< The Finance Professionals' Post: April 2012

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16 posts from April 2012


Video: The Positives of Investing in Technology Micro-caps

The volatility of investing in mirco-caps may scare away some investors, but there are many opportunities to find hidden gems in the sector. As seen on CNBC's Talking Numbers, Barry Sine, Managing Director of Drexel Hamilton, gives an overview on the positives of micro-caps. The ability to pinpoint specific markets and segments can be especially rewarding when investing in new technologies, which are in favor this year.

Positives of microcaps:

  • The financial statements are much simpler. Financial statements of microcaps are very straight forward, as opposed to having multiple sectors and a complex balance sheet .
  • The management teams are very accessible. It is common to have direct communication with the management team and CEO of a micro-cap company.
  • There is the ability to pinpoint a very specific market down to a country, or even a state.
  • You can zero in on a specific technology or trend and capitalize on it. With trends and innovations like social media, display technology, and memory, there is potential for great rewards.
  • If you do not want to invest in the companies that make these new technologies, you can invest in the companies that own the patents.


Update: Commodities Are Different (in a "Full World")

The concern I raised last June that we should enforce the Bank Holding Company Act and not allow the too often irresponsible, gigantic, TBTF, and taxpayer-subsidized banks to engage in proprietary physical commodities trading has now been raised in a new article by Reuters. Abuse by large-scale, trading-driven firms, more so in physical commodity markets than in financial markets, can lead to drastic harm in the real economy as we learned from Enron's manipulation of the California electricity markets. But, as I detailed in my post, the issue is much bigger than speculators driving price swings in commodities. A world with finite resources and planetary boundaries will have allocation problems that markets cannot handle effectively or fairly. Rising commodities prices, and the effects they have on the poor, are primarily due to the fundamentals of limits to growth we are beginning to bump up against. The confluence of allocation, pricing, equity, and limits questions when dealing with scarcity of critical resources where there are no easy substitutes is already posing real challenges, as we discussed in our “Big Choice” essay.

Continue reading "Update: Commodities Are Different (in a "Full World")" »


The Formula to Approaching CFA Level II Formulas

CFA Exam Prep

The Level II curriculum is chock-full of formulas which makes it very easy to jumble it into a massive helping of Greek alphabet soup in your head on exam day. Here are some tips to avoid this exam-day scenario:

DO NOT Memorize

Instead of memorizing, find ways to understand and categorize the cirriculum at a functional level.

Prof. John Veitch, PhD, CFA teaches candidates to eliminate memorizing almost all formulas in the foreign exchange section (Level II SS 4) by conceptualizing cross-currency calculations as triangles and covered interest rate parity as boxes. If you know what the sides of the triangles and boxes mean, all that’s left is to plug in the variables. This technique can be used for calculating rates and arbitrage opportunities. For exchange rate predictions, he "standardizes" the approach as the beginning rate times an adjustment factor that has a common form regardless of whether it's inflation or interest rates doing the adjustment.

Continue reading "The Formula to Approaching CFA Level II Formulas" »


Beware of Unintended Economic Consequences


Unissued bank note from the
Second Bank of the United States

Many observers are beginning to examine the unintended economic consequences of major reform legislation in the areas of health care (The Patient Protection and Affordable Care Act) and financial services (The Dodd-Frank Wall Street Reform and Consumer Protection Act). Such consequences have often followed sweeping actions taken by various elements of the federal government. All three branches have at times seemed equally oblivious to the unintended economic consequences of their decisions.

Continue reading "Beware of Unintended Economic Consequences" »


When Accounting Fraud Brings Down the House of Cards

Certified Public Accountants, in spite of the trade or business, have a responsibility to uphold the very best standards of ethics and professionalism. CPAs are usually viewed as one of the foremost trusted professions within the world. They are additionally among the foremost regulated professions, the requirements to obtain the CPA designation being one of the most stringent (including having to complete a series of education and knowledge requirements before being allowed to take a seat for the US CPA Exam). Even once they pass the CPA Exam, they must maintain their education through continuing professional education as regulated by their state board of accountancy. Additionally, if they are a member of a state CPA society and/or the American Institute of CPAs, they need to maintain higher levels of CPE and a code of professionalism.

