Market Wrap Up

Spring Week Edition

30th March 2016

Wednesday 30th March 2016

Market Wrap Up

The Market Wrap Up Team

Editor in Chief (Outgoing)

Conor Ludden
conor.ludden@wfsocieties.org

Editor in Chief (Incoming)

Aatif Khan
aatif.khan@warwick.ac.uk

Co Editors
Jack Melbourne
j.a.k.melbourne@warwick.ac.uk

Nathaniel Stott
n.stott@warwick.ac.uk

Edmond Phua
e.phua@warwick.ac.uk

Dillon Tan
d.tan@warwick.ac.uk

Analysts
Toluwani Adejuyigbe
t.adejuyigbe@warwick.ac.uk

Tim Maecker
t.maecker@warwick.ac.uk

Fariha Azad
f.azad@warwick.ac.uk

Thomas Mitchell
t.mitchell.1@warwick.ac.uk

Gytautus Karklius
g.karklius@warwick.ac.uk

Pietro Theotokis
p.theotokis@warwick.ac.uk

Fariha Azad
f.azad@warwick.ac.uk

Nikhil Sanghani
n.sanghani@warwick.ac.uk

Edmond Kwok
w.h.kwok@warwick.ac.uk

Freddy Newmarch
f.newmarch@warwick.ac.uk

James Patten
j.patten@warwick.ac.uk

Oscar Wingrove
o.wingrove@warwick.ac.uk

Wednesday 30th March 2016

Market Wrap Up

The WFS Market Wrap Up

The WFS Market Wrap Up is published fortnightly by the Warwick Finance Societies Wrap
Up Research Team. Receive the Wrap Up via email newsletter by joining the WFS, or look out
for archived issues on www.wfsocieties.org

In this Weeks Issue

Economic Calendar page 4

Monetary Policy page 8

Economic Calendar

Helicopter Finance and

Solving the Monetary
Policy Dilemma

Technology page 5

Artificial Intimidation
By FARIHA AZAD

Healthcare page 6

Genome Sequencing for

only $999, Buy Now!
By EDMOND PHUA

Technology page 7

Why Europes tech scene

still has a long way to go
By JAMES PATTEN

By CONOR LUDDEN

Companies page 10

An Enduring Conglomerate
That Works
By AATIF KHAN

Derivatives page 12

Trends in Interest Rate

Swaps
By OSCAR WINGROVE

Definitions page 13

Glossary

Wednesday 30th March 2016

Market Wrap Up

Economic Calendar
Key dates to look out for over 2016
Remaining 2016 FOMC Meetings
April
26 27

Remaining 2016 ECB Meetings

April
21

June

14 15

June

July

26 27

July

21

September

20 21

September

November

12

October

20

December

13 14

December

Remaining 2016 BOJ Meetings

April
27 28

Remaining 2016 BOE

Announcements
April
14

June

15 16

June

16

July

28 29

July

14

September

20 21

August

October
November
December

31 1

September

15

19 20

October

13

November

December

15

Wednesday 30th March 2016

Market Wrap Up

Artificial Intimidation
Our future is headed towards artificial
intelligence and there is nothing investor
sentiment can do about it.
By FARIHA AZAD in TECHNOLOGY
The emergence of AI (Artificial Intelligence) in
almost all reaches of life is becoming increasingly
commonplace. From self-driving cars, winning the
quiz show Jeopardy, sending arguably racist tweets
and permeating financial markets, AI is truly
increasing in both reach and breadth, but what about
the demand?
The results of approximately fifty years of research
and development are only starting to materialise. We
hear a lot about deep learning, which is essentially
computer programming that studies troves of data to
learn patterns. Give a computer millions of pictures
of fish, and it will learn how to distinguish fish from
foe.
Now we see an emergence in asset managers turning
to AI with investment algorithms that scour vast
datasets for tradable patterns. BlackRocks San
Francisco-based Scientific Active Equity arm is an
example of this; in fact, CEO Larry Fink is betting
that a trillion points of data can help revive his firm's
ailing stock-picking business. Ewan Kirk, head of
Cantab Capital, a Cambridge-based quantitative
hedge fund has remarked on AIs focus on pattern
recognition. He argues that markets are dominated
by noise and chaos and that patterns are harder to
find. Considering how current computer-driven
hedge funds are able to parse signals amid market
noise implies that the power of computation is
underestimated.
Legg Mason, Global Asset Managers, conducted
surveys as part of its 2016 Global Investment Study,
which questioned 5370 high-net worth global
investors (worth $200,000 or more in investable
assets). They found that only a third of these people
would trust online platforms or robo-advisers with
their money. The arguments are a preference for the
human touch and again that markets are too
complicated for AI techniques. DeepMinds AlphaGo
algorithm recently beat the ancient Chinese abstract

