Covered Call

When people buy a call option, they would make profits if the market price of stocks is higher than the strike price of the call option. If the market price of stocks is lower than the strike price of call option, they would lose the amount of cost when they purchase a call option. When they sell a call option, they also have possibilities to lose or gain. However, if they purchase covered call, their profit could be a double and lose could be reduced an half. This is how covered call works. When people buy stock of A which we call an underlying asset, they also buy a call option of stock A at the same time. Then, they sell the call option. When the market price is lower than the strike price which they are already sold, they could make profits from the premiums by selling the call option. For example, let’s assume the stock price is $50, the exercise price is $55, and the premium of call is $4. The covered call buyers can make $9 profit ($55-$50+$4). If the market price is higher than the exercised price, the covered call buyer’s payoff would be reduced. Nevertheless, some people think when the market price is higher the covered call buyers can make profits from their premiums by selling a call option, and their stock price of A also goes up. I think that also make sense. However, the important thing is how much the market price goes up. If the difference between the market price and exercised price is less than the call option premiums, the covered call buyers still can make a profit. For example, let’s assume the stock price is $57, the exercise price is $55, and the premium of call is $4. Even though the covered call buyers should sell the stock with exercised price, $55, to the call option buyers, the covered call buyers still could make a profit $2 ($57-$55+$4). Nevertheless, if the difference between the market price and exercised price is higher than the call option premiums, the covered call buyers would loss. For example, if the market price goes $70, they would loss $11($70-$55+$4).
In conclusion, the potential profits of covered calls are limited, but the potential losses of covered calls are in unlimited. I think most of financial derivatives also make limited profits and unlimited losses


http://www.investopedia.com/articles/optioninvestor/04/021104.asp

http://www.forbes.com/2009/04/06/options-income-portfolio-personal-finance-investing-ideas-covered-calls.html

http://en.wikipedia.org/wiki/Covered_call

Opinion in " to invest or not to invest"

I agree with Unique that it is time to invest, but I do not think that is realistic for a middle-class. Throughout the 100 years of history in the U.S stock market, the U.S stock market keeps going up and down over 100 years. Thus, investors simply forecast the current crashed stock market would go up and be stable in the future, but they do not know exactly when would that happen occurs. However, I think that theory is only works for people who are available to invest for the long-term. The reason is that as the investors forecast the future stock market, the stock market would go up, but the time is matter. Thus, even though people who have little or no spare money to invest know they would get great returns in the future if they invest into the stock market, it is hard for them to take that action. If people have little spare money to invest, they want to have the returns in the short period of time because a longer time they invest into the stock market, their volatility in financial management would be a higher. In other words, the longer they put their spare money into the stock market; there is less possibility to solve their financial problems. Thus, I think it is not realistic for the most of middle class.
Most of people who want to invest now do not know where to invest. In addition, some investors would recommend investing in gold. When the stock market is unstable, people tend to invest into commodities, such as gold, oranges, and apples. In addition, as we all know gold is limited, so people think the price of gold would never go down. People simply buy actual gold, and re-sell them when the price of gold is higher. Or people buy mutual funds that are related to gold mining companies. However, I want to notice that the gold investments also have risks. First, if people try to buy actual gold, it contains additional 10% of fees to buy actual gold. The cost is a high compared to buy stocks. Next, a volatility of gold price is high. In March 2008, the price of gold per ounce was $1000, but the price fall down to $700 in October 2008. The 30% of gold price was gone down in 7 months. Thus, people should notice that price of gold could be down. Last, the returns in the mutual funds that are related to gold mining companies are also affected by foreign currencies. The reason is that the size of mutual funds is relatively small, so the most of brokers of that funds also invest internationally. Therefore, I would recommend to people to consider seriously before they invest in gold.




http://www.fool.com/investing/dividends-income/2008/10/24/invest-without-the-stress.aspx

http://goldprice.org/gold-price-history.html

http://uniquebl0gs.blogspot.com/2009/04/to-invest-or-not-to-invest.html

Short Selling

Short selling is a method that selling a current stock with the market price, but actually the stock seller did not purchase the stock with his or her money that he or she sold. He or she borrowed the stock and sold it, so he or she should buy back the same stock with the future value, which the stock buyer and his or her broker specified in the contract. Thus, if the future value of the stock value decrease, he or she would make a profit. For example, I sell the Stock A with $15, and I did not purchase that stock with my money. I borrowed that stock and sell it to the stock market, so I gain $15. However, I should buy back the amount that I borrowed before I and my broker specified the period of time. Thus, if the future value of the stock goes below $15, I make a profit. Nevertheless, if the future value of the stock goes over $15, I make a loss, and the amount of loss would be unlimited. The reason is that the price of stock could go up to $100 or more. Thus, if an investor invests through short selling, he or she should consider the short selling could bring unlimited loss. However, the maximum profit of the short selling is limited because the lowest stock price would be $.01. If I sold stock at $10, the maximum profit I can make is $9.99 from that stock.
Personally, I do not like the way of investment like short selling. The reason is that the profit is limited and the loss is unlimited. If an investor buys a stock with his or her money, the investor could estimate how much would the investor loses on his or her investment if the stock defaults. However, if an investor invests through short selling, he or she cannot estimate the loss of worst cases.

http://en.wikipedia.org/wiki/Short_selling

Opinion in CEO Compensation

I read Dwayne’s article about CEO compensation, and he thinks that CEO gets too much compensations. In addition, a company reduces CEO’s compensation, and the company can pay more to lower level workers with that reduced compensation. However, I do not agree with Dwayne’s thought.
As of 2004, when CEOs got their total compensations, only 15% of the compensations was their salaries, a 23% was their bonuses, and a 62% was the long-term incentives such as stock options, restricted stock, and performance units/shares. Thus, basically, if CEOs do not perform their job well or their companies’ shares go down, the 62%, which is the long-term incentive, of their total compensations could be reduced. However, there were some exceptions. Some CEOs’ compensations were increased while their companies’ shares were decreasing. For example, the CEO of Merrill Lynch, Stanely O’Neal, had more than $160 million of total compensation while the company was dropping down 40% of its share value, and imposed huge debts. I think only a few CEOs get their compensations like the way Stanely O’Neal had gotten. In addition, those CEOs cause normal people to think that CEOs’ compensations are too high. Some CEOs got underpaid, for example, Jack Welch, the former CEO of General Electric, raised GE’s assets from about $14 billion to $500 billion before he retired, but he got the compensations relatively lower with his achievements.
Most of CEOs are having too much stress on their heavy works and pressures, the most of CEOs work around 60 hours per week, and they bring their work to home. Even though their pays are about 160 times of the average workers’ salary, I think they deserve it.

