Sum it up !

Bad graphs are everywhere - this time it's Khaleej Times

2019-10-12T18:52:00.000+05:30

Nobody sets out to make a bad graph. But it happens. Again and again. It happens in places where you would expect people to know better.

Let's look at the following example from Khaleej Times published on Oct 11 in the business section:

Khaleej Times (Oct 11, 2019 Page 14)

Khaleej Times (Oct 11, 2019, Page 16)

Storytelling is an art. The art is further exemplified when the storytelling involves data. The story in the article could have been told differently to resonate better with the readers. However, I'll focus on the following chart from the article to discuss the basics of data visualization.

Let's analyze this chart:

This is a horizontal bar chart, which flips the vertical bar chart. The horizontal bar chart is easier to read especially when the category names are long (e.g. San Francisco Bay Area).
The chart is easy to read because of the way we typically process information - starting at the top left and making z's with our eyes across the screen or page - the structure of the horizontal bar chart is such that our eyes hit the category names before the actual data.
The chart uses the logical ordering of categories by ordering the cities in descending order (and not alphabetically)

The 'bad elements' that wreck this chart:

The data is presented in Trillions but the color coding distinguishes it based on Trillions and Billions. The size of Singapore is 1 Trillion whereas Chicago is 980 Billion. It is not very obvious when you read the chart - a higher number (980) is placed below a much smaller number (1)
The data for billions seems to be entered manually and there is an inconsistency in the data and bar size for Seoul, Paris and Shenzhen (980 billion each) whereas bar is the same as Osaka (790 billion)
Distinguishing trillions and billions add nothing to the story that the data is trying to communicate. In fact it confuses the reader. Color is a very important affordance in design and makes it obvious to the reader on how the product (in this case the data or the chart) is to be used. Pre-attentive attributes are used to draw the reader's attention to where we want them to focus - in other words to high light the important stuff.
The title of the chart does not indicate what the data indicates. $ 3 trillion or $ 980 billion means what ? Is it the overall GDP of the city or the overall wealth of the individuals ? It is not very clear from the chart.
The color used in the chart places more emphases on the countries with blue bars. The hue of peach color has less pre-attentive attribute than hue for blue color.
The number orientation is not very consistent. Some numbers are mentioned with no decimal (3) and some are presented with one decimal. Changing the number from trillion to billion is a disaster which we have already discussed.
The message in second part of the article - The Big Apple Rules: New York has 65 billionaires and over 380,000 millionaires as residents is not coming out clearly in the chart. In fact if the person does not read the second part of the article, the message is completely missed.

Let's try and see how we can improve the affordances of the chart:

The chart title is altered to indicate what the data means
Sub-heading is added to give context of the data that needs to be highlighted
Color is used as a pre-attentive attribute to highlight New York city
Top 10 countries are colored in Blue (other than New York) and the next 10 are de-emphasized by using a grey color
The data is presented in consistent terms - 2 decimal and one measure of currency is used
Legend for currency is placed close to the first bar for ease of readibility
No color legend is given, the color used (orange, blue and grey) signals the emphasis of data
The color used are color blind safe

The focus of this article was to highlight the inconsistencies in the chart and not analyze the effectiveness of storytelling, which is another interesting perspective to analyze. The article talks about 'Why Dubai matters to the rick' but does not indicate how Dubai is placed in the ranking of world's wealthiest cities. The credibility of the story is lost if it fails to gives the complete picture and shares information selectively.

We have the best tools available today for preparing 'sexy' looking charts. However, storytelling is an art and cannot be automated by the tool. Stories resonate and stick with us in ways that data cannot.

7 Global Economies that are increasingly looking addled and distorted due to low interest rates

2016-02-20T13:02:00.000+05:30

Central Bankers across developed economies seem to believe that there is an interest rate so low that resultant financial market wealth will ultimately spill over into the real economy. The negative aspects of low yields and financial repression are making the following economies increasingly addled and distorted:

1. Venezuela

Bankruptcy just around the corner due to low oil prices and policy mismanagement. Current oil prices are a function of low interest rate central bank policies over the last 7 years

2. Puerto Rico

Default underway due to over spending, over-promising of retirement benefits and inability to earn adequate investment returns – due to ultra-low global interest rates

3. Brazil

In deep recession due to low commodity prices, governmental scandal and exorbitantly high real interest rates to combat the effect of low global interest rates and currency depreciation of the Real.

4. Japan

260% governmental debt/ GDP ratio – economy failing to kick start even with the booster dose of two of the three arrows from Abe’s armor. Japan is today, what America could be tomorrow

5. Euroland

‘Whatever it takes’ says Draghi. An economy that lost its spark plug has hit an effective negative interest limit that makes investing in these economies increasingly difficult. Low interest rates beget growth – defies logic in Euroland’s case

6. China

Debt/ GDP is 300%, loss of USD 1 Trillion in reserves to support an overvalued currency, distorted economic model relying on ghost towns, dirty factories and government spending which never seems to transition to a consumer led growth. Economy looking increasingly addled

7. U.S.

US economy is in a Black Hole. No one knows how the Fed will handle is enormously expanded Balance Sheet. Housing sector delivered, corporate sector still nonplus and shaky, high yield bonds are back – internally generated growth model seems to be keeping the engine going, for how long – no one clearly knows

Monetary policy is a means and not the only means – out of Abe’s three arrows, most of the central bankers have overused the two arrows of fiscal and monetary policy adjustments. The third arrow – structural changes – lies unused, both in Abe’s and Central Banker’s arsenal.

Boom boom.....bust !

2015-06-30T10:44:00.000+05:30

Greece's got some company! American controlled Caribbean island of Peurto Rico is deep in the water and is seeking help from Uncle Sam. Same problems, same consequences - un-competitive economy, bloated payroll and retirement benefits backed by investors from mainland seeking juicy returns. In both cases the parent company i.e. Eurozone in case of Greece and US in case of Peurto Rico does not allow the 'subsidiary' to declare bankruptcy.

Its going to be chaotic and litigious days ahead. I've ordered a truck load of newsprint and a sack of coffee to sit back, relax and watch yet another 'batting' collapse unfold.

Long live...Peurto Rico ! Long live Greece !

Reference Links:

http://www.bloomberg.com/news/articles/2015-06-29/from-puerto-rico-to-greece-credit-traders-put-on-the-defensive

http://www.bloomberg.com/news/articles/2015-06-29/puerto-rico-will-seek-to-suspend-debt-payments-in-restructuring

http://www.cnbc.com/id/102764396

Sum it up ! : Coming Soon to a market near you – Lehman II

2015-06-29T11:57:00.001+05:30

Blogged about #grexit in Feb 2011, things have panned out not very differently....

Sum it up ! : Coming Soon to a market near you – Lehman II: An alternate view on Greece currency crisis and how Greece should think differently. Greece should be saying...

'Corridor talk' : Entrepreneurship lessons from the 'corridors' of IIMA

2015-06-28T11:06:00.000+05:30

Entrepreneurship one-liners from the corridors of IIMA....

Biggest question for a start-up - Will the dogs eat the dog food

Entrepreneurship is the Pursuit of opportunities without being limited by the resources at hand

Bet on the jockey not on the horse

Tame uncertainty – transfer it to others

There are two moments of truth in the life of a start-up– the first order and the reorders

There are vitamins and there are painkillers, choose what you want to use to satisfy an unmet need

Don’t marry assumptions, divorce them as soon as they get old

Don’t ask the taste of iron from the iron-smith, ask it from the horse

Do not hire the chef before you identify the recipe

If you hire a chef to do X, he will only do X

Say it truthfully, say in completely and say it first

The color of money is more important than the money itself

In a hurricane eve the turkeys can fly

If all I have is a hammer, I treat everything as a nail

A team with B idea > B team with A idea

Would you rather be rich or rather be a king

Rather rule in hell than serve in heaven

Passion for the idea and passion for the business are not the same

Fueling desires lead to more desires

Trust = Credibility + Reliability + Intimacy / Self-orientation

Metcalfe’s law states that the value of a network is proportional to the square of the number of

connected users of the system.