strategy board games world champion. The response

regarding AIs strengths and applicability to markets
is varied. Some argue that the premise of a game like
Go is different to markets because games follow
rules.
Returning to the issue of the lack of a human touch
in AI approaches, the increasing popularity of mobile
banking must be noted. Alongside this, a third of
people who are not happy with their current advisers
and open to other suggestions would embrace roboadvisers. The reduced cost of such initiatives,
compared with face-to-face financial advice, is
another incentive. There will be people who do not
want to pay 2.5 per cent a year to go to an office and
see someone, compared with a 0.5 per cent charge,
says Adam Gent of Legg Mason.
At the commercial level Google (GOOG), Microsoft
(MSFT) and Facebook (FB) are using AI, from voice
recognition to the items displayed in your newsfeed.
The same deep learning technology is being used in
autonomous cars that can now achieve superhuman
levels of perception. As you can see the technology is
far more than simple image recognition. At the
moment the market does not exist so everyone
involved is a competitor: Intel (INTC) and Freescale
Semiconductor (FSL) for microprocessors, Mobileye
(MBLY) for sensors and Nvidia (NVDA) for GPUs.
AI seeping in to all corners of modern life is
inevitable, simply because automation is ease. The
common consumer may find the prospect of AI
frightening due to its portrayal in popular culture
and investors may be skeptical, but such sentiment
does not matter when all large corporation are
pushing for it. If AI becomes commonplace in all
other sectors of life, it is sure to have a strong footing
in the world of finance and markets too. But what
would the markets be without the human touch?
WIC

Monday 28th March 2016

Market Wrap Up

Affordable genome sequencing can change the

healthcare industry, medical cures and even our
daily lives.
By EDMOND PHUA in HEALTHCARE
Consumers can now find out the possible diseases
they will suffer in their lifetime, even figure out the
most appropriate treatment to administer for less
than $1,000.
The first human genome sequencing was called the
Human Genome Project (HGP). The HGP was an
international scientific research project set out to
determine the sequence of chemical base pairs,
which make up human DNA, and map all of the genes
of the human genome. The project was officially
launched in 1990 and took 23 years to complete,
incurring a cost of $2.7 billion (in 1991 dollars). The
idea that $1,000 genome was the affordable price
point for personal genome sequencing was developed
from this project.
Rapid advancement in genome technology has seen
the cost for genome sequencing drop dramatically.
To be exact, it has fallen about a million times
compared with two decades ago. Back in January
2014, Illumina announced their HiSeq X Ten system
that can deliver whole genome sequencing at a cost
of $1,000. A year following the announcement, startup Veritas Genetics was able to offer the service at an
official price of $999 to consumers.
Whole Genome Sequencing (WGS)
Every human has 20,000 25,000 protein coding
genes, with over 3 billion subunits (subunit of A, C, G
and T) in our DNA. The complex system of large
numbers gives rise of millions of different
combination that makes up the human biology.
Whole Genome Sequencing (WGS) is a laboratory
process that determines the complete DNA sequence
and the identity of 3 billion sub-units that compose
the human genome. It reveals information of the
current state of our body, the risk of potential

diseases and the hereditary diseases that we can pass

on to our children.

Thousands of U.S. Dollers

Genome Sequencing for only

$999, Buy Now!