http://dwang9.blogspot.com/2009/04/ceos-compensation.html
http://www.investopedia.com/articles/fundamental-analysis/08/executive-compensation.asp
http://equityprivate.typepad.com/ep/2006/03/yesterday_finan.html
http://economistsview.typepad.com/economistsview/2007/09/reich-ceos-dese.html
http://www.blnz.com/news/2009/03/23/Executive_Isnt_That_Excessive_Some_5335.html

Arbitrage

Arbitrage is the method of making profits from different a price of same asset in different markets. The basic idea is that people should buy underestimated assets and sell overestimated assets, so they make profits when the over or underestimated prices go back to their right prices. People easily can find in a currency exchange market. When you buy U.S dollar in London, Seoul, and Beijing, the price of U.S dollar would be the different. Thus, if people buy U.S dollar in London relatively cheaper than Korea and they can re-sell the U.S dollar in Korea, they can make profits from the difference price between the two countries. Many people use statistical arbitrage, and that is people perform arbitrage by using a statistic on the certain events. People estimate the expected value of certain events, and then when the events are underestimated they invest into those events. For example, people flip a coin and the probability of having tail and head are 50% and 50%. If 70 people bet $100 on having tail in next flip and only 30 people bet $100 on having head in next flip. However, important thing is if the 70 people win they will be get only make $42 (30 people (loser) x $100 / 70 people (winner)) of profits. If the 30 people who bet on having head in next flip win they will be get $233 (70 people (loser) x $1000 / 30 people (winner)) of profits. Thus, if people know how to get expected value from there, they bet on having head in the next flip. Arbitrage is a one of the safe ways to invest, so it is used by hedge funds. However, arbitrage also has a weak point that is if an investor forecasts future poorly, the investor will lose on his or her investment. For example, company A tries to take over company B, and the stock price of company B is $30. Let’s assume if company A takes over company B successfully, investors expect the stock price of B will go up to $40. If the Company B’s early trades of stocks are priced at $35, there is $5 difference between early trades and expect stock price. That is we call risk arbitrage. If company A takes over company B successfully, the investors would make $5 profits. Nevertheless, if the company A could not take over company B, the stock price of company B probably goes below $30, and the investors would lose on their investments. Many investors think arbitrage is considered as risk free investment, but investors should consider those unexpected event in the future.



http://www.investopedia.com/articles/trading/07/statistical-arbitrage.asp

http://en.wikipedia.org/wiki/Risk_arbitrage

http://cafe.daum.net/hedgemanagement/6d8t/2?docid=1GKJ2%7C6d8t%7C2%7C20081223163550&q=statistical%20arbitrage&srchid=CCB1GKJ2%7C6d8t%7C2%7C20081223163550

Opinion in "McDonald’s first quarter revenue drop "

The main idea of Tewodros' article is that even though McDonald's sales increase, thier profits decrease due to foreign currency flcutuation and company’s raw materials such as ingredients of burgers and salads costs go up. Tewodros suggested that McDonald should hedge with third party to exchange McDonald’s foreign currencies into close the value of current U.S dollar. In addition, by making forward contract, McDonald could buy their raw material with fixed cost in contracted period. I agree with hedging against the raw material part, but I disagree with the way Tewodros suggested to McDonald to overcome the foreign currency fluctuation.
I would suggest McDonald to use "triangle arbitrage" between different markets to make profits. For example, McDonald makes profits in German with M 100,000(mark), and McDonald could exchange M 100,000 into $(U.S) 100,000 in the past. However, McDonald would exchange M 100,000 into $(U.S) 95,000 in current period due to currency fluctuation. Tewodros said McDonald should find third party entities to hedge the exchange process, but I think in the real situation McDonald would be hard to find third party entities to exchange Mark currency into U.S dollar at close value of current U.S dollar. I suggest McDonald to make profits from “triangle arbitrage”, and this is let’s suppose M 100,000 is equal to $ 95,000 and 1,000,000 Japanese yen in London since 1,000,000 Japanese yen is equal to M 105,000 and $ 100,000 in Japan. McDonald could make $ 5000 profits using “triangle arbitrage”. In order to make profits from “triangle arbitrage”, McDonald should fully understand how the one currency affects to the other currencies.
Tewodros suggested McDonald to grow own raw material such as lettuce, tomato, pickles, and etc in the long-term. However, I suggest that before McDonald grows their own agricultural products, they should calculate Net Present Vale and Risk Adjusted Return on Capital to whether they would make profits from that project.

http://kasmo83.blogspot.com/2009/03/mcdonalds-first-quarter-revenue-drop.html

http://www.gocurrency.com/import-risk.htm

Opinion in public education system

I read Dwayne’s and Amber’s article that it says U.S has poor education system, and the U.S should spend money on education system to boost, and this will not let the U.S have this kind of financial crisis. Before the U.S spends their money on education system, the U.S needs to know what the main problem the U. S is having, and how they will solve them. Both Dwayne and Amber mentioned lots of thing about problems in education system, but I do not agree with that the lack of concern for student at a college is also one of the problems in the education system, but I think the U.S should concern about K-12 first, then it is not late to solve the problem in the university education system. Thus, I think the U.S should focus on K-12 first.
According to the Programme for International Student Assessment (PISA), it tests math, science, and readings to 15 year-old students, and 57 countries participate for this. The U.S is ranked 30th in science 34th in math out of 57 countries, and the U.S had problem with collecting data for reading section, so their ranks are omitted. As we see that data, the U.S education is below the average. Finland is ranked 1st in overall, so the U.S tried to benchmark the Finland’s education systems. Finland primarily focuses on readings, the 61% of elementary student in Finland read newspapers, and these could be school newspaper, or regular newspaper. In addition, the school provides more chance to debate with classmates. Thus, it makes each student has his or her own thought on the topics. Second, Finland spends lots of money on teacher’s salaries. It does not mean that the teacher’s salary is just high. To be a teacher in Finland, the teacher should be qualified for their high standard of requirements, so the every teacher is well trained. Third, the school provides classes for each student’s level, so if a student A is not good at math, the school provides lower level of math class for student A, and similar students. If a student B is good at science, the school provides advanced science class for student B. However, interest thing is most students in Finland are not embarrassed even though they get into lower level classes.
In conclusion, if the U.S spends money for the qualified teacher, more libraries, variety levels of classes, the U.S’s education system will be improving fast. Even though the U.S spends more money on education system, the result would not come out immediately, but the great result would come out after ten years from now. Thus, I think the spending money on education is the one of the U.S government’s long-term risk management.

