla Sparked an Electric Revolution to End the Age of Oil by Hamish McKenzie

Airbnb, Albert Einstein, augmented reality, autonomous vehicles, barriers to entry, basic income, Bay Area Rapid Transit, Ben Horowitz, business climate, car-free, carbon footprint, Chris Urmson, Clayton Christensen, cleantech, Colonization of Mars, connected car, crony capitalism, Deng Xiaoping, disruptive innovation, Donald Trump, Elon Musk, Google Glasses, Hyperloop, Internet of things, Jeff Bezos, John Markoff, low earth orbit, Lyft, Marc Andreessen, margin call, Mark Zuckerberg, megacity, Menlo Park, Nikolai Kondratiev, oil shale / tar sands, paypal mafia, Peter Thiel, ride hailing / ride sharing, Ronald Reagan, self-driving car, Shenzhen was a fishing village, short selling, side project, Silicon Valley, Silicon Valley startup, Snapchat, South China Sea, special economic zone, stealth mode startup, Steve Jobs, Tesla Model S, Tim Cook: Apple, Uber and Lyft, uber lyft, universal basic income, urban planning, urban sprawl, Zipcar

In 2015, Jia had sold more than $30 million worth of his company’s shares and then lent the profit back interest-free. Leshi explained the practice to the Journal by saying Jia preferred to pledge shares rather than bring in outside investors because he wanted Leshi to focus on long-term growth. The risky maneuvers left the company vulnerable to any sudden shifts in the stock market. For instance, any drop in Leshi’s share price could potentially trigger a margin call, which a brokerage issues when it needs an investor to put up more cash to meet the minimum requirement to keep holding a stock. In such an event, Jia would have to sell his shares or find more funds to repay his loan, jeopardizing his entire financing structure—and therefore every company he touched—if his bets continued to go badly. In early 2015, Leshi revealed its plans to combat China’s air pollution, announcing that it would build an Internet-connected electric car and that it already had 260 engineers in California.


pages: 327 words: 90,542

The Age of Stagnation: Why Perpetual Growth Is Unattainable and the Global Economy Is in Peril by Satyajit Das

"Robert Solow", 9 dash line, accounting loophole / creative accounting, additive manufacturing, Airbnb, Albert Einstein, Alfred Russel Wallace, Anton Chekhov, Asian financial crisis, banking crisis, Berlin Wall, bitcoin, Bretton Woods, BRICs, British Empire, business cycle, business process, business process outsourcing, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Clayton Christensen, cloud computing, collaborative economy, colonial exploitation, computer age, creative destruction, cryptocurrency, currency manipulation / currency intervention, David Ricardo: comparative advantage, declining real wages, Deng Xiaoping, deskilling, disintermediation, disruptive innovation, Downton Abbey, Emanuel Derman, energy security, energy transition, eurozone crisis, financial innovation, financial repression, forward guidance, Francis Fukuyama: the end of history, full employment, gig economy, Gini coefficient, global reserve currency, global supply chain, Goldman Sachs: Vampire Squid, happiness index / gross national happiness, Honoré de Balzac, hydraulic fracturing, Hyman Minsky, illegal immigration, income inequality, income per capita, indoor plumbing, informal economy, Innovator's Dilemma, intangible asset, Intergovernmental Panel on Climate Change (IPCC), Jane Jacobs, John Maynard Keynes: technological unemployment, Kenneth Rogoff, knowledge economy, knowledge worker, light touch regulation, liquidity trap, Long Term Capital Management, low skilled workers, Lyft, Mahatma Gandhi, margin call, market design, Marshall McLuhan, Martin Wolf, Mikhail Gorbachev, mortgage debt, mortgage tax deduction, new economy, New Urbanism, offshore financial centre, oil shale / tar sands, oil shock, old age dependency ratio, open economy, passive income, peak oil, peer-to-peer lending, pension reform, plutocrats, Plutocrats, Ponzi scheme, Potemkin village, precariat, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, Ralph Nader, Rana Plaza, rent control, rent-seeking, reserve currency, ride hailing / ride sharing, rising living standards, risk/return, Robert Gordon, Ronald Reagan, Satyajit Das, savings glut, secular stagnation, seigniorage, sharing economy, Silicon Valley, Simon Kuznets, Slavoj Žižek, South China Sea, sovereign wealth fund, TaskRabbit, 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 market place, the payments system, The Spirit Level, Thorstein Veblen, Tim Cook: Apple, too big to fail, total factor productivity, trade route, transaction costs, uber lyft, unpaid internship, Unsafe at Any Speed, Upton Sinclair, Washington Consensus, We are the 99%, WikiLeaks, Y2K, Yom Kippur War, zero-coupon bond, zero-sum game

The ten-year US Treasury bond rate increased by 1 percent, causing losses of around US$40–50 billion on bank holdings of US Treasury bonds. The US Fed suffered losses of around US$190 billion, reversing its cumulative gains. Higher mortgage rates slowed the refinancing of existing mortgages and the recovery of the housing market. Stock and asset prices also fell sharply. Price falls reduced the value of financial assets used as collateral for loans, triggering margin calls and leading to a withdrawal of liquidity from markets. Higher US rates drove a rise in rates across the world, with the exception of Japan, which had launched a new QE program. In emerging markets, there were large outflows, exposing their reliance on foreign capital, and currencies fell, resulting in losses on foreign currency debt. The taper tantrum forced Bernanke to furiously backpedal.