$50,000
$5,000
$500
$50
$5
$0
Cost per Genome
200120022003200420052006200720082009201020112012201320142015

Source: National Human Genome Research Institution

Treatment Implications
WGS can affect the diagnosis and treatment of the
diseases such as Cancer, which is a genomic
mutation. For decades, treatment for cancer relied on
one-size-fits-all approach, putting individuals
through unintended side effects. With WGS, medical
teams can identify the genes that drive cancer in
individuals and apply precision treatment that works
best for them. The same can be achieved for other
diseases like Alzheimers, diabetes and even other
common illnesses. Medical teams can therefore
assess an individuals genomic makeup and predict
the response to a specific medication. Doctors will be
able to tailor specific chemical composition in a drug
for patients on long-term medication, enhancing
drug absorption rate and reducing side effects.
The technology can be applied into our daily lives.
Veritas Genetics created a mobile application called
myGenome, a fully sequenced genome card for
consumers to carry around. The companys objective
is for every individual to carry full genome cards and
using them to select our food, personal care products,
and out fitness routines to find out the best ways to
maximize your health.
Healthcare Industry
The potential for this industry is vast. In 2013, the
global genomics market was valued at $11.1 billion.
Over the next 4 years, the industry is expected to
experience compound annual growth rate of 10.3%,
reaching $22.1 billion by 2020 (Persistence Market

Monday 28th March 2016

Market Wrap Up
Research, 2015). The broad use of diagnostics
therapeutics (an umbrella term that includes genome
sequencing) in hospitals and medical organizations
are main drivers of the industry. As healthcare costs
continue to increase along with the rising demand
from the ageing population, the market value of
genome sequencing industry is likely to skyrocket.
Industry leader like Illumina has the most to benefit.
Over the past five years, Illumina has experienced
revenue growth of 19.7% CAGR over the past five
years, outpacing many of its peers. Revenue growth
is expected to sustain as more clinics adopt the
genome technology. Technological advantage, along
with being the only FDA-approved genome
sequencing instrument, will help maintain Illuminas
90% dominant market share.
Personal genome sequencing will allow the
healthcare industry to deliver pre-symptomatic
treatments that will stop the development of chronic
diseases before it even starts. By leveraging the
increasing information and knowledge of each
individual, companies that provide commerciallyviable, tailored drugs will emerge. Knowledge of the
anatomy of our genes might reveal answers for
behaviours or traits in our body that stretch far
beyond existing medical treatment. This can change
the healthcare industry that we know today.
WIC

Why Europes tech scene still

has a long way to go
By JAMES PATTEN in TECHNOLOGY
A lot has been said about the growing dominance
U.S. investment banks hold over their European
counterparts. Such so, that similar comparisons are
being made within the technology sector, where
European start-ups continue to lag behind.
This has traditionally been accounted for by factors
associated with geographical location and market
size. For example, although Europe has a larger
overall population, it is divided into several different
languages. As a result, launching a start-up in the

U.S. yields a far greater probability of gaining

traction and sufficient revenues for growth.
Europe has been plugging at these same excuses for
far too long, and the attention is now shifting towards
Europes overly risk averse culture. The European
Commission has laid out a 2020 action plan
claiming that Europe needs a thorough, farreaching cultural change to compete with US
enthusiasm for launching start-ups.
However, it is not Europes enthusiasm that should
be under scrutiny. There are many constellations of
enterprises scattered all over emerging tech hubs
such as London and Berlin. In spite of this, Unicorn
success stories are still few and far between (startups valued in excess of $1bn), as start-ups
continuously fail to scale sufficiently to take on the
Silicon Valley giants.
Prioritising family control over outside capital
opportunities for expansion has often been the model
favoured by Italian and German companies.
However, it is simply not plausible in global
technology.
Therefore, similarly to investment
banks, cultural reforms should not be at the focal
point in developing solutions to the entrepreneurial
deficit. Instead, emphasis should be placed on
revitalising business practises.
Londons finance sector highlights the potential of
deep capital markets. In fact, the City offers more
than just finance: it is an epicentre for global
expertise in business and product development.
The reverse could be said for Silicon Valley. The
finance skills are instead contained within the
entrepreneurial sector, translating into a greater
willingness to invest Venture Capital (VC) finance.
The U.S. can therefore boast more sophisticated
support systems and greater transfers of capital to
start-ups.
European start-ups and corporates need one
another. The exchange of innovative thinking and
resources for scaling up sounds like a solution that
could solve Europes shortcomings in both
technology and finance.
WIC