http://dwang9.blogspot.com/2009/03/public-education-system.html

http://rmi4350.blogspot.com/2009/03/problems-with-public-education-system.html

http://www.newsweek.com/id/175894

http://www.pisa.oecd.org/document/2/0,3343,en_32252351_32236191_39718850_1_1_1_1,00.html

Adverse selection vs. Moral Hazard

Adverse selection and Moral Hazard contain similar meaning that both use insurance with malicious intent. Also, the adverse selection and moral hazard contain the information asymmetry. However, the both take different approach.

In adverse selection case, people who have high risk in certain thing, such as high risk in eyes, legs, death, etc, pay same premium with standard people and get same amount of insurance payment. Underwriting could distinguish that and set new premiums for the certain people. However, most of time it is hard an underwriter to distinguish whether he or she needs a higher premium than standard people. For example, people who play soccer 4 times a week and they plan to buy insurance with their legs. They have higher probability to be injured with their legs compare to standard people, and the people who play soccer pay same amount of premiums as the standard people pay unless the people tell that they play soccer four times a week. I do not think that is fair.

In moral hazard case, for example, people buy health insurance that covers certain amount of hospital fees if the people stay in hospital for four days or more. Let’s assume the people are injured very light, and a doctor recommends them to stay in hospital a day or two, but the people would tell the doctor that they do not feel good and want to stay two more days, so they can get insurance payments. I think because of adverse selection and moral hazard, the insurance companies’ underwriting policies becoming more complicated.

http://en.wikipedia.org/wiki/Moral_hazard
http://en.wikipedia.org/wiki/Adverse_selection

Freezing salary is not the good way to manage a firm or business

Money gives the greatest power in the capitalism, and we are living in the capitalist economy. In the economic recession period, many firms lay off their employees, and freeze their salaries. I read a Jon’s article (http://enterpriserisk-jonf.blogspot.com/2009/02/salary-freezes.html) that he said freezing salary is the one of best ways to make a firm or business secure. However, I think the freezing salary would not make any difference. In the economic recession period, many firms focus not to lose their profits, and want to keep their assets. It means many firms prefer security in the economic crisis. There are three actions the firm should take in the economic crisis, and those are promoting employees, recruiting new employees, and preparing for an economic boom.

First, it is hard for firms to increase their employees’ salaries, and most firms freeze their salaries. However, incentive system is the one of best ways to overcome current period. If a firm promotes certain employees, and increases their employees based on accurate evaluation, the incentive system encourages other employees to work better and harder. The incentive system is needed, especially in economic recession period.

Second, this is time to recruit new qualified employees and think about to lay off unqualified employees. Most of the time the firm and current employees refresh themselves with new qualified employees. Thus, the new qualified employees could give positive effect on the firm in economic recession period. Nevertheless, the unqualified employees could affect negatively to firm, so economic recession period could be the good time to recruit new qualified employees.

Last, economy goes up and down periodically, but people do not know when the economic crisis will end. In addition, it is hard to take an action, such as starting a new project. Thus, firms should be prepared for an economic boom. To be prepared, the firms should scout for new talent. As I talked about earlier that recruit new qualified employees is the important factor in the economic recession period. Thus, the firm should train them well, and be ready to take an action in economic boom.

http://www.onlinebusadv.com/?PAGE=176
http://dhanil.blogspot.com/2008/10/how-to-overcome-economic-crisis.html

Opinion in AIG bonus

There are many newspaper articles talk about AIG bonus, and 99% of articles conclude that AIG’s action was totally wrong. I read a Dwayne’s article(http://dwang9.blogspot.com/2009/03/aig-bonuses.html) about AIG bonus that AIG’s action was wrong. I partially agree with Dwayne, but I am writing this journal to advocate AIG. When I read the article about AIG, I knew that there were reasons why AIG pays bonus with bailout money.

The first reason was that the AIG had to perform its contract that says $55 million should be paid in last December, and 165 million should be paid on March 13, 2009. Thus, if AIG is able to pay bonus even if the money was bailout money, the 400 employees had a right on their bonus, and wanted to get those. Some employees might sue AIG if AIG did not perform the contracts.

The second reason is that if AIG pays salaries with bailout money, nobody would complain about that. This is the point that once the bonus is officially stated in the contract, the bonus should be considered as salary.

Last, a lack of regulation on bailout money makes the AIG use bailout money whatever AIG wants. When the U.S government supports AIG with bailout money, which is our taxes, the U.S should have regulated with that money, and asked AIG to disclose everything that related with the bailout money. However, the U.S government’s action was too late. Now, the new bill, which is 90% of bonus would be taxable to the federal and the rest of 10% would be taxable to the state, passed from the U.S Congress. Even though the U.S government owned 80% of shares of AIG, the lack of concern and regulation made AIG to waste that bailout money on paying bonus.