pages: 323 words: 92,135

Running Money by Andy Kessler

Andy Kessler, Apple II, bioinformatics, Bob Noyce, British Empire, business intelligence, buy and hold, buy low sell high, call centre, Corn Laws, Douglas Engelbart, family office, full employment, George Gilder, happiness index / gross national happiness, interest rate swap, invisible hand, James Hargreaves, James Watt: steam engine, joint-stock company, joint-stock limited liability company, knowledge worker, Leonard Kleinrock, Long Term Capital Management, mail merge, Marc Andreessen, margin call, market bubble, Maui Hawaii, Menlo Park, Metcalfe’s law, Mitch Kapor, Network effects, packet switching, pattern recognition, pets.com, railway mania, risk tolerance, Robert Metcalfe, Sand Hill Road, Silicon Valley, South China Sea, spinning jenny, Steve Jobs, Steve Wozniak, Toyota Production System, zero-sum game

Look, people are always selling. You can find some cement company in Indonesia whose stock is under pressure for months at a time, but we hold off. A cheap stock is not the time to buy, because it will always get cheaper. We just wait for the puke.” “Which is what, exactly?” Jim prodded. “It’s when there are no bids. Some guy at Fidelity has fund redemptions or maybe some leveraged-up hedge fund has a margin call. These guys not only want to sell, but they have to sell. An involuntary impulse. They puke it up. You can take it off their hands at almost any price. They are just glad to get rid of it.” “I get it,” Jim said. “Yeah, it’s hard to sit around and wait for these things, but you know it when you see it. When someone pukes up a stock, it’s Making Your Month 33 not hard to miss. Mispriced securities all over the table.


pages: 329 words: 95,309

Digital Bank: Strategies for Launching or Becoming a Digital Bank by Chris Skinner

algorithmic trading, AltaVista, Amazon Web Services, Any sufficiently advanced technology is indistinguishable from magic, augmented reality, bank run, Basel III, bitcoin, business cycle, business intelligence, business process, business process outsourcing, buy and hold, call centre, cashless society, clean water, cloud computing, corporate social responsibility, credit crunch, crowdsourcing, cryptocurrency, demand response, disintermediation, don't be evil, en.wikipedia.org, fault tolerance, fiat currency, financial innovation, Google Glasses, high net worth, informal economy, Infrastructure as a Service, Internet of things, Jeff Bezos, Kevin Kelly, Kickstarter, M-Pesa, margin call, mass affluent, MITM: man-in-the-middle, mobile money, Mohammed Bouazizi, new economy, Northern Rock, Occupy movement, Pingit, platform as a service, Ponzi scheme, prediction markets, pre–internet, QR code, quantitative easing, ransomware, reserve currency, RFID, Satoshi Nakamoto, Silicon Valley, smart cities, social intelligence, software as a service, Steve Jobs, strong AI, Stuxnet, trade route, unbanked and underbanked, underbanked, upwardly mobile, We are the 99%, web application, WikiLeaks, Y2K

The mobile internet world squeezes and exposes the legacy on the one hand – this is why many banks have struggled to incorporate mobile services with their internet banking services – whilst the global, European and national regulatory requirements are placing further pressures on the core processes as well. Just look at the erosion of processing fees thanks to the Payment Services Directive in Europe or the Durbin amendment to Dodd-Frank in the USA, or the intraday and soon real-time margin calls for collateralisation under the European Market Infrastructure Regulation and Dodd-Frank, if you want to see how that changes things (not to even mention Basel III). Finally, assuming you managed a successful migration to the new world, there are still massive exposures to risk. We live in a world where technology drives our markets and yet the fear of changing technology is killing us. Therefore banks avoid migration to new core systems, and are handcuffed into legacy operations through their legacy systems.


Concentrated Investing by Allen C. Benello

activist fund / activist shareholder / activist investor, asset allocation, barriers to entry, beat the dealer, Benoit Mandelbrot, Bob Noyce, business cycle, buy and hold, carried interest, Claude Shannon: information theory, corporate governance, corporate raider, delta neutral, discounted cash flows, diversification, diversified portfolio, Edward Thorp, family office, fixed income, high net worth, index fund, John von Neumann, Louis Bachelier, margin call, merger arbitrage, Paul Samuelson, performance metric, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, survivorship bias, technology bubble, transaction costs, zero-sum game

He later commented about the trade, “Situations that simple and clear are few and far between, but we made a large part of our living off scenarios just like that.”34 Those situations were about as close to riskless as any investment can get. If the stock, which Thorp was short, rallied, he was protected by his long position in the convertible bond, which would rally in sympathy with the stock. If it failed to do so, and the spread between the two widened to the point that Thorp would get a margin call on the short, he could simply convert the bonds into stock and close out the position. If the price of his long bond position fell, he would be protected by the short in the equity, which would fall along with the bond. If it didn’t, and the gap widened, he could simply close out the position for no loss, or continue to collect the coupon. And so Thorp spent his days searching for little arbitrages to clip in obscure, thinly traded securities. 84 Concentrated Investing He had been plying his trade in arbitrage for more than a decade by the time Ma Bell announced its breakup.