Monday 28th March 2016

Market Wrap Up

Helicopter Finance and Solving

the Monetary Policy Dilemma
By CONOR LUDDEN in MONETARY POLICY
A few weeks ago, I attended a talk by Lord Adair
Turner, who is currently chair of the Institute for
New Economic Thinking, a think-tank co-founded by
George Soros following the financial crisis. Its
primary aim is to promote and pursue innovative
economic ideas in the 21st century. One of these is
monetary finance, otherwise known as helicopter
money: when Lord Turner outlined this concept at
his talk, there was quite evidently some scepticism
among attendees. How on earth, many wondered,
could a system in which an independent monetary
authority finances a government be considered
prudent policy? Such a system could not only be
considered non-credible and unethical, but also
unconstitutional and illegal, without the appropriate
frameworks in place. Ultimately, the past five years
have taught us that the current monetary policy tools
are largely ineffective in a zero- interest rate, low
inflation and low growth environment: a radical new
approach is needed to ensure the effectiveness of the
monetary transmission mechanism, and helicopter
finance could be a route to achieve this.

Eurozone inflation has been painfully low in recent

years (Source: Eurostat)
Helicopter money is by no means a new concept, far
from it. In fact, it was first put forward by the
renowned economist Milton Friedman in his 1969
paper, The Optimum Quantity of Money. The

direct transfer of printed money was Friedmans

solution to disinflationary and deflationary threats in
an economy, and was developed later by Ben
Bernanke with the idea of monetary-financed tax
cuts: however, this hybrid of fiscal and monetary
policy has never been attempted in a major economy
before, and there are certainly a few valid reasons for
this. When policy-makers and academics consider an
economy in which government deficits are financed
by a central bank printing money, they are likely to
envision Germany of the 1920s or Zimbabwe of the
past decade, both of which suffered severe
hyperinflation. The threat to central bank
independence (a central pillar of modern monetary
policy) from helicopter finance is a very real one, and
is often the reason it is considered a taboo subject.
This issue, among other potential pitfalls, must first
be addressed before a credible argument is
presented. Firstly, central bank independence: any
policy would have to place restrictions on the portion
of public deficits which could be financed by a
monetary authority, but further than this, there must
be controls to prevent unnecessary financing when
the economy is healthy. Quantifying the required
amount of monetary finance across different
scenarios is a difficult (but important) task, and
would help prevent government manipulation of
business cycles.
Secondly, there is the problem of coordination: fiscal
and monetary policy have, in recent years, pursued
wildly different paths. For the former, austerity and
spending cutbacks have dominated the agenda,
especially in the UK and the Eurozone, while
expansionary policies (initially interest rate cuts, and
then QE) have characterised the latter. An
illustration of this discordant relationship was the US
fiscal cliff crisis in 2013, in which attempts to
prevent exceeding the debt ceiling led to public
spending cuts; these arguably hampered the efforts
of the Fed to reflate the economy. Im not suggesting
governments and central banks should directly work
together to design policies, but central banks
(particularly the ECB and Bank of England) would
need a broader mandate than inflation rate-targeting
in order for helicopter finance to work effectively. In
essence, this is coordination, rather than
cooperation, of policy.

Monday 28th March 2016

Market Wrap Up
Some commentators have argued that monetary
finance doesnt offer anything that isnt already
available to governments. The government could
issue bonds to either private investors or the central
bank: the latter of these is a cheap form of finance, as
all profits made by the central bank from holding the
bonds are remitted to the government. The assertion
is that in either this case or monetary finance, the
monetary authority pays the same in interest from
the increase in deposits: however, this assumes that,
under a monetary finance scenario, the additional
money created is stored in bank accounts. This is
highly unlikely, given that the funds from monetary
finance are directed at the real economy, while those
used for asset purchasing programmes largely
remain within the financial economy: the Bank of
England estimates that the 375bn of QE led to a
boost in spending of only 23bn- 28bn in GDP (or
6.5-7% of the total amount).
QE programmes involved the large-scale purchase of
financial assets in markets. Primarily these asset
purchases have been targeted at government bonds,
but commercial debt and ETFs have also been bought
by central banks. While QE has brought some
stimulus to financial markets, the benefits for the real
economy have been transitory and potentially
dangerous, artificially inflating the values of certain
assets. While instability across economies can be
attributed to a much broader range of factors,
monetary authorities must recognise that their
current policies are insufficient in order for
developed economies to return to pre-crisis growth
in wages and living standards. Thankfully, senior
figures have begun to recognise this: Mario Draghi,
governor of the ECB, described helicopter finance as
a very interesting concept, but the ECB is
prohibited from financing member states. Could this
be circumvented by directly financing citizens of
these states in some form? Possibly, but this would
require much debate around how it would be
implemented in practice.