Continue reading "When Accounting Fraud Brings Down the House of Cards" »


CDS Credit-Event Auctions


Introduced in 2005 to facilitate cash settlement in the multi-trillion dollar credit default swap market, credit-event auctions have a novel and complex two-stage structure that makes them distinct from other auction forms. Examining the efficacy of the auction's price-discovery process, we find that the auction price has a significant bias relative to pre- and post-auction market prices for the same instruments, and that volatility of market prices often increases after the auction; nonetheless, we find that the auction generates information that is critical for post-auction market price formation. Auction outcomes are heavily influenced by strategic considerations and "winner's curse" concerns. Structural estimation of the auction carried out under some simplifying assumptions suggests that alternative auction formats could reduce the bias in the auction final price.

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The Leadership Issue: Investment Reports Must Ask 'Who's in Charge Here?'

When you are researching a company, be sure to tackle the leadership issue. Your clients will see true added value in your recommendations if you go beyond a company's bottom-line numbers and carefully look at the powerful but intangible factors that can make or break a company.

Say you are researching a company that is "white hot" right now, for example. If the person at the helm is clueless when it comes to leadership skills, the company will not be around for long.

Continue reading "The Leadership Issue: Investment Reports Must Ask 'Who's in Charge Here?'" »


Regulators Walk the Line on the Volcker Rule

Regulators are on the horns of a dilemma as they attempt to balance the conflicting concerns raised by their proposed rule for the implementation of the Volcker Rule, a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act banning FDIC-insured financial institutions from proprietary trading. Those concerns will be the topic of a discussion moderated by Martin Fridson, Global Credit Strategist for BNP Paribas Asset Management, at NYSSA’s upcoming 22nd Annual High Yield Bond Conference.

The Securities and Exchange Commission, the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency released their joint implementation proposal in October 2011, and their request for comment resulted in over 14,000 letters. The Agencies’ proposal states the upfront challenge: that the delineation of what constitutes a prohibited or permitted activity under the Volcker Rule “often involves subtle distinctions that are difficult both to describe comprehensively within regulation and to evaluate in practice.” It goes on to say that the Agencies’ proposed rule was crafted to “not unduly constrain banking entities” in their business to provide “client-oriented financial services including underwriting, market making, and traditional asset management services,” but, at the same time, not to conflict with “clear, robust, and effective implementation of the statute’s prohibitions and restrictions.”

Not surprisingly, the Agencies’ best efforts to navigate these contentious waters appear to have satisfied few. On the one hand, industry lobbyists claim the Agencies’ rule places complex and onerous requirements on banks to prove that they are not engaged in propriety trading. They contend that the proposed rule will seriously compromise their market making function, raise the cost of capital, and result in knock-on effects for the economy, employment, and the banking industry’s global competitiveness.

Public interest advocacy groups, on the other hand, are clamoring just as energetically for a “bright line” interpretation of the Volcker rule that ensures banks have no room to circumvent its original intent. The latter claim it is the banking industry’s own success at lobbying to create exceptions to the Volcker Rule prohibitions on proprietary trading that led to the complexity of the Agencies’ current ruling. Many on both sides of the fence now argue that the proposed regulations will be unenforceable and should be simplified or scrapped and entirely rewritten.

A study by Oliver Wyman commissioned by the Securities Industry and Financial Markets Association illustrates the industry’s broad case against what it calls a “restrictive interpretation of the Volcker Rule. It warns of the huge liquidity impacts that would arise, including higher corporate funding costs, a reduction in household wealth due to compromised functioning of securities markets, reduced access to credit for small businesses, reduced ability for investors to exit investments, higher trading costs and lower returns for pension and mutual funds, and reduced ability for companies to transfer risks resulting in a “reduction in overall efficiency of the broad economy.”

Perhaps one of the most closely reasoned responses to industry’s criticisms of the Volcker Rule has been advanced by Wallace Turbeville, a former Goldman Sachs investment banker who testified in January 2012 before the House Committee on Financial Services on behalf of Americans for Financial Reform. In his testimony he pointed out that industry analyses of liquidity impacts have downplayed or largely ignored the reality that the Volcker Rule could not be interpreted in any way as a prohibition against proprietary trading. These activities, Turbeville, says, will instead migrate to non-taxpayer protected institutions. The Volcker Rule, he notes, merely “prohibits institutions that enjoy the benefits of a federal safety net from engaging in the risky businesses of proprietary trading and hedge fund sponsorship and ownership.” In his opinion, it will be a good thing if the rule does result in “the unavailability of cheap capital (subsidized by the public) that induces financially unsound trades.”