pages: 311 words: 94,732

The Rapture of the Nerds by Cory Doctorow, Charles Stross

3D printing, Ayatollah Khomeini, butterfly effect, cognitive dissonance, combinatorial explosion, complexity theory, Credit Default Swap, dematerialisation, Drosophila, epigenetics, Extropian, gravity well, greed is good, haute couture, hive mind, margin call, negative equity, phenotype, plutocrats, Plutocrats, rent-seeking, Richard Feynman, telepresence, Turing machine, Turing test, union organizing

At first, they use normal voices, but they quickly ramp up to high-pitched squeals, and then burst the nonsound barrier with a nonboom that rattles Huw’s teeth with impressive pseudophysics. The three new instances diff-and-merge back into the djinni with a trio of comic pops and the djinni rubs his hands together. “Had to raid the pension fund to do it, but I think I’ve done for little what’s-her-number. An insult to one is an insult to all, so I just brought in the rest of my instance-sibs and margin-called that bitch so hard, she’ll be begging for spare cycles for the next hundred in realtime.” He shakes his head. “Noobs are all the same; think that once they’ve been around the block a few times, they can do whatever they want.” “What happened to my debt?” “Oh.” The djinni shrugs. “She flogged that as soon as I started my counterattack. I figure she had the countermeasure prepped in advance.


pages: 314 words: 101,452

Liar's Poker by Michael Lewis

barriers to entry, Bonfire of the Vanities, business cycle, cognitive dissonance, corporate governance, corporate raider, financial independence, financial innovation, fixed income, Home mortgage interest deduction, interest rate swap, Irwin Jacobs, John Meriwether, London Interbank Offered Rate, margin call, mortgage tax deduction, nuclear winter, Ponzi scheme, The Predators' Ball, yield curve

The world of money was in upheaval. Funds were rushing out of the stock market and into safe havens. The conventional safe haven for money is gold, but this was not a conventional moment. The price of gold was falling fast. Two creative theories made their happy way around the trading floor, both explaining the fall in gold. The first was that investors were being forced to sell their gold to meet margin calls in the stock market. The second was that in the depression that followed the crash, investors would have no need to fear inflation, and since for many gold was protection against inflation, it was less in demand. Whatever the case, money was pouring not into gold but into the money markets-i.e., short-term deposits. Had we had a money market department, we could have made a killing presiding over this movement, but we did not and could not.


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

Using a different SR won’t affect these numbers much, although the annual loss figures will be slightly better (worse) if the true Sharpe is higher (lower). 139 Systematic Trading skew strategies large losses are much less likely, as you can see in table 22. However the typical cumulative loss is higher. With negative skew it’s vital to have sufficient capital to cope with the very bad days, weeks and months you will occasionally see. This is especially true with high leverage and the risk your broker will make a margin call at the worst possible time. With positive skew the difficulty is psychological; committing to a system when you spend most of your time suffering cumulative losses. TABLE 21: HOW DO TYPICAL LOSSES LOOK WITH NEGATIVE SKEW? INDIVIDUAL LOSSES ARE HIGHER THAN IN TABLE 20, BUT CUMULATIVE LOSSES ARE SMALLER Percentage volatility target Expected 25% 50% Worst daily loss each month $3,100 $6,100 Worst weekly loss each year $8,500 $17,000 Worst monthly loss every ten years $18,100 $36,000 Worst daily loss every 30 years $11,500 $23,000 10% of the time, the cumulative loss will be at least $3,700 $7,400 1% of the time, the cumulative loss will be at least $7,100 $14,000 The table shows various expected losses (rows) and different percentage volatility targets (columns), for a negative skew option selling strategy given trading capital of $100,000.101 The strategy has a Sharpe ratio of 0.5 and skew of around -2. 101.


pages: 363 words: 98,024

Keeping at It: The Quest for Sound Money and Good Government by Paul Volcker, Christine Harper

anti-communist, Ayatollah Khomeini, banking crisis, Bretton Woods, business cycle, central bank independence, corporate governance, Credit Default Swap, Donald Trump, fiat currency, financial innovation, fixed income, floating exchange rates, forensic accounting, full employment, global reserve currency, income per capita, inflation targeting, liquidationism / Banker’s doctrine / the Treasury view, margin call, money market fund, Nixon shock, Paul Samuelson, price stability, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Ronald Reagan, Rosa Parks, secular stagnation, Sharpe ratio, Silicon Valley, special drawing rights, too big to fail, traveling salesman, urban planning

October 6, 1979 Meeting of the Federal Open Market Committee (FOMC) to agree to new policy package, unveiled at 6 p.m. press conference. Plan includes increase in discount rate to 12 percent, new reserve requirements, and a new focus on controlling the money supply instead of short-term interest rates. March 14, 1980 Carter unveils Anti-Inflation Program, including plans to submit a smaller 1981 budget (reduced by $13 billion) and to impose credit controls. March 27, 1980 Silver price decline sets off margin calls against Hunt brothers’ massive holdings, threatening Bache Group and other financial institutions. April 28, 1980 First Pennsylvania Bank announces it has received a $1.5 billion rescue, sponsored by the Federal Deposit Insurance Corporation (FDIC) and Federal Reserve. May 22, 1980 In midst of sudden recession, Fed rolls back most of the credit controls implemented in March. October 2, 1980 Monetary policy tightening ahead of the election incites mild presidential criticism.