Monetary finance is neither an ideological or political

argument: it is a rational one. Whatever methods
policy-makers choose in an attempt to boost ailing
economies, the stakes are higher than ever, if they are
to prevent developed nations from falling back into
recession over the next few years. Is monetary
finance too good to be true? Only time will tell.
Read Adair Turners Between Debt and the Devil,
and check out www.positivemoney.org for more
information on monetary finance.
WIC

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WWW

Monday 28th March 2016

Market Wrap Up

An Enduring Conglomerate
That Works
Buffets Annual Letter to Shareholders is a reminder
of how sticking to tried and tested investing
principles leads to a fortress conglomerate which
has very little foreseeable downside and perpetual
outperformance of the S&P500.
By AATIF KHAN in COMPANIES
Each year investors go over Buffets Annual Letter to
Shareholders with a fine toothed comb to find any
nugget of information which the Oracle of Omaha
can offer them.
With current turmoil in financial markets, various
funds suffering from style drift, the Graham
inspired Buffet philosophy of value investing
continues to serve as a poster boy for a sure method
of generating recession proof earnings.
In fact, investing $50 into Berkshire Hathaway stock
50 years ago would today be worth more $600,000.
Today, not everyone would be able to afford Class A
Berkshire equity, valued at a share price of
$210,000, but Class B stock (at a more modest price
of around $140) should be more affordable, and is
something investors ought to look into for their
portfolio. Berkshires stock doesnt pay dividends,
the only difference (between Class A and B stocks)
being Class B stock is subject to stock splits and has
fewer voting rights.
There are a few traits which have served Buffet well
and which have helped Berkshire Hathaway
continue to stand the test of time and outperform the
S&P 500, in terms of compounded annual growth, at
19.2%.
Cash rich balance sheet
Berkshire net income has been growing for over five
years ($24.08bn last year), with 2015 operating
earnings at $17.36bn (up from $16.55bn in 2014).
2015 assets in cash and cash equivalents stood at
more than $70bn, growing at more than $700m per
month for the last 12 months.

If the state of the economy declines, Berkshire

Hathaway can easily deploy its war chest for
innumerable purposes: create shareholder value by
lending to subsidiaries, from which they can charge
interest at relatively attractive rates, make cheap
acquisitions from small mid cap companies (to
capitalise on future trends) to taking entire public
companies private. Additionally, they could use up
some spare free cash flow to buy back stock,
especially if their price reaches 1.2x book value (the
price at which Buffet himself is more than happy to
buy back shares). The hardest challenge facing
Berkshire right now, if anything, is being able to find
an actual use for the money lying around (which is
creating no value for Berkshire shareholders).
Conservative and future investing
Buffet doesnt take unnecessary risks: however, he
is extremely disciplined in not paying any more than
necessary for ownership of businesses with a high
return on capital.
Despite the anticipation surrounding his letter, the
Oracle doesnt mention anything with respect to
recent market volatility, divergent credit policies,
Chinas economic slowdown, negative interest rates
or the general worry of a U.S. led global recession.
Basically, everything which has worried investors
for the past 6+ months is absent.
This might seem surprising when at Berkshire
Hathaways 2015 10 K filing, it mentions the risk
factors to the conglomerate: deterioration of
general economic conditions may significantly
reduce our operating earnings and impair our
ability to access capital markets at a reasonable
cost.