If the rate of change on the outside exceeds the rate of change on the inside, the end is near

QSQT – Quarter se quarter tak.

If you want to make someone redundant give them inspection jobs

A crisis is a terrible thing to waste

You need big, hairy and audacious goals (BHAG)

If you can’t innovate, be a fast follower

Components of innovation strategy

The place where you add the most value, is also the place where there is the most uncertainty

URL - Ubiquity first, revenues later

Hire for attitude not for skill

Hard is soft, soft is hard

A cleaning lady in the office can tell more about the company, than anyone else in the company

Start-up – is like having a baby – you can read a lot about it, but you have to experience it to know what it really means and what goes with it

I hate curves....the cacophony of 'bell curves'

2015-06-28T01:33:00.001+05:30

I hate curves, not the ones on display but the one that most of the HR managers swear by in their year end assessments – the bell curves. If all you’ve got is a hammer, everything looks like a nail; no wonder HR managers eat, drink and sleep bell curves. Recently I was asked to evaluate and suggest the performance appraisal system of a large sized company and what an experience it turned out to be. I realized that most of the HR managers are as possessive about their ‘bell curves’ as Ms. Kardashian is about her B&B (even Microsoft is; – every time I mis-spell her name, it gives me a prompt!)

In the company, I noticed that the actual break up talent literally followed a bell curve:

o Approx. 20% are A level performers

o Approx. 70% are B level performers

o Approx. 10% are C level performers

Although A-level performers were (still are hopefully) adding a lot of value to the company, it was the B level performers who were the heart and soul of the company and are a very interesting bit. The normal hypothesis is that the company is mediocre, because the B level performers are mediocre. However in this case I feel the hypothesis is not true.

A-level performers were small in number and they were relatively new in the company as compared to the B level performers. Also I believed that A-level performers were not likely to be the ones who will stay very long with the company and build up institutional knowledge that is so essential in any business. This makes the B level performers invaluable, as their knowledge base of the company is very deep rooted.

These B level performers were with the company for long and know the cycles the company has gone through; they understood the company ever better than some of the A level performers. Surprisingly these B-level performers tend to pursue organizational goals over personal ones because they value stability both for themselves and for the company. This fact came out through observation and discussion with a diverse set of people. Irony is that although these B-level performers exhibit such extraordinary patience with career development still because of the compulsions of rating systems we tend to overlook their contribution.

Besides recognizing and rewarding A-level performers, very few companies have an explicit strategy for recognizing B players, on whom so much of the company’s long-term success depends. Even small gestures go a long way in building the recognition and sense of achievement among B-level employees.

Most of the HODs are themselves A-level players and therefore tend to identify with A-level players in their teams (which is not a bad thing). This is another reason why B-level players are sometimes (in fact most of the times) not given stretch assignments. This also explains the concern of under utilization of employees in certain departments. This under-utilization has a spiraling affect; the employees who are not given stretch assignments grow frustrated that their seniors are not really interested in their career development. Because of mediocre to poor ratings they also don’t believe that HR will represent their best interests.

Possible solution: I suggested to the management a mentor-ship program for B-level employees. The program can be structured as formal or informal mentor-ship wherein the senior- junior or peer to peer mentor-mentee relationship can be formed to align the aspirations, passions and skills of these B-level employees with the overall objectives of the company. HODs can act as mentors and it can be structured as a voluntary program.

This isn’t just about promotion or increments—it’s much more about developing the potential of the employees who, I definitely feel, form the core in any company’s scheme of long term things.

As for HR managers – their obsession with ‘bells and whistles’ is not likely to fade away anytime soon.

Why would a specialist want to be a generalist?

2013-04-15T08:31:00.000+05:30

Why would a specialist want to be a generalist?

After the moderators hauled the last load of verifications in the third week of December, I finally got a chance to look at the class profile of IIMA PGPX 8 batch for 2013-14. Although privacy issues do not permit discussing class profile at this stage, this article would still be of interest to prospective students of PGPX at IIMA and other one year general management programs.

My first glance at the class profile generated a silent question in my mind – Why would a specialist want to be a generalist? The class profile emitted the themes of diversity, broad knowledge base, exposure to multiple disciplines and specializations with a lot of breadth. But after going through individual profiles, I was on tenterhooks to dissect the generalist v/s specialist conundrum.

Thankfully a knowledge transfer session organized by the outgoing batch was around the corner and I got a chance to volley my conundrum in the ‘green room’. To get a broader perspective on the subject I tried to speak to a diversified sample of X7ers on what value addition they feel a general management program like PGPX provides to people of specialist domains. There was one particular response which stood out and left a lasting impression on my mind.

This wonky X7er served an ace and cleared the air by citing the proverb “To a man with only a hammer, every problem looks pretty much like a nail”. He went on to explain that the man who has various tools will limit bad cognitive effects from the man with a hammer tendency. He made sense but I had a follow up question – How can a ‘specialist’ overcome the hammer tendency and achieve worldly wisdom through this program (read PGPX)?

A letter perfect response to my follow up left me awestruck. The ‘wonk’ stated the matter concisely – for a specialist attaining a worldly wisdom is an ongoing process of, first, acquiring significant concepts – the models – from many areas of knowledge and second learning to recognize patters of similarity among them. The first is a matter of educating yourself and the second is a matter of learning to think and see things differently. He was candid in acknowledging that acquiring knowledge of many disciplines may seem a daunting task. But he was equally straightforward in stating that fortunately, you don’t have to become an expert in every field. You merely have to learn the fundamentals principles – the big ideas and learn them so well that they are with you always.

So as I take the first step on a pathway towards a goal of flexible thinking and broadening my knowledge base derived from exposure to multiple disciplines, I look forward to understanding the truly big ideas of each discipline and then connecting them back to my specialist domain. I hope to be back on this post after a year to testify on this conundrum from my own personal experience.

Reactions to the Union Budget (2013-14) - Travel and Tourism Industry Perspective

2013-03-04T11:55:00.000+05:30

Reactions to the Union Budget (2013-14) - Travel and Tourism Industry Perspective

The finance minister has presented the union budget amidst a difficult macroeconomic situation. Current account deficit is at a record high and fiscal deficit is swelling. The economy is in a ‘stagflation’ kind of a situation in which inflation is rising and GDP growth is falling. The domestic situation is precipitated by weak economic data from global economies. Under these constraints the Finance Minister has done a good job of presenting a budget that addresses the larger issues and looks at the bigger picture. The budget will essentially have a J Curve effect on the economy. Things will turn worse in short term before stabilizing and improving in the medium and long term. It’s after a long time that we have seen a firm commitment from the government to address the long term issues over the short term quick fixes.

The budget has done two important things. Firstly it has reassured the markets that the government is ready to step out of its comfort zone to follow the fiscal prudence path necessitated by the burgeoning current and fiscal deficits. Secondly it has communicated to global investors that India stands committed to carry out reforms to correct macroeconomic imbalances and aim for a sustainable growth path.

The effect of the budget on travel and tourism can be dissected from two different angles – the short term effect and the medium to long term effect. In the short term the budget is negative for the tourism sector and may lead to a demand pullback. Across the board increase in taxes on luxury products will hurt demand for luxury travel in the short term as the additional expenditure on luxury products will reduce disposable income of high net worth individuals for discretionary purchases such as travel. Although there is no change in slabs for personal income tax and there is only a marginal relief in the form of tax credit, the budget through its far reaching tentacles of fiscal consolidation will hurt demand for travel from low and middle income group segment. Food inflation is still high and in spite of efforts to control inflation, the rise in fuel prices and reduction in subsidies will have a negative impact on the discretionary spend of low and middle income group. The demand from industry / businesses will also remain weak in the short term as the interest rates remain very high and there is very little incentive for the industry to increase capital formation/ spending. The investment deduction allowance will encourage only the small and medium enterprises to make investments.