In conclusion, before people criticize about AIG I recommend them to think about why the AIG has to take that action. Then, people would not take an action emotionally, and they would not be one-sided. Thus, their critique would be more accurate.

http://www.nuwireinvestor.com/blogs/investorcentric/2009/03/niceaig-is-paying-165-million-to-people.html

http://thecaucus.blogs.nytimes.com/2009/03/16/rep-frank-joins-chorus-on-aig-bonus-outrage/

http://bzt-inside.tistory.com/809?srchid=BR1http%3A%2F%2Fbzt-inside.tistory.com%2F809

Agree with what President Obama is doing

I do not agree with professor Grace thought that President Obama seems not to care about the U.S economy and, that makes the stock market go down. President Obama is focusing on health care, renewable energy, and education. According to washington post, the U.S increase its budget on health care, renewable energy, and education by 22 billion, 39 billion, and 81 billion respectively for year 2009. Spending huge money on those do not seem to help current the U.S eocomy and stock market. However, President Obama has reasons, and they are failing of bailout program, controlling inflation, and looking ahead in long-term perspective.
First, big auto companies such as ford, chrysler, GM were asking for a bailout program, ,but the bailout program would work for thoses companies for very short-term period. In addition, those companies would ask another bailout program unless they solve long-term problems. That is the reason why President Obama wants to stop bailing out, and he wants to spend that money on health care, renewable energy, and education. Second, even though the U.S economy is facing shor-term pain, the U.S should set a goal for a long-term. If the U.S spend more money on education, our future generations are less likley to make this kind of the worst situation. Even if they have the worst economic situation they will cope with those difficulties well. By spending money on renewable energy, the U.S could control its inflation. When the oil price goes up, other prices would also go up soon, so the inflation depends upon the change in energy sector. Thus, if the U.S could make the energy prices stable, the U.S could control its inflation. Also, when people research more on renewable energy, they need more people to work with them, and it will create more jobs. In addtion, those active works would increase the prices of energy sector in stock maket. When the economy is unstable, people tend to rely more on insuraces. Thus, President Obama wants to help people, especially poor people to have their insurances. I think every moves that President Obama makes has a reason. Thus, I recommend people to give him more time, and do not push him.

http://www.businessweek.com/bwdaily/dnflash/content/mar2009/db20090313_686911.htm
http://www.bloomberg.com/apps/news?pid=20601068&sid=asxecTzJN6iM&refer=home
http://www.vheadline.com/readnews.asp?id=78007
http://www.bloomberg.com/apps/news?pid=20601070&refer=home&sid=aA0XK8TY8HYs
http://www.washingtonpost.com/wp-dyn/content/story/2009/02/26/ST2009022601696.html

Importance of risk management in stock investments

There are two main reasons why investors need to manage their risks in a stock market, ant those are the risk management finds investors’ own styles and gives more chance to win in the stock market. The systematic risk could be overcome by long-term investments, and the non-systematic risk could be overcome by diversification. These are the two basic ways to manage risks in the stock market. In addition, a writer Mr. Kim, who is a professional financial planner, mentioned about a diversification method that when the investors diversify their portfolios, their stocks should be negatively correlated. Therefore, if one stock goes down, the other stock may go up. This is the basic way to diversify your portfolio. By the way, I think that it is a good risk management for the individual investors that let the fund manager can take care of their stocks, if the individual investors are not sure to win in the stock market. In addition, investing stock is too stressful for individual investors because they might have their own jobs, and families. Therefore, they have limited time to watch their portfolios, but the most individual investors tend to spend too much time on real-time graphs and value of stocks. Even though the individual investors made huge profits on their investments, that way may stress them physically and mentally. Thus, choosing right risk managements in the stock market is important.
In conclusion, if investors are worried about investment in stock market, let the fund managers do it. If investors want to learn the investment by doing their own, then follow those two basic methods, which are investing in long-term, and diversification. Again, when the investors diversify their portfolios, they should choose stocks, which are negatively correlated, so they would not lose a lot in the worst situation.

http://blog.daum.net/kwh4097/11300167?srchid=BR1http%3A%2F%2Fblog.daum.net%2Fkwh4097%2F11300167

Correlation

When a firm estimates about two new projects whether the firm should take both or not, the firm calculates its variance, expected value from the new projects, and volatility. To get those, the firm needs to get the correlation between the two new projects, and we call the correlation as “rho”. If the rho is a positive number, the each new project has positive effects on each other. For example, if a project A and a project B have rho 0.88, it means if the project A is succeed on its projects, then the project B is more likely to be succeed on its project. However, the rho cannot be more than positive 1 and less than negative 1. If the project A and B have a rho –0.88, it means the each project has negative effects on each other. For example, if the project A is succeed on its project, then the project B is more likely to fail in its project. If the rho is 0, it means they are not correlated each other, so the one project does not dependent on the other.
I think if a firm is thinking to start two or three new projects, the best scenario is open those three projects successfully. Thus, the firm should consider correlated between those projects whether those projects correlated positively, negatively, or uncorrelated. If those are correlated positively, it is easy to manage those projects together.

http://en.wikipedia.org/wiki/Correlation_(in_statistics)

Liquidity is an important key in economic depression period

Current ratio measures whether a company has enough money to pay its liabilities over 12 months period, and it is calculated by current assets divided by current liabilities. For example, company A has $2 million of current assets, and $1.5 million of current liabilities. Then, company A’s current ratio would be 1.3333:1. It means that company A has 1.3333 dollar of assets when it has a dollar of debts. In addition, a recommended current ratio for any company would be the 2:1; it means the company has twice more assets than its debts. Thus, we can conclude that company is very secure. However, if the current ratio is too high, it does not mean that the company manages its capital wisely. The reason is that if the company’s assets are too much, which is more than double, relative to its liabilities, it means the company does not use its assets efficiently. The company could invest or start a new project with those assets. If a company’s current ration is less than 1, it does not mean that the company is facing shortfall in its cash. The reason is that the company’s inventory turns over quickly, and its cash keep flowing such as grocery stores and fast food restaurants, so the current ratio could become less than 1. People have two perspectives on low current ratio. One is that the company uses its assets efficiently, and other perspective is that the company manages its capital so risky. In conclusion, if a company tries to use its assets fully, and it invests and starts a new project with its assets, its current ratio would be low. In addition, if the company tends to keep money instead of investing or starting a new project, its current ratio would be high. However, we cannot conclude which company is better than the other.