Monday 28th March 2016

10

Market Wrap Up
But Buffet sees 10 K risks as seldom useful in
assessing (1) the probability of the risk
materialising, (2) the ranges of costs likely to be
incurred and (3) the timing of the potential loss.
Perhaps amusingly, the only threat which Buffet can
identify in his letter, against which he is powerless
is a cyber/biological/nuclear/chemical attack in the
U.S.
A basic protection against this is a diversified
portfolio, and Buffet focuses on necessity
industries and products, including insurance,
rail, finance and energy/ utilities. Numerous
cash flow streams provide him with a
competitive advantage over what he calls
one-industry companies.
The decline in oil prices and coal usage has
proved detrimental to BNSF railroads, which
moves 17% of U.S. intercity freight. To
compensate for this, especially with last years
Paris Climate Change Conference in mind,
Berkshire now owns 7% and 6% of all wind
and solar generation respectively in the
United States.
Even if any of Berkshires investments
perform poorly in a given year, their long term
trend reflects the efficacy of his strategy in
hand-picking cheap and fundamentally sound
companies. The chart below displays
Berkshires largest five investments (by equity
market cap.) in Wells Fargo (WFC: US), Coca
Cola (KO: US), IBM (IBM: US), American
Express (AXP: US) and The Procter & Gamble
Company (PG: US)

management. Building that up takes patience;

Buffet adapted Benjamin Grahams style of
investing, searching to hold companys for
years instead of selling them when in the
money by a certain percentage.
Looking at the Oracles investments, there are
a few things Buffet looks for in a company,
which should serve as a good base for
investors of all experience:

Businesses which provide a unique

product e.g. Coca Cola, Budweiser,
Phillip Morris.
Strong brand, unique assets, long
term contracts, industry with barriers
to entry.
Companies which provide a needed
product and arent subject to be
affected by future trends e.g. Buffet
said the internet is unlikely to affect
peoples chewing gum eating habits.

For anyone who wants to learn what Buffet

looks for in a companys financial statements
(and to generally learn how to interpret
company statements), a good book to read is
Warren Buffet and the Interpretation of
Financial Statements: The Search for the
Company with a Durable Competitive
Advantage.
For anyone interested in reading any
Berkshire Hathaway documents used in this
article, then follow the links below:
2015 Annual Letter to Shareholders:
http://www.berkshirehathaway.com/letters/2015
ltr.pdf
2015 Annual Report:
http://www.berkshirehathaway.com/2015ar/201
5ar.pdf

Source: Bloomberg Markets

Berkshire Hathaway offers investors what

they want: size, scale, cash heavy balance
sheet, a P/L account growing on all fronts,
portfolio diversity and, above all else, great

2015 Form 10 K:
http://www.berkshirehathaway.com/2015ar/201
510-K.pdf

WIC

Monday 28th March 2016

11

Market Wrap Up
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Trends in Interest Rate Swaps

and Financial Reporting
By OSCAR WINGROVE in DERIVATIVES

In the post-recessionary era, lenders have faced

depressed revenues from mortgages and other credit
products due to near-zero interest rates. Major banks
in the US have been dealing with this issue by entering
into tens of billions of dollars worth of receive-fixed
interest rate swaps. In this derivative agreement, the
banks trade their cash flow of interest payments on
mortgages (floating rate) for a new cash flow of
interest payments at a fixed rate. As the banks have
been able to lock in a fixed rate for 5 years or more,
since 2009 they have mostly received a far higher fixed
rate than they paid in floating rate. This may seem like
a minor operation, but in fact JP Morgan, BAML and
Wells Fargo were able to make $42bn in less than 5
years using this method.
The cash flows from interest rate swaps in the last 7
years have given the major banks much-needed
liquidity at a difficult time, contributing towards their
Core Capital Requirements mandated by the Basel III
regulation. However as the global economy has
improved, quantitative easing ends in the US and the
Fed begins to raise rates, these swaps could become a
cause of major losses. This is because the floating rate
they are paying the counterparty of the swap could
exceed the fixed rate they are paying. On the other
hand, the banks can take consolation in the fact that
the higher interest rates will bring increased capital
from debtors, somewhat offsetting the losses on
interest rate hedging instruments. If we are to have a
decade of higher interest rates, it is likely that interest
rate swaps will become much less popular for the
major banks. This may have a negative impact on
firms that act as clearing houses for these products,
although more frequently, the banks themselves are
taking on clearing house roles.