In the medium and long term the fiscal consolidation measures taken by the government will yield some positive results and economy may start to make a turnaround. There will be a three dimensional positive impact on the economy in the medium to long term. Fiscal and current account deficits will come down, Indian Rupee will appreciate relative to the US Dollar and inflation will taper off. The finance minister has taken stern measures to keep fiscal deficit under check and reduce current account deficit by putting measures in place to reduce gold import and reduce the fuel subsidy bill with a monthly increase in fuel prices. All these measures will give enough room and the confidence to the reserve bank to cut interest rates and infuse liquidity in the system. The reduced fiscal and current account deficit will also ensure appreciation of Indian Rupee relative to Dollar which will in turn reduce the fuel bill even further. The inflation is also likely to taper off and this will increase spending by individuals. This three dimensional impact in the medium to long term will propel demand both from individuals and businesses. The strengthening of macroeconomic fundamentals will have a multiplier effect on demand for travel and tourism.

Having said that the budgets have traditionally been disappointing for the travel and tourism sector as the subsequent governments have failed to recognize and encourage the potential of this industry. In fact there is a long pending demand of the industry for a ‘priority industry sector status’ for travel and tourism which yet again has failed to find favors. The finance minister has talked about rationalization of direct taxes and efforts to fast track the GST rollout, but he has failed to address the long pending demand of easing out service tax complexity and ambiguity in the travel and tourism industry. Among other pending issues not addressed in the budget are the rationalization and reduction of taxes on ATF, tax concessions to tourism industry for infrastructure spending, fast track and single window clearing system for tourism and hospitality projects etc.

This budget reminds me of a 4x100 relay race in athletics. The finance minister has run a good first lap and handed over the baton to the reserve bank. It’s for other stakeholders including the reserve bank to compliment the good first lap of the finance minister by putting in their best efforts and ensure a podium finish.

How bad governance and an elephant footed Judiciary is derailing the Indian economy...

2013-01-18T17:10:00.000+05:30

How bad governance and an elephant footed Judiciary is derailing the Indian economy...

By all estimates India is poised to be the third biggest economy by 2050 sharing space with China and America. It is all set for a very high growth trajectory eclipsing China’s high growth rates anytime between 2015-2020. The basis of these estimates remains that India’s political landscape remains stable and policy framework remains strong. But as we are all set to board a high speed growth train, suddenly we have acquired travelling sickness (in terms of poor governance, policy logjam and slow justice). We are not in the best frame of mind to board the train. Rather the train is apprehensive to board us, lest we spoil their spick and span train with our sickness. It is thus giving us time to sort out our sickness before we are afforded an opportunity aboard the fastest economic growth train. This is one train we cannot afford to miss and this is one train we want to board with our best foot forward.

India is an emerging economy with a young population and strong economic fundamentals. Free judiciary (though the speed of justice remains a drag), democratically elected government, independent central bank and developed financial markets are the pillars of our economic growth and red tape, corruption and poor infrastructure remains the irritants in the growth process.

The question that we are answering here is how and why bad governance and elephant footed judiciary jeopardizes the good work and threatens to derail the economic growth engine?

India remains heavily dependent of foreign investment in order to sustain and increase our GDP growth rate. Currently we import more than we export, thus the current account deficit and we pay for our imports (which are more than our exports) by borrowing from abroad (foreign investment). FDI in any form is welcome as that is helping the country generate growth and thus this form of foreign investment is pro growth. Foreign investors when investing in a country look for the following parameters:

1. High growth rates – India is currently in the high growth phase and thus investment by foreign investors in India is giving them high return on their investments.

2. Current account deficit

3. Fiscal and monetary policy

4. Fiscal deficit

5. GDP/Debt

6. Liquidity

7. Political Risk Premium

8. Stability of currency

I ‘ll try and brief on parameters in the next blog.

Is a large current account deficit sustainable?

2012-10-20T00:20:00.000+05:30

Is current account deficit a bad economic signal?

A country faces a trade deficit when its imports exceed its exports. As long as foreign investors are willing to finance this difference by net capital flows into the country, the situation poses no economic problem. The depreciation pressures from current account are balanced by appreciation pressures from financial account. A current account deficit is sometimes caused by economic growth – faster growth – more imports than exports. Higher economic growth also gives attractive returns to invested capital and attracts foreign investment. These capital flows provide natural financing for current account deficit.

Is a large current account deficit sustainable?

Normally in a developing economy a deficit ranging from 2-8% of GDP is observed. At the higher end – it’s a concern particularly when the foreign investment comes from debt investments rather than foreign private investors. In India the Current Account Deficit is hovering around 4-4.5% of GDP.

A large current account deficit is sustainable if non residents are willing to finance it continuously. As soon as foreign investors reduce their financial flows, or seek to repatriate their invested capital, the financing of the current account deficit will disappear and adjustments will need to take place, usually in the form of the currency depreciation. Recall also that income payments are part of current account, so too large a foreign debt burden can exacerbate current account deficits.

Currently the Current Account Deficit in India is around the danger mark and that explains the government’s urgency in taking steps that send positive signal to foreign investors and the capital inflows improve. Mamta and company please pay heed – the situation is not that comfortable.

Give me a quote on LIBOR

2012-10-17T10:34:00.000+05:30

How LIBOR / EURIBOR is getting rigged?

Each morning at 1100 in London, submitters at panels of some of the world’s biggest banks send their estimates of borrowing costs in various currencies and for various terms. A few minutes later the benchmark figures flash to life on tens to thousands of traders’ machines around the world and ripple out into the pricing of loans, derivatives and other financial instruments. Even if markets were functioning properly some of the banks submitting estimates would struggle to borrow at any interest rate – let alone the rate they have been submitting. The problem is starkest for EURIBOR – where individual banks have been submitting rates that are likely to be a good deal lower than the rates they would have to pay in actual transactions. The biggest banks in Italy and Spain generally estimate the cost of borrowing Euros for a year at about 1.1%. The rate is much lower than the 4-5% their governments pay to borrow for the same period. Solution – banks that claim one price but actually pay another when they borrow should face a hefty fine.

Central Bank's Toolbox

2012-10-17T10:17:00.000+05:30

What are the policy tools available with the Central Bank in a bear zero interest rate environment?

Normally a Central Bank’s preferred choice of policy tool for inflation is short term interest rate. But when happens when the interest rate drops to zero and the central banks commits to keep interest rates are near zero in the near future? What are the policy tools available with the Central Bank in such a low interest rate scenario?

QE or quantitative easing is the answer. QE, a form of asset purchase has now come to refer to several flavours of asset purchase programme. It is generally used when the traditional measures/ tools like lowering interest rates are exhausted. One version of QE is credit easing in which the aim is to support the economy by boosting liquidity and reducing interest rates when credit channels are clogged. Fed’s purchase of MBS demand for which has weakened sharply during the financial crisis fall into this category. Another type of asset purchase aims to boost the economy without creating new money. An example of this is the Fed’s ongoing Operation twist in which Fed sells short term debt and uses the proceeds to buy long term debt giving investors cash for long term debt prompting them to invest more money in other assets. QE proper is a third type – the most straightforward way is portfolio rebalancing – the investors who sell the securities to the central bank then take the proceeds and buy other assets raising their prices. Lower bond yields encourage borrowing, higher equity prices raise consumption, and both help investment and boost demand.

Why is infaltion sticky in India?

2012-10-16T10:28:00.000+05:30

Monetary policy and fiscal policy are in contradiction. Monetary policy is tight whereas fiscal policy is loose which has resulted in a flat yield curve. Inflation remains high as the output gap is still not negative - demand has gone down but investment has dropped more than demand and thus there is no situation of an excess capacity in the system. Thus the prices are sticky. In sectors, such as auto, where there is excess capacity, prices have come down. Solution - Prop up demand, slashing interest rates will not solve the problem as capex cycle is very low and investment is not forthcoming.

Decoding the Liquidity Conundrum of 2008: How the events played out.