http://en.wikipedia.org/wiki/Current_ratio

A changed world for Financial Advisers

A financial planner, Frank Boucher, has been thrown into despair about financial systems and markets that how those crashed so quickly. He also mentioned that investment the method, “diversification”, did not work in this financial crisis. Bonds are not exceptions. However, we can learn from this depression period. Mr. Boucher recommended that the people who invest in real estates and stock convert to cash or Treasuries. This is a basic idea that if people hold their stock for long-term, their risky would go down. However, most companies’ stocks were cut half in 2008. I think the financial market is like a highway and the car is an investor. The reason is that if it raining, storming, and snowing, every car drives slowly. If an investor wants to make huge profits on this depression period, the investor should take a risk, but if the investor fails on his or her investment, he or she will lose a lot. This is same a driver who is willing to get his or her destination fast in snowy days. The driver could get his or her destination much faster than the others if he or she takes a risk, which means the drivers goes fast. However, if the driver has an accident while he or she driving in snowy days, the accident would be much bigger than accident in regular days. That’s why Mr. Boucher recommends investors to keep cash instead of taking aggressive approach in the stock market.

http://www.businessweek.com/investor/content/feb2009/pi20090210_191817.htm

RAROC

RAROC estimates probability of a firm’s profits on its investment, and RAROC also adds expected risks rates into calculation, so RAROC could measure more realistic value. There are three basic risks, and those are market risk, credit risk, and operational risk. RAROC is an upgrade version of ROC since ROC measures without adding expected risk rates into calculation. RAROC was developed by Bankers Trust in 1970. The main purpose of the RAROC is to set optimal amount of capital to hold while a firm is investing in a new project. There are two reasons RAROC to allocates capital, the one is risk management, and the other is evaluation. RAROC is calculated by expected return divided by economic capital. The economic capital is similar as VAR. It measures the amount of capital a firm needs in the worst situation. Economic capital is little different from regulatory capital. The regulatory capital is the minimum amount of money, which regulators require to have. However, economic capital the amount of money for companies’ the worst case scenarios.
I think it is very hard to expect those three risks, market risk, credit risk, and operational risk, also hard to average and compare those tree risks. The reason is that equality of certain value of market risk is different from credit risk, and operational risk. For example, if market risk is 2, we do not know whether the value, 2, of market risk works same in the credit risk or operational risk. I think to increase accuracy of RAROC, we need to focus on accuracy the three value of risks to be reasonable and acceptable.


http://www.riskglossary.com/link/economic_capital.htm

http://www.12manage.com/methods_raroc_ko.html

Currency Swap

As we talked about the currency hedging in the Aspen’s case, a currency swap could be the good way of hedges. This is how the currency swap works. This is an exchange contract that two individual foreign companies make a contract that if company A needs to exchange into its local currency, then the company B swaps the currency in fixed rate. For example, the U.S company expands its market in Europe, and it is worried about fluctuations in Euro currency. The U.S company needs to find the European company which expands its market in the United Stats. If the U.S company makes huge profits in Euro, and the U.S company need the U.S dollar, but the current the U.S dollar currency market is so bad, then the U.S company can ask the European company, which already made a contract with the U.S company, to exchange currency into the U.S dollar with fixed rate. The European company performs in the United States, so the company would have enough U.S dollar to exchange with Euro. This is good for the both parties. Thus, I think this is the another good way to hedge in currency. However, when a company selects its a counterparty, the company should consider weather the counterparty is healthy and stable in financially.

http://en.wikipedia.org/wiki/Currency_swap

Heinz’s profits with currency hedging

Due to an economic depression, many people do not tend to eat outside. They prefer to eat in their houses. Heinz ketchup made huge profits in the economic depression season. The reason is that when people eat in their houses, they would probably consume more ketchups than the past. The most food companies’ biggest expenses are their ingredients cost. Therefore, the big food companies import their ingredients from other countries, which costs lower than in the United States. However, if the food companies were not aware of currency rates between the United States and counterparties, and then their profits could go down in case of the currency effect negatively. Nevertheless, Heinz had a good ability on forecasting the world’s currency market, and they hedged the currency. Thus, they would not get in any troubles in case of fluctuation currency market. I think this case is a little different case with an ASPEN technology case. For Heinz perspective, if the U.S dollar value is higher than Japanese yen, they could buy more ingredients or buy same amounts cheaper. However, ASPEN would make fewer profits if Japanese yen is higher than the U.S dollar because ASPEN made profits from Japan, and need to cash out into the U.S dollar. I think if companies hedge on their uncertainty factors, they would not make huge profits, but their probability of losing their assets in case of economic depression is very less.

http://www.forbes.com/2008/11/22/heinz-ketchup-closer-markets-equity-cx_lal_mlm_1121markets32.html

Poor cash returns spur appetite for risk

Individual savings accounts (ISAS) are only available in the resident of United Kingdom. They are designed for savings and invest purpose with tax benefits. They have two components of it, and one is cash component and the other one is a stock and shared component. Recently, people who have cash component which is similar to savings accounts want to change their component to stock and shared components because of huge interest rate cuts from the banks. Thus, they are seeking alternative way to grow their money, and that is a bond and a stock market. However, if they change their component to the other, they cannot take their money back to the original account. As we all know that the world’s economies are getting worse, so it is hard to invest in stock market even professional investors. However, fund managers who work for ISAS diversify their portfolios more than they did in the past. Thus, they are sure they would maintain their expected rate of returns even in the bad market. Lundie mentioned that clients need to keep 15 percent of their account in cash, and divide rest of money into five or six funds. I think keep the certain amount of cash is very good idea because if economies go extremely bad, diversifying would not work well. By the way, investing in corporate bonds is another good way to overcome this period. Corporate bonds give higher return of rate than savings accounts, and it is less risky than stock market. I recommend people to invest in bonds in this period because even if a company goes to bankruptcy the bonds holders will have priority over stock holders.


http://www.ft.com/cms/s/0/38e18852-f4b9-11dd-8e76-0000779fd2ac.html?nclick_check=1