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Another trend comes from the world of financial
reporting. It is becoming increasingly clear to
financial services institutions that the disclosure of
derivatives and hedging activities in financial reports
is currently highly flawed. The Chartered Financial
Analyst Institute published an ethics study in 2013
identifying key problems with derivatives disclosures
(cfainstitute.org, 2013). They found that companies
gave very limited descriptions of their derivatives
usage and associated risks, even when the annual
changes in market value of their derivative hedges
exceeded 100% of their net profit for the year.
Hedging activities are often left out of the risk
assessment statements given by board of directors in
annual reports, despite that they can sometimes
represent the greatest risk to the firm. The CFA
Institute recommend that firms describe clearly the
nature and magnitude of their hedges and disclose
data evaluating the maximum potential risk to the
firm caused by the derivatives. The CFA Institute also
assert that when firms are identifying material risks,
derivatives should be considered in terms of their
potential loss not their market value. The Financial
Reporting Standards and International Financial
Reporting Standards are constantly adapting their
treatment of derivatives. If more detailed derivatives
disclosure was required by regulators, investors would
be able to better assess risk and better identify when
managers are using derivatives to hide poor
performance.
WIC
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Glossary
2 10 Spread: Yield difference between 10 year
treasuries and 2 year notes.
ABX index: Financial benchmark which measures
the overall value of mortgages made to subprime
borrowers. Index uses CDS contracts to generate
value. Higher value means more subprime risk.
Angel investors: Institutions which invest in very
risky companies, often before they have any revenue
and are in the R&D phase. Such businesses have little
exposure to capital markets and are startups/small businesses.
Block trade: Large quantity of securities submitted
for sale or on order. Price is arranged between parties,
outside of open public markets.
Compound Annual Growth Rate (CAGR): The
mean yearly growth rate of an investment, often a
better metric than simply looking at yearly growth
rates as it gives a smoother, annualised rate of return.
Drawbacks of CAGR it ignores volatility and implies
growth was steady at the time. CAGR = (final
value/initial value)^(1/investment time horizon) 1.
Capital asset: Usually property, plant and
equipment (PPE). Such assets play a fundamental role
in a businesss profit generation and have a long
depreciation lifecycle. Capital assets are fairly illiquid
and are only liquidated in worst scenarios e.g.
bankruptcy, restructuring. Depending on the
industry, capital assets may be the dominant portion
of all assets e.g. oil exploration, shipping.
Capital structure: Refers to the debt and equity
combination used to finance long term growth and
overall operations. Start-ups and early growth firms
are likely to be heavy in common equity and less
exposed to long term debt due to an uncertain revenue
forecast, whereas, say, a utility company with a regular
revenue stream would be more comfortable in using
debt to finance long term operations.
Carry trade: Sell a currency with a lower interest rate
and use the funds to buy another currency which
yields a higher interest rate i.e. borrow at low interest
to invest in assets which yields a higher interest rate.
Japan had really low rates from mid-90s to financial
crisis.

Cash equivalents: Investment securities which are

short term, have a high credit standing and are highly
liquid. E.g. U.S. T-bills, bank certificates of deposits,
bankers acceptances, corporate commercial paper.
CBOE VIX: Shows market volatility expectations for
the next 30 days, constructed using implied volatility
from S&P 500 index options. <20 is calm/steady
expectations, >30 is high uncertainty/fear.
Class A stock: Often have more voting shares than
Class B, but not always. Companies often try to hide
the disadvantages of owning shares with fewer voting
rights by calling those shares Class A and those with
more Class B. For a detailed description, you have to
look at a companys bylaws and charter.
Commercial paper: Unsecured, short term debt
issued by a corporation. Maturities rarely longer than
270 days. The proceeds from sale can only be used
towards financing current assets. Financing fixed
assets requires SEC involvement. Major benefit is
commercial paper doesnt need to be registered with
SEC as long as it matures before 9 months, making it
a cost effective way to finance.
Credit risk: Risk of loss from a borrowers inability
to meet contractual obligations. This risk arises
whenever a borrower expects future cash flows to pay
a current debt. Investors are credited with more
(perceived) risk through a higher interest rate.
Credit spread: Spread between treasury and nontreasury securities which are identical in maturity but
not in credit rating. E.g. AAA rated bonds offer a
higher return than government bonds because their
credit is worse. Tighter spreads imply improving
private credit worthiness.
Debt restructuring: Used by companies to change
the terms of the existing debt agreement/issue in
order to avoid default, utilise lower interest rate or
better manage overall revenue streams.
Defensive acquisition: Acquiring other firms as a
defence
against
market
downturns/possible
takeovers. Usually done by acquiring smaller
companies in same business, so other companies cant
acquire enlarged firm due to antitrust law.