2012-10-10T02:52:00.001+05:30

To understand the liquidity conundrum of 2008, we need to understand the difference between banks and non banks. In U.S. banks are highly regulated and have to maintain capital requirements and adhere to reserve ratios. The deposits of banks are insured by FDIC, which means that depositors are not concerned what the bank is doing with the money as the deposit is secured by the government. Another features that distinguishes banks from non banks is that the banks can discount their assets with the central bank to repay the depositor when required be. On the flip side non banks or the shadow banking system consist of conduits like REIT, CLO, CDO etc. These are levered institutions which take a lot of risk and are loosely regulated. they don’t have access to fed Discount window and deposits are not secured by FDIC. Therefore non banks are more susceptible to change in the risk appetite of their deposit base. Two primary funding sources of their deposit base – reverse repo and asset backed commercial paper. When the market’s risk appetite is strong, the liabilities of shadow banking system look stable. Brokers MTM investor’s collateral at face value, requiring reasonable margins and never hassle the non banks for more collateral and the asset backed commercial paper is picking up 2-3 bps versus conventional commercial paper. Everything looks fine, every 45-90 days bankers roll over the asset backed commercial paper and effectively the shadow banks have the same stability in their liabilities as the traditional banks. Rating agencies act as quasi regulators in case of shadow banks. However the shadow banks are able to get better of credit rating agencies by securing desired rating for their products through external and internal credit enhancements.

Non banks were able to hold an asset at a tighter spread than the regular banking system because leverage allows a non bank to hold an asset at a tighter spread relative to its funding cost and still generate an acceptable return on equity. For example if one broker has levered 12 times and another has levered 50 times and they have the same return on equity objective , then the broker who is levered 50 times will buy all the assets. This was the reality at the beginning of 2007. Those who questioned the reasonableness of the spreads were told that it was all a result of an enormous pool of liquidity. But the game was coming to an end. The liquidity was in fact was leverage and non transparent pool of money. The first sign was that when structured investment began to issue asset backed commercial paper, which gave the issuer the option to extend the maturity for a fixed period of time. This made the buyer the lender of last resort for a mere 2 bps. In Feb 2007, a Bear Sterns HF revealed that its reverse repo lenders had asked for more collateral to ensure that it does not lose money on the investment. When Bear Sterns conceded that it did not have more collateral, the lenders decided to sell off the collateral that they had. This was a wakeup call that initiated a run on the shadow banking system and the disappearance of liquidity. Traditional banks could not experience bank runs because FDIC insurance makes the govt the lender of last resort. Shadow banks however did experience the modern day version of bank run in 2007. The combination of not having the protections of FDIC, being under pressure from reverse repo brokers to put up more collateral, and facing an asset backed commercial paper market that refused to refinance took the market from unlimited liquidity to liquidity crunch. The non banks could not sell their assets fast enough to satisfy the increased risk aversion of their lenders. The liquidity dissipated and volatility returned to the market because investors state of mind changed their risk appetite. Financial instability hypothesis – This hypothesis states that stability is inherently destabilizing because stability leads to the extrapolation of stability into infinity, which encourage more risk seeking financial structures, particularly with debt. Therefore the more stability a marker has and the longer it lasts, the more unstable the foundation of the stability becomes. Stability is destabilizing because it begets more unstable debt structures.

Problem with the housing market

In this situation a borrower who buys an asset, the income generated by the asset plus other income is insufficient for amortizing the principal or even playing all of the interest. At the maturity the borrower has a balloon payment bigger than the original loan as the interest was not paid. The borrower is betting that the value of the collateral will go up. Borrowers who take on a Ponzi debt are betting that if they can buy an overvalued asset, when the balloon payment comes due, another borrower will pay a higher overvalued price for the collateral. The collateral cannot just hold its value, it has to go up.

By 2006 the preponderance of debt creation at the margin was Ponzi unit finance. A classic example is the 2/28 subprime adjustable rate mortgage in which borrowers put no money down, get a teaser rate for two years, and can opt to pay less than the full amount of interest. The borrowers choose how much interest to pay, and the rest is put towards principal. After two years the interest rate goes up by 5%. The majority of the marginal borrowers for the year 2004-2006 made use of this mortgage structure.

No one defaulted as the property prices were going up and there was no gain in defaulting on the balloon payments. But by the first quarter of 2007, the subprime mortgages issued in 2006 had a surge of early payment defaults. The percentage of borrowers not making the first payment on their mortgages rose quickly which signalled that the property market had reached the ponzi stage. The value of the property was less than the value of the loan due, so there was no gain in paying up the loans hence the defaults.

Quiz Questions (Part II)

2012-08-18T12:28:00.000+05:30

Quiz 1: The closing Ceremony of olympic games was held on the same day of the month the opening ceremony of Olympics held somewhere else some years later. The difference between the years of both the days of same month is multiple of 10. Can u identify about which two Olympics games I am asking about?

Quiz 2: Name the common link between, Bill Sikes, Mr Micawber, Wackford Squeers, Betsy Trotwood, Pumblechook and Quilp.

Quiz 3: Name the financial exchange that let's companies buy, sell and hedge patent rights, just like any other asset.

Quiz 4: Which two cars are the official limousines of American Presidents. Name of one these cars entered into the Webster's Dictionary as a synonym for 'the best'.

Quiz 5: How many total sponsors are there of Olympic Games and what are these sponsors collectively known as?

Quiz 6: What is the minimum age required, in theory, to join Facebook?

Quiz 7: Name the female only regiment, the first of its kind in Asia, that was set up by Subhas Chander Bose, to fight for Indian Independence.

Quiz 8: Why was it not possible in Ancient Greece to stitch a sponsor's logo to an Olympic athlete's shorts or singlet.

Quiz 9: Name the sport in which Crown Princess of a Royal Family participated at the Olympics.

Quiz 10: Name the sport in which left handed players face discrimination.

Quiz 11: V.S., V.S.O.P, XO, Napoleon are different quality grades of what category of alcohol?

Quiz 12: Analyse the featured pic and name the company whose logo evolved from the name of the featured player. The company’s name literally means ‘chirping of birds’.

Quiz 13: Name the company that refurbished its logo in 2010 to change the color of one alphabet in its logo from yellow to orange.

Quiz 14: Name two countries, participating in London Olympics, whose contingent of players, has more women than men.

Quiz 15: What was that one important thing that Pierre de Coubertin, the person who revived the Olympics in 1896, changed about the Olympic Games.

Quiz 16: Name the brand, that is named after an Olympian Greek God whose portrait is pictured below.

Quiz 17: The pic features the logo of a beer brand. Name the brand.

Quiz 18: The Facebook shares, listed on Nasdaq on May 18, are currently trading at around USD 20 a piece. At what price did the stock made its debut ?

Quiz 19: Name the university in US, that houses a library in which books are cleverly retrieved by robots.

Quiz 20: Name the company . . .the company, formed by 11 engineers in 1984 at the Chinese Academy of Sciences, is the sponsor of National Football League, America for the next season.

Quiz 21: Identify the monument/ building/ structure from the sign in the pic...

Quiz 22: Identify the hotel from the pic.

Quiz 23: At what temperature do the fahrenheit and celsius coincides?

Quiz 24: Which global religion, the only global religion to have been invented in the last 200 years, believes that God created out of chaos, rather than out of nothing?

Quiz 25: Name the company/ product....This company,formed by a Danish Carpenter in 1949, makes toys. At present there are roughly 75 bits of this toy for ever person on the planet.

Quiz 26: Which world leader, also the head of a country, has 6 wives and 21 children?

Quiz 27: According to Big Mac Index, if a Big Mac costs USD 4.33 in US, USD 2.79 in Russia and USD 5 in Brazil. Which country's currency, as per Big Mac Index, is undervalued relative to USD?

Country Risk Analysis: Indian Economy

2012-01-25T17:02:00.000+05:30

Country Risk Analysis: Indian economy

Last year I read a report which said India’s economic growth is set to overtake China’s economic growth in a couple of year. It also said that by 2050, China, America and India are poised to be the three biggest economies. However the report listed these findings subject to some caveats related to country risk analysis. I make an attempt here to discuss these caveats and analyze their implications on the general well being in

context of the Indian economy.

How sound is the fiscal/ monetary policy?

A persistent ratio of Fiscal Deficit to GDP over 4% is viewed with concern. Countries with ratio of debt to GDP of more than 70-80% of GDP are extremely vulnerable.