pages: 356 words: 103,944

The Globalization Paradox: Democracy and the Future of the World Economy by Dani Rodrik

affirmative action, Asian financial crisis, bank run, banking crisis, bilateral investment treaty, borderless world, Bretton Woods, British Empire, business cycle, capital controls, Carmen Reinhart, central bank independence, collective bargaining, colonial rule, Corn Laws, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, Doha Development Round, en.wikipedia.org, endogenous growth, eurozone crisis, financial deregulation, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, George Akerlof, guest worker program, Hernando de Soto, immigration reform, income inequality, income per capita, industrial cluster, information asymmetry, joint-stock company, Kenneth Rogoff, land reform, liberal capitalism, light touch regulation, Long Term Capital Management, low skilled workers, margin call, market bubble, market fundamentalism, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, microcredit, Monroe Doctrine, moral hazard, night-watchman state, non-tariff barriers, offshore financial centre, oil shock, open borders, open economy, Paul Samuelson, price stability, profit maximization, race to the bottom, regulatory arbitrage, savings glut, Silicon Valley, special drawing rights, special economic zone, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tobin tax, too big to fail, trade liberalization, trade route, transaction costs, tulip mania, Washington Consensus, World Values Survey

It drove down real interest rates in the United States and Europe and sparked a credit boom, inducing banks to go on a wild goose chase for yield and inflate their balance sheets. Free capital mobility ensured that investors in Europe and elsewhere ended up sitting on a pile of toxic mortgage assets exported from the United States. Whole countries such as Iceland turned into hedge funds, leveraging themselves to the hilt in international financial markets in order to exploit small differentials in margins. Calls for increased regulation of finance were rebuffed by pointing out that banks would simply get up and move to less regulated jurisdictions.23 The immediate causes of the financial crisis of 2008 are easy to identify in hindsight: mortgage lenders (and borrowers) who assumed housing prices would keep rising, a housing bubble stoked by a global saving glut and the reluctance of Alan Greenspan’s Federal Reserve to deflate it, financial institutions addicted to excessive leverage, credit rating agencies that fell asleep on the job, and of course policy makers who failed to get their act together in time as the first signs of the crisis began to appear.


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

Thorp read a news article saying that some people were buying silver. The demand for silver had long been greater than the supply. The difference had been made up by melting down and reclaiming old jewelry and other silverware. Stores of reclaimable silver were running low. Using his savings, Thorp bought some silver at about $1.30 an ounce. It went up to about $2. He bought more silver on margin (with borrowed money). The price fell. Thorp couldn’t meet the margin calls and lost about $6,000, a crushing sum at the time. “I learned an expensive lesson,” he said. The lesson was: You are unlikely to get an edge out of what you see in the news. A couple of Texas investors contacted Thorp. They had heard of him through the blackjack publicity. They identified themselves as experts in picking life insurance stocks and wanted to know if Thorp might be able to help them.


The Permanent Portfolio by Craig Rowland, J. M. Lawson

Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

You will need to buy the shares back at a much higher price in order to return them to the broker to cover your short sale. The losses can add up quickly because although a price can drop to zero (which is good if you are shorting the stock), the price can also continue going up indefinitely (very bad for a short sale). The potential for loss is therefore unlimited with shorting (in reality the broker will issue a margin call and clean out your account to cover the losses before that happens). Since shorting stocks can result in larger losses than the initial investment, this activity should be avoided in the Variable Portfolio. Likewise, there are some private business investments that can leave you on the hook for more than you invested. In particular, avoid any investment that makes you a co-signer for debt that is larger than what you have put in.


pages: 407 words: 104,622

The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution by Gregory Zuckerman

affirmative action, Affordable Care Act / Obamacare, Albert Einstein, Andrew Wiles, automated trading system, backtesting, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, blockchain, Brownian motion, butter production in bangladesh, buy and hold, buy low sell high, Claude Shannon: information theory, computer age, computerized trading, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversified portfolio, Donald Trump, Edward Thorp, Elon Musk, Emanuel Derman, endowment effect, Flash crash, George Gilder, Gordon Gekko, illegal immigration, index card, index fund, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, Loma Prieta earthquake, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, Mark Zuckerberg, More Guns, Less Crime, Myron Scholes, Naomi Klein, natural language processing, obamacare, p-value, pattern recognition, Peter Thiel, Ponzi scheme, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, Robert Mercer, Ronald Reagan, self-driving car, Sharpe ratio, Silicon Valley, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, Steve Jobs, stochastic process, the scientific method, Thomas Bayes, transaction costs, Turing machine