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Market Wrap Up
Deposit rate: Interest rate paid by bank to deposit
account holders. Deposit accounts include certificates
of deposit, savings account and self directed
retirement accounts.
Eurodollar: U.S. dollar denominated deposits at
foreign banks or foreign branches of American banks.
Such dollars escape regulation by the Fed Board. Since
the Eurodollar generally has less regulation, such
banks can operate on narrower margins than U.S
based banks. Thus it has expanded as a way of
avoiding regulatory costs in dollar denominated
financial intermediation.
Exchange fund: AKA Swap fund. A stock fund which
allows investor to exchange their big holding in 1 stock
for units in a portfolio. Provide easy way to diversify,
while deferring capital gains tax as there is no actual
sale.
FDIC: Federal Deposit Insurance Corporation.
Insures U.S. deposits, against bank failure, up to
$250k per institution so long as bank is a member firm
(through premium payments).
Federal Funds Rate: Only applies to highly
creditworthy institutions. Its the interest rate banks
charge one another to lend overnight funds to meet
reserve requirements. The Fed sets a minimum
amount banks must hold to protect against bank
failure AKA reserve requirement. Currently it stands
at 10% of total deposits. Reserves are usually held in
the Fed. Discount rate is the rate at which the fed
charges banks for overnight funds, Fed Funds Rate is
the rate at which banks charge one another for
overnight funds.
Free Cash Flow: FCF represents the amount of
money a business is able to generate after accounting
for all costs in maintaining its asset base. Such funds
allow a firm to pursue avenues in increasing
shareholder value. Otherwise, its hard to develop new
products, do M&A or pay dividends and reduce debt.
General partnership: Management duties and
profits/losses spread equally among management,
regardless of equity stake size in partnership. But each
partners has unlimited liability. GPs can make
management decisions for the overall partnership.

Headline inflation: Measures total inflation in

economy, including commodities like food and
energy.
Holding company: Usually a parent corporation,
limited partnership or limited liability company,
which doesnt necessarily produce anything. However
a holding company does own enough voting stock in
another company to control its policies and
management, but it does not manage the daily
company operations of subsidiaries.
Index option: Derivative which gives the right to
buy/sell a basket of stocks like the FTSE 100, at an
agreed future price and date.
Limited Liability Company (LLC): Company
members cant be held liable for company
debts/liabilities.
Loss leaders: Pricing strategy where the price of one
product is lowered below cost price, in order to
stimulate demand in other goods.
Mark to Market (MTM): Assets are valued based
off how much they could sell for under current market
conditions. This differs from historical cost
accounting which looks at the original purchase price
and simply lists that on a balance sheet. So this
accounting technique records market valued assets,
not book value.
Mezzanine financing: Lets firms gain capital via
uncollateralised loans, with options built into the deal.
The firm can quickly assess capital to finance
expansion/assets, without needing to create
shareholders with voting rights. If firm defaults,
outstanding balance is converted into shares via
options. Mezzanine financing often charges higher
interest rates since little due diligence is involved.
Usually need good track record to get funding e.g.
established status/product, profitable history and
viable expansion plan.
Municipal bond: State issued debt to finance capital
expenditure. Such bonds are triple exempt (from
state, local and federal taxes), especially if you live in
the issuer state and are typically popular with those in
the higher income bracket.

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Market Wrap Up

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Market Wrap Up
the investment, and the income from it, to go up or down. The information in this document is believed to be correct but cannot
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