The central bank needs to be commended for maintaining an independent monetary policy and taking effective measures to balance growth with inflation. It’s the fiscal policy which is leaving the economy barefooted. Currently the central bank is raising rates in hope to rein inflation by squeezing money supply. But the inflation is proving to be sticky and not responding quickly to monetary tightening. Part of this can be blamed to lack of tandem in monetary and fiscal policy. Government is spending more than its earnings and the spending is acting like a stimulus. This stimulus is aiding growth and fueling inflation. Worst still the government spending is increasing in non productive areas like subsidies and populist social programs which lack metrics for performance and delivery mechanism effectiveness measurement.

What are the economic growth prospects for the economy

The economic growth prospects of India look so much like Virender Sehwag’s batting. One day the economy looks like its invincible and portrays a healthy picture for future growth. The very next day, economy starts looking vulnerable The long growth prospects of the economy looks very optimistic. But after Lehman brothers and Euro crisis, who has seen long term. Still the policy paralysis in a difficult environment has stalled the growth momentum. The medium term growth prospects depend largely on external macros and internal proactive policy.

Is the currency competitive and are the external accounts under control

A small current account deficit on the order of 1-3% of GDP is probably sustainable, provided that the economy is growing. The current and near term projections for current account deficit is 2.7 % of GDP. Though there may be a spike in import bill on account of depreciating Rupee, exports too may rise easing the burden on current account deficit. The current account deficit is within reasonable limits and is likely to be so in the medium and long term. But at the same time, current account deficit poses the maximum risk to India’s economy. Any substantial shift could lead to a run on the Rupee and the economy could come under serious stress. Phasing out subsidies and an efficient tax system has become indispensible.

Is external debt under control

India’s has a current account deficit so it borrows money from abroad, or in other words foreigners are net investors in the country. But the amount of money India has borrowed in within bounds on a relative basis.

Is liquidity plentiful

By liquidity we mean forex reserves in relation to trade flows and short term debt. An important ratio is reserves divided by short term debt. A safe level is 200% while a risky level is under 100%. The country is sitting on a reserve base which is roughly equal to short and medium term external debt. This limits the ability of RBI to intervene in the forex market to support the rupee in times of downward pressure of Rupee. Still the situation is not as comfortable and as regards the forex reserves India is just within its means.

Is the political situation supportive of the required policies

In India, as in America, being in opposition means opposing every policy move of the ruling party even if it means opposing your original stand. There is a talk of party paralysis in India thanks to inaction of UPA. But there’s a lot of contribution of opposition parties to this policy paralyses. Without getting into this debate, this factor is the biggest contributor to country risk of India. In fact on a valuation metric, political risk will have the highest beta.

Overall I would like to wait for a couple more months before starting to under weigh India in my global portfolio. The country risk premium is relatively high compared to other emerging economies. The economy is facing strong headwinds from abroad and tailwinds from within the country. Big steps need to be taken to ramp up the GDP and its growth metrics.

Business Quiz

2011-12-22T17:11:00.000+05:30

Business Quiz:

Sum does some brain storming to prepare a few mosaic Quiz Questions. Try how many you can answer (Answer them by leaving a comment and leave your email address to know the correct answers)

Quiz1: Name the airline that used a famous Belgian Statue of a urinating child in one of its advertisement and used the words “pissed off high fares?” to play a spoof on one of its competitor's high fares.

Quiz2: Which head of an airline served in full cabin crew uniform as a flight attendent on a competitor airline’s flight after losing a bet on F1?

Quiz3: Which English word meaning "the faculty of making fortunate discoveries by accident" is derived from the name of an island in the Indian Ocean? How is it derived?

Quiz4: Name any other city that you can create by shuffling the letters in TOKYO?

Quiz5: Adnan Nevic, born on Oct 12, 1999 in Sarajevo,

Bosnia

; what is special about this person?

Quiz6: Which famous company derive its name from the last letters of the city that inspired it.

Quiz7: Where on the earth would you find "one hundred thousand islands"?

Quiz8: Translate “Can’t you see this” into a Hindi idiom to name the F1 driver who is also the brand ambassador for a hair care product.

Quiz9: Name the company. Its business model is offering a daily discount deal, whereby the buyers/ customers buy a product or service very cheaply if a minimum number of people sign up for the offer.

Quiz10: Which animal is reputed to have a thousand legs?

Quiz11: Which famous gun derives its name from the two cities where it was designed and manufactured?

Quiz12: Which American Multinational recently put out an advert seeking applicants for job vacancies? They said in the advert that ‘sexual minorities’ (transgenders, gays, lesbians, bisexuals) would be given extra points in the screening process. (The advert was later withdrawn due to public uproar).

Quiz13: Which Multi-National Company is named after a type of African antelope?

Quiz14: Name the politician. He is the mayor of a city in US and we have a Television channel by his name in India.

Quiz15: Name the politician whose teenage daughter got pregnant when she was campaigning for a political post. She also said during campaigning that “Russia is just across the border of an American state”.

Quiz16: Name the famous monument in Africa that features a scantily clad man and woman, holding a child. It’s a bronze statue built with a colossal expense of USD 27 millions.

Quiz17: Analyze the featured pic to name the product launched in 1990 by a legendary auto company. The product uses a type of patented engine that produces a "potato-potato” sound.

Quiz18: During which cricket match in

India

the crowd gave

Pakistan

a standing ovation after they defeated India…in India!

Quiz19: Name the fruit/ vegetable which gains prominence in the coming week. A type of beer is also brewed from this fruit/ vegetable. (Try and explain the reason for prominence)

Quiz20: Name the concept that is used by a publishing house to determine undervalued/ overvalued exchange rates based on an informal way of measuring. The pic features a very important element of this measurement concept.

Quiz21: Name the product I am referring to - Queen Victoria received this product as a wedding gift. There are over 2000 varieties of this product one of which is Leicester. NASA exploited a myth about this product to play a spoof on April fool’s Day.

Quiz22: Combine the name of a popular Bollywood movie based on Alzheimer's disease and the actress featured in the pic to name the company I am referring to.

Quiz23: Which airline’s flight steward quit his job by opening the door of a moving aircraft and jumping out through plane’s emergency chute?

Quiz24: You 'never' actually own this product, you merely look after it for the next generation. Name the brand who claims this.

Quiz25: Name the car company, whose cars are said to have a grill which look like a Greek Temple.

Quiz26: He used the code word of

India

Sri Lanka

cricket matches to receive and pass secret information. Name this head of a

company who was recently sentenced to prison over charges related to financial sector.

Quiz27: What is featured in this pic?

Quiz28: What is featured in the pic and what is this particular place called?

Quiz28: The Economist and Harvard Business Review have carried out separate articles on this “Hindi” word which roughly means frugal innovation. This term is also used for a type of a vehicle in rural India. Name the word.

Quiz29: Which Governor of a state in US recently ordered all the state employees to answer their phone by a particular salutation? This was done to boost employee morale and help sell the state to outsiders. (Hint: Only a lady can think of such a thing)

Quiz30: Name the non government organization whose logo is featured in the pic. The organization was formed in 1961 in England. The present Secretary General of this organization is an Indian.

Quiz31: Name the destination featured in the pic (Hint: Its an exotic SPA destination)

Quiz32: Name the famous animated sitcom which has a character called Maggie? It also was awarded a star on the Hollywood wall of fame. It is also famous for the annoyed grunt of one of its characters, “D’oh”.

Quiz33: Name the Bollywood actress who has live in Hong Kong, China, Japan, France, Switzerland, Krakow, Berlin, Belgium, Hawaii and England before moving to Mumbai?

Quiz34: What is common in these cities - Monaco, Melbourne,

Valencia

and Singapore?

Quiz35: Name the auto brand which derives its name from a river in Italy. There are museums devoted to this brand in Milan and England. The Indian government acquired this company in 1950 and after hitting record production in 1985, the production of this brand was ceased in

India

in 1997.

Quiz36: Name the car company - The world of bullfighting is a key part of this company’s identity and it names most of its cars based on the name of bulls

Quiz37: Name the brand whose advert featured models in the nude, wearing only shoes and a python wrapped around them. Also name the models.