Risk tolerance

When people invest into stocks or funds, they measure VAR to specific stocks, and they can estimate how much they could lose in the worst cases. If they have enough money to lose more money, we called they have high-risk tolerance. Risk tolerance is the how much you can accept loses. Thus, people need to know their current risk tolerance, and they need to choose right investing methods for their current situations. If they have high-risk tolerance, it means they can take higher risks, so they can invest more aggressively. If people have low-risk tolerance, of course they can take higher risks, but I do not recommend that because once they lose in higher risks, they would not afford to pay the amount of loses.
There is another part of risk tolerance, and it is emotional risk tolerance. It is related with financial risk tolerance because if you have more money, you are less likely to get stressed on losing. However, I recommend you to invest own your style, for example, if you have a lot of money, but do not want to take higher risk, then I recommend you to invest in corporate bonds otherwise you get stressed. I know many individual investors are watching their portfolios with computers almost eight hours a day, and do nothing. I do not want people to do like that especially if they are individual investors.
In conclusion, you need to know your risk tolerance financially and emotionally, then you should be fine on your invest.

http://www.allbusiness.com/personal-finance/3878802-1.html

PADA risks focusing too heavily on costs

We learned simple math to calculate a firm’s net profits in class before, and it is revenue-cost. For example, company A invests for their new projects and makes better work place for their employees, those are all their cost. However, company A is expecting more revenues from their huge investments. Here is company B that it wants to maximize their profits by reducing all costs, and this approach is what PADA (Personal Accounts Delivery Authority), which provide pension plans, is concentrating on. A writer of this article Rodd Ruppert did not agree with concentrating too much on their cost, and I also agree with the writer. First, if a firm’s minimize their costs, they would also be minimized their diversification because diversifying their portfolio is also another costs. Thus, NAPA would not manage their risk. Next, they do not spend money for their employees’ educations and better communication systems. In short-term, the minimize costs for employees’ educations and set up the communications systems could bring them higher revenues. However, I think invest for their employees’ educations and set up the better communication system is not consider as cost because those will bring huge profits in long-term perspective. Therefore, I do not think minimize cost does not have any relations to maximize profits. I think the minimizing cost will bring more profits in short-term period, and the company should set the goal for the long-term period.


http://www.ft.com/cms/s/0/77bdc90a-8240-11dd-a019-000077b07658.html

Risk control central to hedging success

Ewan Kurk, who is a former partner of Goldman Sachs, launched his hedge fund corporation named Cantab Captial Partners in March 2007. Their return was about 50 percent in last year. Interesting thing is that Mr. Kurk wanted good mathematicians to lead their company in front. I was wondering why Mr. Kurk did not hire experienced people to lead their company. However, he wanted to focus on designing good hedge fund models. If they have good models, Mr. Kurk could operate their company easily. They have more than 20 models, and each model is expected by specific returns. In addition, they diversify their capital into those models, so they can maximize their profits by reducing risks. I think when investing firms invest their capital they usually divide their capital into risk free rate such as bonds and higher risk rate. However, Cantab Capital Partners wanted to hold more on securities of higher rate of returns if they think those are worth. Moreover, Mr. Kurk mentioned that if people lose their money in invest, they tend to blame their bad luck, and if they earn, they think their skills are good. Thus, Mr. Kurk also educate ethical attitude to their employees to not to have vanity. I think the ethical education is really needed for every company.


http://www.ft.com/cms/s/0/aedd9e84-fa03-11dd-9daa-000077b07658.html

Net Present Value

To maximize firms’ profits, the firms consider adding new projects sometimes. The new projects could increase of decrease firm’s profits. When the firms start their new project they need operational cost, initial cost, and etc. Thus, the firms usually spend lots of money in the beginning of the year. If the firms do not earn less than what they invested, they should not start their new projects. Thus, the firms need to assess the impact of the new projects. To calculate the impact of new projects, we need to use net present value function: net cash flows divided by the discount rates. To calculate net cash flow, we could simply subtract cash outflows, which are costs, from cash inflows, which are revenues. When we divide discount rate, the important factor is what interest rate we should use. Risk managers decide the rate of return as if they could earned from similar projects. Thus, if a firm adds a risky new project, its discount rate would be higher than the lower risk project. If the firm’s net present value is greater than zero, the firm can take the new project. If it is less than zero, the firm should not take it. If it is equal to zero, the firm may or may not take it. However, I do not recommend to add a new project if net present value is zero. The reason is that net present value equals zero means they are in borderline, so they could lose or earn profits. In addition, we do not know probability to lose or earn from that new project. Thus, I would not recommend investing if net present value equals zero. I have a concern that when we calculate net present value, the net cash flows and discount rates are not guaranteed factors. Those are only assumed by risk managers. Sometimes, a new project ends up with negative profits in the real field even though their net present value is positive. Therefore, if net present value is not high enough, I do not recommend taking the new project.

http://en.wikipedia.org/wiki/Net_present_value

The Unseen predator

As I talked about ERM earlier, it is the system that it takes care about all the risk such as internal and outside risks. Moreover, ERM finds the cause of the risks, amount of the losses, and find out the solutions for those losses of the risks. However, according to Risk Management magazine, many firms did not apply ERM system. The reason is the firms should spend money for build ERM systems, and the firms felt like that is not worth it. However, ruin of Enron makes the firms to consider the ERM should be the essential part of the firms. I think if firms did not catch their risks at the beginning, the risks would get riskier, and to recover firms from riskier problems, the firms should spend a lot of money or they would be faced with bankruptcy. There is a critical point of ERM; some risk managers started to educate the how ERM works, but it was hard to learn because there are no certain manuals on setting ERM and also, ERM is too broad. Thus, many risk managers were struggling to work on that. Many people think the job of risk management as a maintain firms’ profits, and they think CEO as take care of all firms’ risks. I partially agree that risk managers maintain firms’ profits, but they actually try to maximize firms’ profits. Some people did not even know whether each firm has a Chief Risk Officer. Through the historical data, risk managers warned the economic gets worse when the bubble economics pops. Therefore, majority people in industry are aware of importance of risk management compared to 20th century.

http://www.rmmagazine.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=332&AID=3831&Volume=56&ShowArticle=1