“I don’t know what the hell is going on, but it’s not good,” Brown told someone. On Wednesday, things got scary. Simons, Brown, Mercer, and about six others hustled into a central conference room, grabbing seats around a table. They immediately focused on a series of charts affixed to a wall detailing the magnitude of the firm’s losses and at what point Medallion’s bank lenders would make margin calls, demanding additional collateral to avoid selling the fund’s equity positions. One basket of stocks had already plunged so far that Renaissance had to come up with additional collateral to forestall a sale. If its positions suffered much deeper losses, Medallion would have to provide its lenders with even more collateral to prevent massive stock sales and losses that were even more dramatic.


file:///C:/Documents%20and%... by vpavan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, asset allocation, Berlin Wall, business cycle, buttonwood tree, buy and hold, corporate governance, corporate raider, disintermediation, diversification, diversified portfolio, Donald Trump, estate planning, fixed income, index fund, intangible asset, interest rate swap, margin call, money market fund, Myron Scholes, new economy, price discovery process, profit motive, risk tolerance, shareholder value, short selling, Silicon Valley, Small Order Execution System, Steve Jobs, stocks for the long run, stocks for the long term, technology bubble, transaction costs, Vanguard fund, women in the workforce, zero-coupon bond, éminence grise

If the shares fall to $40, your equity has dropped from $2,500 (the amount of your original investment) to $1,500 (100 shares x $40 minus your $2,500 loan = $1,500). That $1,500 in equity meets the broker's 30 percent maintenance margin requirement (30 percent of $4,000 = $1,200). But if the value of your shares falls to $25, your equity has evaporated altogether (100 shares x $25 minus your $2,500 loan = 0). Your broker will make what is known as a margin call, demanding additional payment of cash or other securities into your account within two or three days. If you are unable to pay, the firm will sell your shares. You may have to take heavy losses, even if you wanted to stick with your investment in the hope that the share price rebounds. Profits and Professionalism In the 1970s, when I oversaw the retail business of our firm, after numerous acquisitions now called Shearson Hayden Stone, part of my job was to hire and train new brokers.


pages: 1,066 words: 273,703

Crashed: How a Decade of Financial Crises Changed the World by Adam Tooze

Affordable Care Act / Obamacare, Apple's 1984 Super Bowl advert, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Bernie Sanders, Big bang: deregulation of the City of London, Boris Johnson, break the buck, Bretton Woods, BRICs, British Empire, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, dark matter, deindustrialization, desegregation, Detroit bankruptcy, Dissolution of the Soviet Union, diversification, Doha Development Round, Donald Trump, Edward Glaeser, Edward Snowden, en.wikipedia.org, energy security, eurozone crisis, Fall of the Berlin Wall, family office, financial intermediation, fixed income, Flash crash, forward guidance, friendly fire, full employment, global reserve currency, global supply chain, global value chain, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, housing crisis, Hyman Minsky, illegal immigration, immigration reform, income inequality, interest rate derivative, interest rate swap, Kenneth Rogoff, large denomination, light touch regulation, Long Term Capital Management, margin call, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, mittelstand, money market fund, moral hazard, mortgage debt, mutually assured destruction, negative equity, new economy, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shale / tar sands, old-boy network, open economy, paradox of thrift, Peter Thiel, Ponzi scheme, predatory finance, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, reserve currency, risk tolerance, Ronald Reagan, savings glut, secular stagnation, Silicon Valley, South China Sea, sovereign wealth fund, special drawing rights, structural adjustment programs, The Great Moderation, Tim Cook: Apple, too big to fail, trade liberalization, upwardly mobile, Washington Consensus, We are the 99%, white flight, WikiLeaks, women in the workforce, Works Progress Administration, yield curve, éminence grise

An avalanche of defaults and foreclosures would in due course grind its way through the system. But that would take years. The first credit default event on which AIG had to pay out did not occur until December 2008. The problem was the anticipatory reaction of financial markets and the fast-moving revaluation of securitized mortgages and the derivatives based on them. In the case of AIG, as it lost its top-tier credit rating, this triggered immediate margin calls from the counterparties to AIG’s insurance contracts. They wanted collateral to prove that AIG could meet its obligations if the mortgages did go bad. It was these collateral calls, running into tens of billions, that threatened to tip AIG over the edge. AIG’s troubles did not end there. It had made life much harder for itself by engaging in the securities lending business. A group within AIG specialized in pooling the high-quality Treasurys and other securities held by AIG’s insurance funds.

Like Bear, Lehman and Merrill, Goldman was acutely vulnerable to a loss of confidence. One of the plays that would see Goldman through the crisis was the big short position it had built, betting against mortgage-backed securities. A big piece of that bet was placed by buying CDS from AIG. Already by June 30, 2008, Goldman had called $7.5 billion in collateral. When AIG was downgraded on September 15, there was a new surge in margin calls. Of the total claim against AIG, which now topped $32 billion, Goldman Sachs and its partner Société Générale accounted for $19.8 billion.24 For AIG the consequences were drastic. It was scrambling for cash at the worst possible moment. With its rating on the downgrade it could not borrow tens of billions through ordinary channels. It could raise the funds only through fire sales, and that meant recognizing the losses on its balance sheet, which would make its position only even more precarious.