Quiz38: The nickname 'SoLoMo' given by a popular venture capitalist refers to which three computer technologies.

Quiz39: Which international hotel chain advertisements feature these celebrities – Lance Armstrong, Christian Louboulin and Jerry Hall (among others)? Hint: Each featured celebrity has chosen a charity to which the hotel chain has made a donation of USD 10,000.

Quiz40: Name the company whose proposed headquarters in US is a ring shaped structure dubbed as spaceship.

Quiz41: Name the brand which the following tagline: ". . . . . mixes with everything except driving".

Quiz42: Name the airline: In Mar 11, the recording of an inflight transmission of one of its pilot's unintentional conversation with his copilot was released to the press. The conversation had foul language and discussed gay, overweight and older flight attendants.

Quiz43: What am I referring to when I say QE, QM, QV ? Name the company who owns these brands. Hint: Its related to travel industry. Its also got something to do with Monarchy.

Quiz 44: Which internet domain was launched in September and the addresses went on sale?

Quiz 45: What is common between New York City, London, Milan and Paris?

Quiz46: Name the brand associated with the following product names:

Red, Black, Green, Gold, Blue, XR21 and King George V

Quiz47: Name the brand associated with "eternity ring", "trilogy" ring and the "right hand ring".

Quiz48: Which airline would you be flying if you fly by "Queen's Own Aviation Company".

Quiz49: Name the airline in which cabin crew used to sing in-flight safety instructions (or sometimes interpret the instructions artistically). The featured picture depicts a Television Show that promoted the airline with a specialized concept. The airline ceases to exist now.

Quiz50: Name the country which is also referred to as the ‘eighth continent’ because of its rich biodiversity; 80-90% of the plants and animal species found in this country are found no where else in the world.

Quiz51: Name this fortnight long fair in which more than 7 million liters of beer is consumed. This is the largest people’s fair in the world.

Quiz52: Name the Company that played an April fool spoof on its subscribers wherein if anyone clicked on the company website’s main page, the whole page turned upside down. The company claimed this was a new layout.

Quiz53: Name the airline whose advertisement is featured in the pic. The advertisement appeared in the March 19th, 1979 issue of major dailies in the west. Yes, the shadow is in pretty much in the same place as where the planes hit on September 11^th,2001. (I’ve cropped the pic to remove the name of the airline)

Quiz54: Name the airline. Every plane in this airline’s fleet is named with a destination containing some part of the airline’s name. The airline is also known for it’s “letter ads” i.e. the ads starting with Dear….and ending with Sincerely…

Quiz55: Relate the featured image to name the NGO which is one of the older human rights associations. It has a separate prison committee to provide assistance to its members who have been imprisoned, tortured, threatened, attacked, made to disappear, and killed for the peaceful practice of their profession.

Quiz56: Name the person. He became leader of a country in 1975. His policies and torture/ force resulted in the deaths of approximately 21 percent of the country’s population (approx 2.5 million people died under his leadership). Gas chambers were one of the ways used by him to execute people.

Why is depreciating Rupee a cause of concern?

2011-12-13T11:19:00.000+05:30

The next two years of policy action (or rather inaction) will decide the fate of India’s growth story. It will decide whether India will emulate Greece or Chinese economy in the next decade or so. Everyone expected India to be rather isolated from the sovereign debt crisis and rather be the growth engine for global economy along with China. But it is turning out to be the other way around. Depreciation of rupee relative to dollar is making news and is hurting when it hurts the most.

Rupee Depreciation

Rupee is currently trading at its cheapest level (in nominal terms) relative to the dollar. It is currently the worst performing Asian currency and its fall has been fairly steep. The depreciation makes Rupee cheaper to buy for the foreigners and it makes the foreign exchange expensive to buy for Indians. This makes Indian exports cheaper and imports expensive. If we compare the valuation of rupee relative to dollar in terms of purchasing power parity (by accounting for inflation); the rupee is overvalued even at these levels.

Why a depreciating Rupee is a cause of concern?

India is heavily dependent on oil imports. A weak currency makes these imports expensive. Worst part is that these expensive imports are heavily subsidized in India
High interest rates in India caused a lot of domestic companies to borrow abroad in the form of external commercial borrowings. The depreciation is hurting these companies hard as the interest and repayment of principal in foreign exchange is expensive. Indian banking system is cramped up because of excessive borrowing program of the government to plug its burgeoning fiscal deficit. This limits their lending limits to the private sector and demand for capital by the government is crowding out the private sector. Thus private sector sought permissions to borrow abroad which is hurting them in the light of a steep depreciation of rupee
Though India’s external debt is not at very high levels, still currently the external debt of USD 313 billion is almost equal to the reserves of USD 330 billion. This limits the active participation of RBI in the money market to stem the steep fall of rupee and keep it near its desired levels. The reserves are not large enough to afford a money market intervention.
Due to a current account deficit position (imports more than exports) the economy is dependent on inflows from abroad. The dependence on foreign inflows is keeping the economy on tenterhooks as any further depreciation will make it difficult for the RBI to accommodate outflow of foreign exchange by the investors in case of a global event. RBI may have to put controls in that case which might result in a full blow exodus of capital from India; the worst case scenario; but highly likely possible.
India is running a very high fiscal deficit; close to double digits if we take the deficit of states into account. The deficit is being financed by foreign investment. The dependence on foreign investment to bridge the fiscal hole which is on account of unproductive subsidies and concessions and not on account of productive capital investment risks a catastrophic fall in the currency in case of a global event.
Every major economy from US to Japan and from China to Korea is trying hard to keep its currency cheap relative to other currencies to give its exporters an advantage over other countries. Cheaper currencies make exports cheaper and thus the advantage. In fact China has accumulated hoards of American Dollars only because it aimed to keep its Yuan undervalued relative to the Dollar. It thus continued to buy Dollar is the money market to keep Yuan relatively undervalued. A depreciating rupee is good news for Indian exporters and it makes Indian exports cheaper. But there is little to rejoice as India currently is a net importer. Policy inaction and lopsided decision making is ensuring no major impetus to Indian exports.

How credit risk can be hedged / transferred?

2011-12-07T17:14:00.001+05:30

A tutorial on how credit risk can be hedged / transferred using the credit risk instruments.

(Key inputs from CFA Institute Readings)

An investor faces three types of credit risk. The risk of default, credit downgrade of the debtor and widening of credit spreads on the debtor’s debt. The credit risk that the investor faces can be sold off to another party, basically like any other insurance contract. The party who assumes the credit risk (or who buys the credit risk) is called the credit protection seller. He may be willing to take this risk for several reasons. He may buy because he believes that the credit quality of the debt will improve. He may see value addition in some major corporate events like mergers or refinancing of debt at lower rates. All these would be positive credit events for the credit protection seller.

There are basically three products that transfer credit risk – Credit Derivatives.

Credit Options

i. Credit options written on an underlying asset

ii. Credit spread options

Credit forwards
Credit swaps

Credit options

The triggering events of credit options can be based on either

The value decline of the underlying asset
The spread change over a risk free rate

Credit options written on an underlying asset

Binary credit options provide payoffs contingent on the occurrence of a specified negative credit event
There are only two options

i. Default

ii. No default

If the credit has not defaulted by the maturity if the option the buyer receives nothing
The option buyer pays a premium to the option seller for the protection afforded by the option
Pay off can also be based on the credit rating of the underlying asset
A credit put pays for the difference between the strike price and market price when a specified credit event occurs and pays nothing if the event does not occur

Credit Spread Options

Payoff is based on the spread over a benchmark rate
Pay off formula

Credit Forwards

Their payoffs are based on the bond values or credit spreads
If a credit forward contract is symmetric the buyer of a credit forward contract benefits from a widening credit spread and the seller benefits from a narrowing credit spread
The maximum the buyer can lose is limited to the pay off amount in the event that the credit spread becomes zero