NYSSA HYB Conference

Turbeville also describes another positive outcome of the Volcker Rule if properly enforced—a reduction in covered banks’ capital bases. “The massive growth of [covered bank’s] assets and the capital to hold them dates from about 1980 when they started a race to compete with each other in the increasingly de-regulated trading markets,” he reports. “Every day until the Volcker Rule is implemented, the American people bear the risk associated with de facto guaranteeing these bloated capital bases.”

Turbeville acknowledges that the rule will have impacts on block trading but he maintains that is also all to the good. “Large market participants, such as mutual funds, can direct massive flows of trading activity to banks and commonly take advantage of this market power,” he notes. “In the post-Volcker Rule environment a given block trade may have to be transacted in smaller units. This is because the non-bank institution will be more sensitive to risk, and because the capital charge will reflect reality, not public subsidy.”

Turbevile reports that as the current July deadline for conformance to the rule approaches, the conversation around what it means to make a market has gotten more detailed and more focused. “There has been an informal sharing of thoughts that has been highly constructive,” he notes. What has emerged, says Turbeville, is a line in the sand. On the one side of that line are those who contend that covered banks must not under any circumstances enter into a transaction unless it has information from a market source about what the outcome of that transaction will be. On the other side are those who would say there should be exceptions to that rule. Whether the Agencies’ final ruling will reflect one or the other interpretation, or will remain in something like its present problematic state remains to be seen.

“We are analyzing the comments and determining a prudent way forward in close consultation with the banking agencies and the CFTC,” says David Blass, Chief Counsel and Associate Director for the SEC’s Division of Trading and Markets. “It is a challenge given the quality and quantify of comments—there are 14,000–15,000 responses in form letters alone.”

The bulk of comments have come from industry groups—not just from covered banks but from an array of institutions on both the buy side and sell side, including mutual and pension funds, hedge funds, and sovereign debt and municipal securities issuers. “I can say we are taking to heart the volume and the diversity of the messages from the comments that have come in,” says Blass. “But we know at the end of the day it is our responsibility to look to what the Volcker Rule was intended to do and not just to listen to interest groups.”

“We have to work through the comments and this goes with every rule, the Volcker Rule is not unique,” Blass reports. “But an added complexity here is that other agencies are involved in the process and we need to coordinate with them. I cannot predict at this time what will happen between now and July 21, though commenters have called for the Fed to extend the conformance period for the statutory provision past July 21, the date the statutory provision otherwise takes effect.”

–Susan Arterian Chang

Susan Arterian Chang is a contributing writer to The Finance Professionals’ Post and Director of Capital Institute’s Field Guide to Investing in a Resilient Economy


Update on Brazil: March 2012

When Worldview last addressed Brazil in the autumn of 2010, the country was on the eve of presidential elections and had been enjoying a year and a half of outstanding post-crisis investment returns and celebrations in the press. The world had rediscovered Brazil and concluded it was a haven from the economic carnage that had ripped through developed world economies. Even among emerging markets, Brazil’s economic and financial performance looked spectacular.

Our piece suggested that while the long-term dynamic in Brazil still looked good, asset prices had likely gotten ahead of themselves and were no longer as attractive as before. The risks we identified had to do with the then presidential candidates lacking charisma, the temptation to over-rely on Petrobras “pre-salt” rents, euphoric animal spirits that could lead to imprudent fixed investments, and a rush of financial capital back to the developed world once signs of a recovery began to look stronger. Some of these risks have diminished, others have taken place, and still others remain.

Continue reading "Update on Brazil: March 2012" »


Want to Ace Your Next Job Interview? Act Like a Narcissist


Narcissists do much better in job interviews than their less obnoxious counterparts, says a new study from researchers at the University of Nebraska-Lincoln scheduled to be published in the Journal of Applied Social Psychology.

Technically, narcissism is a mental disorder in which people have an inflated sense of their own importance and a deep need for admiration. Those with narcissistic personality disorder believe that they are superior to others and have little regard for other people’s feelings.