pages: 549 words: 116,200

With a Little Help by Cory Efram Doctorow, Jonathan Coulton, Russell Galen

autonomous vehicles, big-box store, Burning Man, call centre, carbon footprint, death of newspapers, don't be evil, game design, Google Earth, high net worth, lifelogging, margin call, Mark Shuttleworth, offshore financial centre, packet switching, Ponzi scheme, rolodex, Sand Hill Road, sensible shoes, skunkworks, Skype, traffic fines, traveling salesman, Turing test, urban planning, Y2K

He armored himself for the inevitable shock, disbelief and protestation, but she just hung her head, resigned. 440 "Figures," she said. 441 He ran his fingers down the spines until he found a cheaper one -- bound with floppy felt screened with a remixed Victorian woodcut of a woman with tentacles for arms. "This one's got mostly the same text, but I can let you have it for, erm," he looked at the sheet again, thinking about the wholesale price, about his margin. "Call it twenty-five pounds." 442 She shook her head again, gave him a wry smile. "Still too much. I should have known. It's mostly the posh kids who've got 'em, the kind who turn up at school with a tenner just for lunch money." 443 "You could just read it online, you know." 444 "Oh, I do," she said. "Been following it since it started." Her eyes flicked down. "Wrote a little, too -- didn't make it into the top 100, though." 445 The Story So Far was part game, part competition, part creative writing exercise, a massive shared universe drama with dozens of sub-plots, mysteries, betrayals, crosses, and double-crosses.


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

Professor Irving Fisher of Yale, one of the progenitors of the intrinsic-value theory, offered his soon-to-be-immortal opinion that stocks had reached what looked like a “permanently high plateau.” By Monday, October 21, the stage was set for a classic stock-market break. The declines in stock prices had led to calls for more collateral from margin customers. Unable or unwilling to meet the calls, these customers were forced to sell their holdings. This depressed prices and led to more margin calls and finally to a self-sustaining selling wave. The volume of sales on October 21 zoomed to more than 6 million shares. The ticker fell way behind, to the dismay of the tens of thousands of individuals watching the tape from brokerage houses around the country. Nearly an hour and forty minutes had elapsed after the close of the market before the last transaction was actually recorded on the stock ticker.


pages: 423 words: 118,002

The Boom: How Fracking Ignited the American Energy Revolution and Changed the World by Russell Gold

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, activist lawyer, addicted to oil, American energy revolution, Bakken shale, Bernie Sanders, Buckminster Fuller, clean water, corporate governance, corporate raider, energy security, energy transition, hydraulic fracturing, Intergovernmental Panel on Climate Change (IPCC), margin call, market fundamentalism, Mason jar, North Sea oil, oil shale / tar sands, oil shock, peak oil, Project Plowshare, risk tolerance, Ronald Reagan, shareholder value, Silicon Valley, Upton Sinclair

McClendon’s email in April 2013 was first reported by Christopher Helman in Forbes in an article titled “Aubrey McClendon Is Now Hiring.” Baihly, Jason, Raphael Altman, Raj Malpani, and Fang Luo. “Shale Gas Production Decline Trend Comparison over Time and Basins.” Paper presented at SPE Annual Technical Conference and Exhibition, September 19–22, 2010, Florence, Italy. Birol, Fatih. World Energy Outlook 2012. Paris: IEA Publications, 2012. Casselman, Ben. “Margin Calls Hitting More Executive Suites.” Wall Street Journal, October 13, 2008. Gold, R. “Costly Liabilities Lurk for Gas Giant.” Wall Street Journal, May 11, 2012. Gold, R., and Daniel Gilbert. “The Many Hats of Aubrey McClendon.” Wall Street Journal, May 8, 2012. Schneyer, Joshua, Jeanine Prezioso, and David Sheppard. “Special Report: Inside Chesapeake, CEO Ran $200 million Hedge Fund.” Reuters, May 2, 2012.


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

“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of these transactions,” Cassano had said. But by early 2008, it was clear that the cocky Cassano’s imagination had been woefully inadequate, even delusional. As earnings collapsed, Cassano was forced into retirement in March. AIGFP had issued more policies on derivatives than it had cash to cover. The “black swan” event of Lehman’s collapse triggered the largest margin call of all time. AIG faced paying billions of dollars to banks all around the world. The failure of parent company AIG could have triggered a global banking cataclysm. No wonder Paulson couldn’t sleep and was throwing up during this period, as he later said in his memoir. I can only imagine his anxiety. I was pacing in my kitchen night after night, watching CNBC International for any clues of what was to come.


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

Then, in the second week of September, Cohen’s lawyers got a call from Anjan Sahni, the co-chief of the securities unit at the U.S. Attorney’s Office. Sahni and his colleagues wanted to talk about settling the case against SAC. Not much had happened during the month of August, after the indictment. The prosecutors noticed, though, that business at SAC had gone on as if nothing unusual had occurred. There were no visible crises in the market, no layoffs or margin calls. Wall Street had absorbed criminal charges against one of the largest hedge funds in the world with barely any disruption. Settling the case was the only resolution that made sense; a trial was a risky proposition for both sides. For the government, losing the SAC case would have led to humiliation, a heavy blow to morale at the office. Mathew Martoma’s trial was approaching, and the FBI still hoped that he would decide to cooperate, in which case prosecutors would need all of their resources to develop that case.