Credit Swaps

It is a contract that shifts credit exposure of an asset issued by a specified reference entity from one investor to another investor
The protection buyer usually makes regular payments to the protection seller
In case of a credit event the protection seller compensated the buyer from the loss on the investment and the settlement by the protection buyer can take the form of either physical delivery or negotiated cash payment equivalent to the market value of the defaulted companies
CDS can be used a hedging instrument
Banks can use the CDS to reduce credit risk concentration
Instead of selling loans, banks can transfer credit risk by means of CDS

Situational profiling an investor by stage of life

2011-11-30T18:30:00.001+05:30

Situational profiling an investor by stage of life

In life stage classifications, investment policy and particularly risk tolerance are determined by one’s progress on the journey from childhood to youth and adulthood, maturity, retirement and death. A person’s ability to accept risk should begin at a high level and gradually decline through his lifetime, while willingness to assume risk should be driven largely by cash flow considerations. An individual’s investment policy can be viewed as passing through four general phases:

o Foundation

o Accumulation

o Maintenance

o Distribution

Foundation

The individual is establishing the base from which wealth will be created (marketable skill, establishment of business, acquisition of educational degree). During this phase, the individual is usually young, with a long time horizon, which normally would be associated with an above average tolerance for risk. Risk tolerance should certainly be above average in the foundation stage if the individual has inherited wealth. Lacking such wealth, the foundation phase may be the period when an individual’s investable assets are at their lowest and financial uncertainty is at its highest.

Accumulation Phase

Earnings accelerate as returns accrue from the marketable skills and abilities during the foundation period and gradually reach their peak. In the early years of the accumulation phase, income rises and investable assets begin to accumulate. Income generally continues to rise as the individual reaches peak productivity. If individual personal spending habits do not change, the gap between income and expenses may widen throughout the accumulation phase, allowing for an increase in savings. This phase is characterized by increased risk tolerance, driven by their increasing wealth and a still long term horizon.

Maintenance Phase

The individual has moved into the later years of life and usually has retired from daily employment or the pressures of owning a business. This phase focuses on maintaining the desired lifestyle and financial security. Preserving accumulated wealth begins to increase in importance, while the growth of wealth may begin to decline in importance. Risk tolerance will begin to decline, not only is the individual’s time horizon shortening but his confidence in the ability to replace capital or recover from losses is often diminished. In this stage investors typically reduce exposure to higher volatility asset classes and increase exposure to lower volatility investments.

Distribution phase

Accumulated wealth is transferred to other persons or entities. This phase begins when the individual is still reaping the benefits of the maintenance phase and retirement. Tax constraints becomes important as investors seek to maximize the after tax value of assets transferred to others. Although asset distribution may take place in the later stages of life, planning for such transfers can begin much earlier.

Although the progression from accumulation to distribution may be linear, it is not necessarily so. Individuals in the accumulation phase may become dissatisfied with a career choice and return to the foundation phase. Situational assessments allow investment advisors to quickly categorize potential clients and explore investment issues likely to be of greatest importance to them. Dynamic relationship exists among the above considerations. The value of situational paradigms therefore lies more in their general insights into human behavior and less in their ability to fully interpret individual circumstances. Investment advisors should emphasize the process of gathering and assessing relevant situational information rather than the specific category in which an individual investor may fall.

Investment Decision Making in Systematic Investment Plans

2011-11-22T11:06:00.001+05:30

Sum evaluated how heuristics affect investment decision making in Systematic Investment Plans.

Investors face two challenges: making good decisions and sticking to them. Most individuals do not make decisions in the rational, well informed and unbiased manner assumed by standard economic theory. There

are bounds to human rationality, self control and self interest which can be explained as under:

Bounded rationality (Human problem solving abilities) Limits on time and intelligence means individuals cannot be expected to solve problems optimally. Experimental evidence suggests most people use rule of thumb (or heuristics) to cope with the limits of their abilities and these heuristics can in certain contexts lead to systematic errors in decision making.

Bounded Self Control: When the right thing to do is apparent, people may fail to do it for reasons of self control (most of us have eaten, drank or spent too much)

Bounded Selfish: Failure to pursue own self interest to the extent normally assumed of homo economics

Status Quo Bias in Decision Making: The option to do nothing or endorse a previous choice

Portfolio Diversification and Investor Perceptions of Risk

There is evidence that investors in SIPs often display attitudes to risk and portfolio construction that are at odds with accepted investment principles. I try and explain some of them as follows:

Myopic Loss Aversion: Seeking to avoid short term losses despite the long term horizon usually in planning for retirement. There is also evidence that the balance of funds on offer unduly influences individual’s choice of asset allocation in SIPs

1/n heuristic: Investors take the range of offer as implicit guidance from the investment vehicles as to the appropriate asset allocation strategy – a so called endorsement effect

Company stock ownership/ Investing in industry in which the investor in employed: One of the most worrying aspects is the high level of investment in own company stock / same industry amongst employees in SIPs. The strategy is dubious as the stock is correlated with the employee’s labor income and future employment prospects. It appears employees do not view their employers’ stock or the industry in which they are employed as risky. The example of Enron highlights this heuristic in investing. Majority of Enron employees invested their pension plans in Enron own stock. Thus when the company went bust, employees lost their jobs and their savings at the same time. Another theory that supports the above belief is that investors like to invest in familiar industries/ companies. There is also a home country bias linked to this theory.

The obvious solution to dealing with significant behavioral barriers to the effective use of SIP for retirement provision is to offer some form of education to participant; which brings to light two kings of investors:

Planners: Who take active interest in providing for their own retirement

Avoiders: Who are either intimidated by financial matters or are simply uninterested

Less attention can be given to those planners who will seek information anyways; in order to have impact on avoiders’ information should be straightforward

Stakeholders in the investment industry should encourage investor education not only in later but also in spirit. It is this lack of education which caused investors to build unrealistic expectations from equities while not weighing the inherent risk in them. The result is a flight of capital from equity markets of domestic individual investor. Wounds take long to heal especially those caused by bears and bulls. It’s about time the investment industry presents a similar flight of capital from SIPs caused by losses to investors who have made wrong pickings without adequately considering the risk/ return interplay.

Euro Crisis: Where is the lender of last resort?

2011-11-11T00:00:00.001+05:30

Sum constrasts the Euro Zone problems with countries who pursue an independent monetary policy and suggest a possible solution to the present Euro Sovereign Crisis.

The Europe problem has been getting complex by the day. It started with Greece and inevitably everyone knew it is destined to spread to PIIGS (Portugal, Italy, Ireland, Greece and Spain) sooner than later. So here we are witnessing history in the making yet again. Europe, a union of nations formed to exploit synergies by forming a common understanding and policy framework on different subjects is falling like a pack of cards.

Complex and difficult situations demand serious path breaking efforts on the part of stakeholders to overcome the difficulty. The regulators and lawmakers in European Union are working their guts out to provide a temporary relief to the nations who found themselves underwater due to excessive spending and faulty policies. Once the bloodshed is controlled by temporary measures, efforts would then made to address the structural issues.

I have gone back and forth to the drawing board many a times trying to deconstruct the Europe Sovereign Crisis and start all over again in finding the missing link by studying the structural framework of Euro.

My recent efforts are aimed at contrasting the PIIGS with some other sovereign nations having independent currencies and monetary policies (i.e. having independent Central Banks). So I started with a comparison of Spain (Euro zone) with Britain (Independent currency and central bank). Both Spain and Spain have similar debts, deficits and inflation (in percentage terms). Spain, as a part of European Union has embraced the Euro and thus has given up its independent monetary policy in favour of a common European Central Bank. Britain, on the other hand Britain has an independent currency and has a central bank that pursues an independent monetary policy.

Let’s suppose that both Spain and Britain face a Sovereign Debt Crisis. The crisis is caused by excessive spending resulting in high fiscal deficit which is financed by foreign and domestic debt investments. As the debt repayment becomes due both the countries are overstretched with their finances and unless their debt is refinanced the creditors face a possible Sovereign Default. In the absence of any other source of refinance, the countries would only be able to refinance at steeply increased rates. Thus borrowing at high yields will increase the risk of a sovereign default by these countries in the future even higher.