Continue reading "Want to Ace Your Next Job Interview? Act Like a Narcissist" »


Recent Research: Highlights from April 2012

"Defending the “Endowment Model”: Quantifying Liquidity Risk in a Post–Credit Crisis World"
The Journal of Alternative Investments (Spring 2012)

Abdullah Z. Sheikh and Jianxiong Sun

This article sets forth the proposition that liquidity risk may be optimized in an attempt to forestall or minimize the impact of a liquidity crisis. For a generic (but typical) endowment asset allocation, the authors find that liquidity levels between 6% and 14% are optimal, all other things equal, because 95% of the time, an allocation in this range would obviate situations in which a portfolio’s payout rate exceeds its liquidity pool. The framework also provides insights for tail-risk events involving a particularly severe liquidity crisis. For a generic endowment portfolio, the analysis indicates that in order to reduce the severity of a liquidity crisis to zero (i.e., eliminate risk completely), the allocation to fixed income would have to be around 35% (close to seven times the payout rate of 5%). Such an allocation would entail a very significant opportunity cost in terms of forgone returns based solely on a desire to mitigate extreme liquidity events (the proverbial “100-year flood”). In the authors’ view, reducing the likelihood of a liquidity crisis to below 5%, may be undesirable for all but the most risk-averse and least return sensitive endowments.

Continue reading "Recent Research: Highlights from April 2012" »


Common Mistakes Made by First-Year CPAs

As with anyone new to a career, you’re bound to make a mistake or two. CPAs are no exception. You can learn, study and pass the Certified Public Accounting exam, but that doesn’t mean you’ll be able to practically apply that knowledge in the real world. Here are a few of the common mistakes that first year CPAs make that you can be aware of and ideally, avoid. Many of these common mistakes will be covered in your CPA exam review course.

  1. Treating sales as revenue before the product is delivered. Sales do not count as income until the product or service has been delivered to the purchaser. Counting sales as revenue before they are realized can cause business decision makers to think the company is more profitable than it is and make false projections. Only count sales as revenue when the product or service has been delivered.

  2. Confusing profits for cash flow. Track what a business is spending and selling. Just because there may be a profit, does not mean there is cash to pay bills. Make sure you are presenting the full picture to your clients or employer so they can make the right decisions by analyzing the profit-debt ratio.

  3. Dipping into cash reserves. Your business clients may be inclined to dip into their cash reserves and make a large equipment purchase or the like. While they will be able to claim depreciation over the years, it will hurt them when tax time comes around. Instead, encourage your client to take out a short-term loan or even lease the equipment if it will need updates over time. Leasing compared to outright purchasing can be of great benefit as there is no large sum of cash required nor do you have to pay for maintenance, etc. Weigh these options and present them both to your clients. Clients like options.

  4. Not reserving enough to pay estimated taxes. Many of your small-business or self-employed clients may be required to pay estimated taxes throughout the year. Make sure these clients have an accurate system that encourages them to put aside the necessary funds to pay their quarterly estimated taxes.

  5. Poor accounting system. Typical in small-business or self-employed environments, it is important to advise your clients on an appropriate accounting system if you are not involved in the day-to-day. They need to be able to record their deposits and expenses while maintaining a record of the transaction with ease. As a CPA you are in the perfect position to advise them on the proper method and software.

  6. Deducting expenses inappropriately. There is a right way and a wrong way to record tax deductions. Especially when it comes to clients with a small business. For example, you can save your client a lot of money by deducting business-related travel expenses as a business expense, versus as an unreimbursed employee business expense.

  7. Passive loss rules. If your client receives a K-1 from any investment, including a business, make sure they are not being limited by the passive loss rules. An active business owner should not be subjected to the passive loss limitation rules. This could mean the difference in thousands of dollars on your client’s tax return.

  8. Failing to elect real estate professional status. If your client is involved in real estate investment, be sure you have filed an election with the status noted. This status will allow your client to take advantage of a number of specific real estate investment deductions. If you miss this election, you cannot file an amended return down the road to correct. Any of those potential deductions are lost. Be sure to file the election for your real estate professional clients.