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

The additional margin deposited is called variation margin and it is an amount necessary to bring the margin in the account balance back to its initial margin level. Unlike initial margin, variation margin must be in cash, not interest-bearing instruments. If a party to a 1 Individual brokerage firms are free to set margin requirements above the minimum established by the exchange. 212 THE GLOBAL MONEY MARKETS futures contract receives a margin call and is required to deposit variation margin fails to do so within 24 hours, the futures position is closed out. Conversely, any excess margin may be withdrawn by the user. Although there are initial and maintenance margin requirements for buying securities on margin, the concept of margin differs for securities and futures. When securities are acquired on margin, the difference between the security’s price and the initial margin is borrowed from the broker.


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 CEO, Martin Sullivan, and Cassano both spoke with great assurance. “We are confident in our marks and the reasonableness of our valuation methods,” Sullivan said. AIG’s mathematical models gave him “a very high level of comfort.”16 The executives went into elaborate detail, yet managed to sidestep AIG’s biggest concern: regardless of what its models said the CDOs were worth, as long as prices kept falling AIG would be hit with continuing margin calls. As investors had no idea that AIG had received any collateral calls, and certainly had no independent means of assessing its CDO contracts, once again they were reassured. Not for the first time, there was a feeling on Wall Street that the crisis was, if not quite over with, then at least past its worst. The Street divided naturally between equity professionals and credit analysts. While the latter worried about default risk, stock traders, by nature and trade, were more bullish.


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

Professor Irving Fisher of Yale, one of the progenitors of the intrinsic-value theory, offered his soon-to-be-immortal opinion that stocks had reached what looked like a “permanently high plateau.” By Monday, October 21, the stage was set for a classic stock-market break. The declines in stock prices had led to calls for more collateral from margin customers. Unable or unwilling to meet the calls, these customers were forced to sell their holdings. This depressed prices and led to more margin calls and finally to a self-sustaining selling wave. The volume of sales on October 21 zoomed to more than 6 million shares. The ticker fell way behind, to the dismay of the tens of thousands of individuals watching the tape from brokerage houses around the country. Nearly an hour and forty minutes had elapsed after the close of the market before the last transaction was actually recorded on the stock ticker.


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

When the bill came back before the House, in an acrimonious few hours, two days later, it was voted into law 263–171. This was just as well, because the markets were suffering a complete crisis of confidence. With the credit lines still frozen and no one sure what House Speaker Nancy Pelosi and her merry men were going to do next, the Dow had caved in another 500 points before that vote went through. Margin calls were raining in, hedge funds were going bust, and God knows what else. The question was, would Hank Paulson’s bailout bill save the world? Answer: not quite. On Monday, October 6, the first full trading day since the bill was passed, the Dow crashed down through 10,000, with an intraday low of 9,525. It closed at 9,955 in a day packed with fear-laden trading and volatility, a day in which the Volatility Index (VXO) broke 50 for the first time since 1987.


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

This forces the short sellers to cover their positions, which causes the price to rise further, accentuating the loss in a short sale. Further, conditions relating to borrowed shares change on a daily basis: the shares may be put on “special,” meaning that the short seller has to pay greater compensation to the lender, and the collateral is revised daily to ensure that the lender holds at least 102 percent of the value of shares lent. Besides satisfying the lenders’ conditions, short sellers are also subject to margin calls from the broker. Recall that S has short-sold 100 shares at $50 each. If the stock price rises to $105, then S’s loss is 100 × ($105—$50) = $5,500, which is more than the initial money in the short seller’s account. Brokers cannot allow this situation to occur. Therefore, if the stock price rises, the brokers will call S to put up more margin money. Failing that, the broker will liquidate the position without further consultation.


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

I have had the opportunity to take on an extraordinary range of assignments in the past 15 years, for 275 clients on six continents. We undertook the investigation of Bankers Trust ordered by U.S. financial regulators after the derivatives losses experienced by P&G and Gibson Greetings. I consulted to the Fed after the LTCM crisis. I was called by Orange County a month to the day before its bankruptcy and asked “to review their portfolio and analyze what the impact of the margin calls they were starting to get would have on their yield.” We were the ones to have to explain to them (and the SEC) that they had more serious problems than a decrease in their yield! We arranged four bailout plans during their final weekend meltdown, but they were not able to enter into any of them. Once Citron was fired, no one at Orange County was legally authorized to enter into a deal. In many ways, the most satisfying assignments I have had over the years have been those that have help clients develop approaches to grow and thrive.


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

If he were ruined, he would ruin many others at the same time. Where the du Ponts trusted Durant, Dwight Morrow and other Morgan partners were suspicious. As GM shares broke below 20, Durant kept trying to hold back the tide by buying up more shares on margin. He continued to deny that there might be a problem. As the stock dropped as low as 12, his losses steadily mounted. By the night of November 18, 1920, Durant needed close to $1 million to meet margin calls before the market opened the next morning. Like Henry Ford, Durant despised bankers, viewing them as complacent men with tunnel vision who plundered the inventions of more original minds. Now he had to phone the House of Morgan and ask whether they would buy his GM stock at the closing price of $12 a share. Pierre du Pont and the Morgan partners, who thought Durant an incompetent, feared a market crash unless he were rescued.