Invest through what we have learned so far

I think I could invest a stock or bond based on what I have learned so far in our class. There are three technical signs that you should know, and they are VaR, alpha, and beta. VaR gives the loss amount of the worst cases. For example, if a portfolio of stocks has a one-day 99% VaR of $2 million, it means that probability that you can lose more than $2 million is only 1%. Therefore, people could estimate budgets for their investment. However, VaR cannot detect Katrina or 911 events because VaR is generated based on historical data. After you estimate your budgets by VaR, you need to know alpha. We could think of alpha as how people reach their goals. For example, two people run 100 meters in Olympic, and the both people set their goals to finish in 10 seconds. One person is finished at 9.5 seconds and the other person is finished at 11 seconds. If I measure the two people by alpha, I can give positive number to person who is finished at 9 seconds, and give negative number to other person. In the real field, if a firm has positive alpha, its managers perform better than their CEO and shareholders expected. If it is negative, the managers did not reach what CEO and shareholders expected. Last, people should consider beta because it measures volatility to the markets movement. For example, if a beta of market is 1.0 and a firm has a beta .5, it means the firm does not depend on market. Thus, if the market crashes, the firm is less likely to crash down than other firms which have higher beta than the firm. Therfore, if you want to invest safer way, you could invest in less beta firms. However, if you are seeking for higher returns, you may invest in higher beta firms. In conclusion, you can make your own portfolios by the combination of VaR, alpha, and beta.


http://www.forbes.com/2008/08/18/alpha-beta-vanguard-pf-education-in_cp_0818investopedia_inl.html

http://www.forbes.com/2008/06/12/oneok-natuzzi-bp-pf-guru-in_jr_0612guruscreen_inl.html

Using Risk Management to Beat the Downturn

As we all know, big firms have healthy risk management systems, so if they manage their risk management department well, they are less likely to having problems in depressions. However, some small firms cannot afford to set up risk management departments, so this article talks about how small firms can manage their risks. It is obvious that nobody likes risk, and people are worried about risks. However, risks could be opportunities if you think other side. Many small firms do not want to spend money on risk management because their business did not have those big problems without risk managing. As I talked the earlier post, most firms, which were facing insolvency, did not prepare in good season. Thus, I think the firms should spend enough money on risk management. If small firms want to analyze their risk without hiring consultants because it is costly they could find intern program from the risk management department of local university, or Society of Actuaries can find a professional for that firms, and those costs are much less than hiring a consultant. Those people could perform basic risk analysis. Therefore, small firms should check their firms often with those low cost, and if they know they are having problems, they should higher a professional consultant to solve their problems.

http://www.businessweek.com/smallbiz/content/jan2009/sb2009018_717265.htm

Risk managers' Stock is rising

Risk managers' role become more important in Wall Street. Stan O’Neal, CEO from Merrill Lynch resigned at October, and Charles Prince, CEO from Citibank also resigned. In addition, both firms are facing bankruptcy. I think it is hard to say that it is all their faults. However, I think they were in charge of those firms, so they resigned or were resigned because they have a responsible for that result. In Merrill Lynch case, risk managers from Merrill Lynch already warned about their risks before that sub prime mortgage crisis period. However, Merrill Lynch was making huge profits from sub prime mortgage, so they could not hear what the risk managers said. Moreover, they expected the U.S economies too optimistically because almost everyone in the U.S did not expect that the U.S economy would be depressed. This is the reason why many big firms are facing bankruptcy today. Nevertheless, some companies also crashed down their business even though those companies follow their risk managers' directions. Some people might think their risk managers did not perform their tasks well, and it could be true. However, I think the risk managers did not gather information well from traders because if the traders and risk managers did not create good relationships, that could happen. Therefore, CEOs should make the good relationship between traders and risk managers, then the risk managers will give CEOs better and clear advise when the firms have problems.

http://www.businessweek.com/bwdaily/dnflash/content/jan2008/db20080128_327302.htm

A beginner's guide to hedging

I am interested in hedging since we wrote a first case study in the class. Thus, I wanted to find out more articles about hedging. This article says if you are not familiar with word "hedging", and then you can think of insurance. However, I do not agree with that.Under insurance, there are no chances to occur unexpected events (random variable). For example, he or she is injured from a car accident, and then he or she will get benefits, which specified amounts in an insurance contract from the insurance company. In case of bankruptcy of his or her insurance company, he or she still can get benefits because every insurance company should re-insure to other insurance companies. Therefore, insurance makes people to estimate their expected loss or benefits more accurately.Under hedging, people cannot guarantee how much they will make profits or whether hedging can help them in the specific seasons. Therefore, hedging is less likely to accurate estimating their expected loss or benefits. However, some types of hedging have similar aspects of insurance, and that is an option. For example, he or she buys stock A for long-term investment, and he or she is worried about short-term loss and buys a put option, hedging or a derivative, for $30 per share. In case of dropping stock price to $15, he or she who bought a put option can sell those stocks at $30. Therefore, shareholders could estimate their expected loss in the worst case accurately. Another example we can simply find at an airline. Due to oil crisis, many airlines have huge impact on oil expenses. If an airline A made a contract, which locking oil prices for 6 months or more with oil distributors, the airline A would not have any impact on oil crisis.In conclusion, insurance and hedging also have a cost, so hedging might not be the best choice sometimes. Thus, I recommend people to consider whether they take hedging or not.

http://www.investopedia.com/articles/basics/03/080103.asp

Introducing roth 401(k)

As I mentioned last journal, the 401(k) is one of the best investing method. Basically, there are two different types of 401(k), the one is traditional 401(k), and the other one is Roth 401(k).This is a similar concept as IRAs. People get tax deduction on the contribution, if they put money into a traditional 401(k). For example, people whose tax brackets are in borderline between 25% and 30%, and they put money into the traditional 401(k), then the amounts they put into the traditional 401(k) are deducted from their tax. Thus, they could be in lower tax brackets. However, they should pay taxes when they withdraw from the traditional 401(k) because those taxes are deferred. Even though government cannot collect taxes at the moment, government would collect more taxes by compounding interest when investors withdraw from their accounts.People who invest into Roth 401(k), they put money which, already paid taxes, into the Roth 401(k). In addition, when they withdraw from the Roth 401(k) account after 59.5 years old. Some people take the Roth 401(k) because they think future tax rate is higher than present, so they want to keep the lower tax rates.If I have to choose one of those, I would choose traditional 401(k). The reason is I may get lower tax bracket. Even though the amounts earned from that account is taxable after withdrawing the net income still larger than Roth 401(k) because more money works for me for a long time with compounding interest.
However, people who prefer a safety plan just like hedging, and then they probably take Roth 401(k) because the amount earned from the Roth 401(k) will be tax-free. Thus, they do not have to worry about future tax rates. In conclusion, a traditional and Roth 401(k) have advantages and disadvantages, so people should consider whether they get tax-free or tax-deduction.