If Britain is unable to roll over its debt at acceptable yield levels it will force its central bank to buy the bonds and in the process devalue its currency. Thus a liquidity crisis is averted by a devaluation of currency. In the case of Spain, refinance at acceptable rates is not possible because it does not have an independent central bank which can be forced to refinance the debt. Thus a liquidity crisis is highly likely in case of Spain if yield on refinancing of debt spikes higher.

One possible solution to this problem could be a consistent effort by the European Central Bank wherein it can give a guarantee to stand by its member countries in times of distress particularly when they face a liquidity crisis (or refinancing problems). For example if Spain needs to refinance its debt and it is unable to do so at reasonable rates, ECB should step in as a lender of last resort and buy the bonds. The value of Euro should thus be made up of weighted average of the respective members states economic parameters. Monte Carlo Simulations and Black Scholes Options Pricing Model can be reconfigured to accommodate financial parameters of member’s states. These parameters can be weighted in accordance with weights (which can be calculated using another set of economic parameters) to derive the targeted value of Euro. ECB should then balance inflation targeting with managing exchange rate expectations thorugh its monetary and fiscal policy.

At any stage the value of Euro should reflect the financial and economic strengths and weaknesses of its members. If PIIGS are refinanced by ECB, the relative devaluation of Euro in accordance with the weight PIIGS in Euro should be undertaken, so as to bring its value to a realistic level. It would not doubt be detrimental to the disciplined and hard working members who have instilled fiscal prudence and best practices in their respective states. A weaker currency would hurt the imports. A weaker currency however would be welcome across the board, especially by the exporters.

The downside to this solution is that bond purchases by central bank expand the money supply, potentially leading to inflation. A hyperinflationary economy may develop as a result of monetising budget deficits. Thus the reluctance of ECB to lend to governments is understandable. Germany is in particular still in the awe of hyperinflation in had to experience during 1920-24 due to monetizing its budget deficit. It’s opposition to such a plan is thus understandable, but as they say tough situations and circumstances demand tough solutions. So Germany pave way for a representative Euro, pay way for maintain order in the union your fondly formed.

Civil and criminal laws: Is obeying them our primary responsibility?

2011-11-05T17:10:00.000+05:30

"The primary responsibility of citizens is to obey their nation’s civil and criminal laws"

The author’s statement that the primary responsibility of citizens is to obey their nation’s civil and criminal laws forms the fulcrum of modern society’s premise of fundamental rights and duties for its citizens. The modern society and representative form of governance confers upon its citizens certain fundamental rights and list the duties its citizens must perform as a part of a society. The obedience of nation’s laws and regulations is one such duty the society expects from its citizens. But in my view the author’s statement is biased and invalid if seen in isolation and without giving due consideration to changing socio economic environment.

Recently the world has seen uprising in West Asian countries particularly those which were under the rule of oligarchs and dictators. The uprising in these countries was primarily against the regime and autocratic laws and regulations which made the oligarchs and dictators strong while undermining the basic human rights of the common man. People revolted against a change in leadership in these countries and demanded for a representative form of government. The author’s statement of obedience of nation’s civil and criminal laws does not hold in the scenario when the common man is affected and he revolts for a change, sometimes even by undermining the nation’s. civil and criminal laws.

Another situation where the above statement does not hold is when the present civil and criminal laws are unjust and formed by people who do not hold the mandate to do so. An example of this is the freedom movement of India led by Mahatama Gandhi. Under the leadership of Gandhi, India fought for its freedom from British Rule by practicing non obedience and non violence.

In a democratic set up where laws and regulations are formed by a representative form of government and duties conferred upon the citizens; the primary responsibility of citizens no doubt is to obey the nation’s civil and criminal laws. Without such obedience, a rule of law will not prevail and a system of justice and fair society will be unthinkable.

In the end I would like to reiterate I do not agree with the author’s statement if seen in isolation. If we make provisions for civil disobedience and non cooperation by citizens if their common interests at large are affected by such laws and regulation, the statement can be accepted as a generalist opinion. The statement also holds for mature societies with a fair system of justice and legislature.

What's more important in an enterprise; the process or the result?

2011-11-05T16:44:00.002+05:30

“In any enterprise, the process of making or doing something is ultimately more important than the final product.”

An enterprise has a perpetual existence. It involves an ongoing process that involves many processes and procedures to produce or manufacture products or services for marketing, selling or consumption purposes. The final product goes through a rigorous process of transformation with varied degrees of time and effort. A process of value addition takes place at each step to produce the final product right from the inception of idea to transformation of raw material and semi finished goods into a final product. Thus the author’s statement that the process of making or doing something in an enterprise is ultimately more important than the final product holds good in my opinion.

The primary reason why I believe process is more important than the final product is because the opportunity to gain a cost advantage or design leadership can be exploited during the various processed and procedures involved in the production process. Innovation if any can be introduced and core competencies developed during the process of making or doing something. The result of such efforts and competencies will reflect in the final result which the final product we are talking about. An example of this process preference can be found in the development of the cheapest car in the world – the Tata Nano; manufactured by Tata Motors. The company gave more importance to the process of designing and production of the car and obtained patents for the processes and production procedures used to manufacture the car. The end product, the world’s cheapest was not only possible through a product centric approach alone. A system led approach made the dream of producing the cheapest car in the world possible.

Another reason why I give more weight to the process than final product is because a systematic approach and streamlined procedures is required for the successful production, marketing and sales of a product. In the systems approach to management the focus of attention is on the processes of doing or making something. Two companies making identical products can be differentiated by the process and procedures each company is following. A well thought out and professionally structured process reflects in the DNA of the final product. One of the biggest examples of a systems led approach is the Apple. The company has introduced blockbuster consumer electronic goods which had caught the fancy of people. Although the company focused on making a cutting edge final product, it obtained its objective by prioritizing the processed and procedures for the same.

However it needs to be acknowledged that the final product is the ultimate destination an enterprises is aiming to reach. All efforts and resources of the company are thus directed towards achieving the objective of a superior final product. But the efforts and resources thus used are channelized through systems and procedures which if used otherwise will prove counterproductive in giving an edge to the company.

Thus I agree with the author’s statement that in any enterprise, the process of making or doing something is ultimately more important than the final product. This is especially true if we take a system led approach to management. An interplay of final product and strong systems and procedures in a coordinated fashion will ensure overall success of an enterprise.

Greece Crisis: Any opportunity for Hedge Funds?

2011-11-04T17:53:00.001+05:30

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My take on how Hedge funds can benefit by investing in distressed assets amid the ongoing Greece Crisis

The crocodile’s eyes are not shedding tears this time. Rather they are lit up with the prospect of a Greek Sovereign default. Most Hedge funds (stakeholder love calling them crocodiles) are under invested in European banks and financial institutions so they are likely to take a relatively light hit as compared to post Lehman crisis. They are also well placed with respect to cash positions primarily because of low investment opportunities in the developed world particularly in the US.

So even the slightest prospect of a Greek Default and a resultant exit from Euro is making the Hedge Fund managers sit up and take notice. An exit from Euro will stretch the Greece economy beyond its means and a bank run will render many businesses bankrupt; particularly the one’s with exposure to other parts of Europe. A business which has Euro debt to pay to financial institutions and banks outside Greece would risk default. The Greece will have a weaker currency post the default and the Euro will strengthen.

A weak currency will make Greece attractive, particularly to Euro zone. Holidaying in Greece will be cheaper for Europeans as Euro will buy more Greece currency. Similarly investing or buying a business in Greece with real assets (say a luxury beach resort) will make economic sense. Hedge funds look for opportunities to buy cheap and sell high by adding value. They may buy businesses in Greece, bargain with creditors for a haircut and keep the business solvent. They may then add value and sell it for a huge profit a couple of years down the line. Buying such claims would be like investing in distressed assets so the risk /return payoff would not be linear. Rather the risk/ return would resemble that of a call option.

Investors and fund managers who are ready to take the extra pain of searching value in the abyss by careful and well structured valuation would find this crisis a blessing in disguise.

My take: Look for a 40-50 room beach hotel in Thessaloniki or Mykonos with debt on its balance sheet. You may be able to pick it up lower than its real asset value.