His debts had bulged to an extraordinary $38 million, and his anteroom was crowded with creditors demanding repayment. The Morgan partners saw a possible repeat of the 1907 panic, with Durant defaults shutting down a string of brokers. In a frenetic, all-night rescue session, the Morgan men bought up Durant’s shares at $9.50 per share—a steep discount from the closing price. The du Ponts put up $7 million, and the House of Morgan raised another $20 million to save Durant from margin calls. By dawn, a new company had been formed to buy Durant’s stock. Durant’s share of the new company was only 40 percent, while the du Ponts held 40 percent, and the Morgan-led bankers took 20 percent as their commission. Pierre du Pont was ready to deal leniently with Durant, but the pitiless Morgan partners insisted that he resign from GM. Overnight, the du Ponts and J. P. Morgan and Company had kidnapped an industrial empire.


pages: 1,169 words: 342,959

New York by Edward Rutherfurd

Bonfire of the Vanities, British Empire, Charles Lindbergh, illegal immigration, margin call, millennium bug, out of africa, place-making, plutocrats, Plutocrats, rent control, short selling, Silicon Valley, South Sea Bubble, the market place, urban renewal, white picket fence, Y2K, young professional

The atmosphere was tense. Glancing up at the visitors’ gallery, he saw a face he thought looked familiar. “That’s Winston Churchill, the British politician,” one of the traders remarked. “He’s chosen a hell of a day to call.” He certainly had. As trading began, Master was aghast. The market wasn’t just falling, it was in headlong panic. By the end of the first hour, there were cries of pain, then howls. Men with margin calls were being wiped out. A couple of times, sellers were shouting out prices and finding not a single buyer in the market. As noon approached, he reckoned the market would soon have fallen nearly ten percent. The anguished hubbub from the floor was so loud that, unable to bear it any longer, he walked outside. In the street, the scene was extraordinary. A crowd of men had gathered on the steps of Federal Hall.

As they left the office, he told Charlie: “I just sold again.” “Already?” said Charlie. “Profit-taking. I lost a bit of money last week, but I just made half of it back again.” The following week, however, the market slumped again. Five percent on Monday; nine percent on Wednesday. And it just kept sliding, day by day. By November 13, the Dow was at 198, only just over half its September high. Investors, small and large, with big margin calls were being wiped out. Brokerage houses that’d lent money that couldn’t be repaid were failing. “Plenty of the weaker banks may fail, too,” William told Charlie. But each morning the street witnessed William Master arriving at his office in his silver Rolls-Royce, as he calmly carried on with business as usual. “We’ve taken losses,” he told people, “but the firm is sound. And so is this country’s economy,” he liked to add.


Debt of Honor by Tom Clancy

airport security, banking crisis, Berlin Wall, buttonwood tree, complexity theory, cuban missile crisis, defense in depth, job satisfaction, low earth orbit, margin call, New Journalism, oil shock, Silicon Valley, tulip mania, undersea cable

Heads turned because Ryan was the one who answered the question. "It's confidence. Buzz here wrote a book about that back when I was working for Merrill Lynch." Perhaps a friendly reference would steady the man down some, he thought. "Thank you, Jack." Fiedler sat down and sipped a glass of water. "Use the 1929 crash as an example. What was really lost? The answer in monetary terms is, nothing. A lot of investors lost their shirts, and margin calls made it all worse, but what people don't often grasp is that the money they lost was money already given to others." "I don't understand," Arnie said. "Nobody really does. It's one of those things that's too simple. In the market people expect complexity, and they forget the forest is made up of individual trees. Every investor who lost money first gave his money to another trader, in return for which he received a stock certificate.

Therefore the amount of money out in the economy in 1929 did not change at all." "Money doesn't just evaporate, Arnie," Ryan explained. "It goes from one place to another place. It doesn't just go away. The Federal Reserve Bank controls that." It was clear, however, that van Damm didn't understand. "But then, why the hell did the Great Depression happen?" "Confidence," Fiedler replied. "A huge number of people really got slammed in '29 because of margin calls. They bought stock while putting up an amount less than the value of the transaction. Today we call that sort of thing leveraging. Then they were unable to cover their exposure when they had to sell off. The banks and other institutions took a huge beating because they had to cover the margins. You ended up with a lot of little people who were left with nothing but debts they couldn't begin to pay back, and banks who were cash-short.


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

It seemed premature to suggest steps to avoid a future crisis with no end in sight to this one. As much as I wanted to cancel the speech, I felt that if I did, the market would have smelled blood. I hurried through my brief remarks, preoccupied and impatient to get back to the office. It had been a rough week. The markets had taken a sharp turn for the worse, as sinking home prices continued to pull down the value of mortgage securities, triggering more losses and widespread margin calls. Financial stocks were staggering, while CDS spreads—the cost to insure the investment banks’ bonds against default or downgrade—hit new highs. Banks were reluctant to lend to one another. The previous weekend there had been a banking conference in Basel, and Tim Geithner had told me that European officials were worried that the crisis was worsening. It was an unsettling confirmation of conversations I had had with a number of European bankers.


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