  9. Missing carry-forward tax benefits. Some tax credits or deductions can be carried forward to the next tax year if your client cannot use them in the current tax year. However, many professionals often forget about these carry-forwards a year later. Be sure you keep accurate records and are carrying forward your client’s tax credits and deductions where necessary.

  10. Not planning ahead for taxes. Tax time is a great time to sit down with your clients and plan for the future. There are only so many deductions and credits that can be taken advantage of without planning. Take some time with your client to analyze their current, past, and future tax and financial situation and determine where they can save on their taxes in the future.

These are 10 of the most common mistakes first-year CPAs often make. By focusing on the needs and goals of each client, and by following the suggested practices of both the National Association of State Boards of Accountancy (NASBA) and the American Institute of CPAs (AICPA), you will be acting well within your professional limits and will almost always satisfy your client(s) or employer.

–Grant Webb, Bisk Education. Bisk has been training accountants and financial professionals for more than 40 years. For questions or comments, Grant can be reached on Twitter @grantwebb2.


Book Review: The End of Cheap China


Cheap goods from China have benefited millions of Americans, increasing their standard of living, vastly attributing to low inflation. Low-cost production is something we have come to accept, moreover, to expect. But as Shaun Rein's new book, The End of Cheap China: Economic and Cultural Trends that will Disrupt the World concludes, this is about to change.

Higher labor costs, shortages of skilled workers, rising commodity and real estate prices are combining to change this happy world for American consumers. It is also changing and disrupting how American companies view and use China. The biggest change according to Rein is that, "Instead of the market to produce in, China has become the market to sell into. China is increasingly becoming the country driven by the "optimistic consumer class."

Continue reading "Book Review: The End of Cheap China" »


Too Systemic to Fail: What Option Markets Imply about Sector-Wide Government Guarantees


A conspicuous amount of aggregate tail risk is missing from the price of financial sector crash insurance during the 2007-2009 crisis. The difference in costs of out-of-the-money put options for individual banks, and puts on the financial sector index, increases four-fold from its pre-crisis level. At the same time, correlations among bank stocks surge, suggesting the high put spread cannot be attributed to a relative increase in idiosyncratic risk. We show that this phenomenon is unique to the financial sector, that it cannot be explained by observed risk dynamics (volatilities and correlations), and that illiquidity and no-arbitrage violations are unlikely culprits. Instead, we provide evidence that a collective government guarantee for the financial sector lowers index put prices far more than those of individual banks, explaining the divergence in the basket-index spread. By embedding a bailout in the standard one-factor option pricing model, we can closely replicate observed put spread dynamics. During the crisis, the spread responds acutely to government intervention announcements.

Continue reading "Too Systemic to Fail: What Option Markets Imply about Sector-Wide Government Guarantees" »


The Myth of the Job Creators

Jim O’Neill (see the review of his book The Growth Map by Bill Hayes [2011]), chairman of Goldman Sachs Asset Management, theorizes that developed countries have entered a second Gilded Age, while emerging markets are simultaneously living through their first. Equally perceptive is his observation that the middle class of the developed nations is squeezed between the representatives of the Gilded Age—their own robber barons, and the “intelligent proletariat” workers of the emerging markets who compete with them for jobs but who have a much lower cost of living.

We are made to believe that this scenario is a necessary outcome of a modern capitalist society. Adam Smith’s notion of the capitalist—the entrepreneur investing (i.e., risking) his own money by organizing production and hiring workers—is all but forgotten, however applicable it was to eighteenth- and nineteenth-century England. In the England of the 1700s, most if not all people in the upper income brackets were noble landowners, bankers, merchants, and industrialists, in about that order; we can be fairly certain that the upper classes did not include journalists, dancers, and actors. For example, Nell Gwynne—famous actress, mistress of King Charles II, and a mother of his children—received an annual pension of 1,500 pounds, which was supposed to make her retirement comfortable but was well below of an income typical of a great lord.

Continue reading "The Myth of the Job Creators" »


Video: Trends in Biotech and What They Mean for the Future

Senior biotechnology analyst, Yigal Nochomovitz, PhD, discusses how to improve investment strategies in the biotech sector. Looking at data and trends from 2011, we can gain a clearer picture of what lies ahead. Surprisingly, small cap investments have been performing better than large cap investments in this industry. Using this information and other insights, we can draw conclusions about the best biotech investment decisions for 2012. 


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