http://www.investopedia.com/articles/retirement/05/introRoth401k.asp

Six ways to maximize the value of your 401(k)

Most people are worried about their future. To secure their unknown future, they need to have enough money to secure their life, especially, when people get old.A 401(k) is one of the best ways to secure their life financially. To maximize the value of 401(k), there are six basic rules.First, people should participate in a 401(k). If you do not put anything in it, you will get nothing. Thus, you need to take courage to make money.Second, you should take the company match. Many people do not know how much they should invest into the 401(k), and the best answer is as much as company matches them.Third, there are different types of 401(k), stock, and bonds. If you are young, you can take a risk, so try to invest for higher returns. The reason is young people have enough time to recover losses if they are failed from the investing.Fourth, you should spread and reduce your risk. For example, you buy stock for Oil Company, and then you need to buy stock that goes opposite direction to Oil Company because when Oil Company’ stock goes down, the other stock that goes opposite direction to Oil Company will go up. Thus, people should spread their risk. Fifth, do not invest with loaned money. Some people invest with loaned money. This is very risky. As we all know, people cannot guarantee the return of invests. However, when people loan money, the interest is fixed. Therefore, these could bring you to pay higher interest rate, while you are collecting lower returns from invest. Last, do not withdraw your 401(k) account in any cases. Some people withdraw their 401(k) when they change their jobs, but is is a bad strategy. When you put your money into it longer, you will get more. Therefore, I recommend you to roll that over to IRA or keep it. In conclusion, if you have an opportunity to take 401(k), I recommend you to take that and invest as much as the company matches you. This is the most important thing that longer you put in, money works for you harder.

http://www.investopedia.com/articles/retirement/05/6WaysMax401.asp

Citigroup Acknowledges Poor Risk Management

We all know Citigroup has the biggest assets in the world, but Citigroup was facing bankrupt and U.S Congress tried to help them with a bail out program. How could this happen to Citigroup? I found this article that published on October 16, 2007. A main problem in Citigroup was lack of collecting fixed-income. It was the time that ruin of sub prime mortgages, so Citigroup’s debt went up to $3.55 million. Citigroup analyzed that they had to focus more on managing credit-risk rather than market-risk. I think if Citigroup hedged against that, they would not face bankrupt. Also, other lender, which only dealt with prime mortgage users, did not have any problems with not paying their loans. Citigroup took excessive risks because they wanted larger profits. However, they should allocate those risks by hedging or insurance.

http://www.nytimes.com/2007/10/16/business/16citi.html?sq=risk%20management&st=cse&scp=11&pagewanted=print

Letters- Risk Management

This article talks about people's opinions on a Joe Nocera's, a columnist for New York Times, Column that talks about Risk at Value models. Risk at Value models can estimate loss of the worst situation.Mr. Venezia' opinion is that do not trust too much on Value at Risk models because it did not prevent Katrina. I do not think people should not trust on Risk at Value models because it did not prevent Katrina. I do not think Mr. Venezia suggested a good example because as we learn from today's lecture, disasters are very random, so it is hard risk managers to forecast and prevent those disasters. However, I agree with his next supporting ideas, even if Value at Risk models indicate 95 percent or higher of confidence level on certain events, at least 20 events in a year went opposite direction. Allan D. Grady, president of Financial InterGroup Advisors, mentioned that risk mangers focus too much on past losses to estimate future risk. I think the collecting the past data to predict future loss is the one way to reduce risks.This article is related to the article "Wall Street Lied to its computers,” and it focuses more on trust their risk management programs. However, this article "Letters- Risk Management" talks about although Value at Risk models is important models to manage risk you may not see a big picture of economic movements if you focus too much on numbers provided by Value at Risk models

http://www.nytimes.com/2009/01/18/magazine/18letters-t-.html?scp=1&sq=risk%20management&st=cse

How Wall Street Lied to its computers

Mr. Hansell, a writer of this article, said he watched many big firms fallen down due to bad bets on mortgage securities.He spent thirteen years to cover trading and finance, so he had to know about quantitative analysts ("quants"). This system estimates how much they might lose on the worst case events. However, Mr. Hansell thinks that Bear Stearns, Lehman Brothers, and other firms bet too much, and “quants” did not save them. He expected that Wall Street bosses ignored the warnings signs, which risk machines found on certain problems, to keep the more profits. In fact, most Wall Street people said risk management computer models basically underestimated the risk of the mortgage securities that is partly correct. The reason is that Leslie Rahl said people who operate risk management systems choose program to informs optimistic and simplified data for their convenience.If they try to trick on their risk management system, it is tricking to their companies. It does not mean that the computer systems solve the problems if they choose right risk management programs and put the right information in the systems. However, that is the mandatory and basic thing to do. Ms. Rahl mentioned that to run that systems, we need people who are honest and have enough experiences in real markets.

(http://bits.blogs.nytimes.com/2008/09/18/how-wall-streets-quants-lied-to-their-computers/?scp=2&sq=risk%20management&st=cse)

Enterprise risk management

Through big companies' ruin and bankruptcy, risk management is not a choice anymore; it is a mandatory and basic part of any business. Enterprise risk management helps companies to maximize profits by managing their risk. I think a big part of risks comes from employees such as a fraud. Section 404 of the Sarbanes-Oxley of 2002 required U.S. trading corporations to have a fraud risk assessment. For example, shareholders want to maximize their shares, so they elect a good CEO. However, the shareholders do not know whether that CEO works for a company or his or her profits. Thus, shareholders want to perform internal auditing often. Under COSO's research enterprise risk management makes companies to become more transparently through internal auditing. Every business has risk, so companies do not have to hide those risks. Disclose their current risks and potential risks to their shareholders, and inform them how to overcome with those. Then, the shareholders will trust more on the company.

http://en.wikipedia.org/wiki/Enterprise_risk_management)