Tools of the Trade

How to calculate beta using an excel spreadsheet

2008-05-05T08:17:00.007+08:00

I've signed up with Box.net to offer a couple of spreadsheets to help finance students with their projects. Beta's a key component of the valuation project. What I am offering is plain vanilla beta coefficent. Nothing fancy. Just an estimated coefficient based on the assumption that the market in which the stock operates in has a relationship with the stock itself.

Here's a link (http://www.box.net/shared/hd9k2xqo8g) to a beta coefficient calculator in Excel.

When you download the file, you'll get an excel file that looks like the one below:

For the calculator, I used price data for a company that I am interested in Noble Group. Next, is a primer on beta.

You can estimate Beta using the Capital Asset Pricing Model.

A company’s beta coefficient simply states the relation between a stock’s excess return in relation to excess market returns.

To obtain the beta we need to estimate it from the Capital Asset Pricing Model equation:
Ri = Rf + β(Rm – Rf) (1)

This equation is actually an application of financial economics. Re-arranging equation (1):
Ri - Rf = β(Rm – Rf) (2)

Ri - Rf is the Excess Return from the Stock. It is equal to a Beta transformation of the Excess Returns earned from the Market.

The Excess Return is whatever you get from the stock or the market after accounting for the risk free rate of return which is the market’s or economy’s risk free rate of return on a Government bond, Rf.

So beta is essentially a ratio of Stock and Market Excess Returns.

Trend: Rising Food Prices

2008-04-22T17:28:00.007+08:00

(wikipedia: picture of a farm in Hebei, China)

Over here in Australia, the two blockbuster trading bets are on a rise and continued rise of mineral ores, oil & gas and grains commodity. Australia stands to benefit quite a fair bit as an old world economy rich in mineral resources and arable land with a relatively tiny population.

In a recent media release from the Reserve Bank of Australia dated 1 April 2008, Governor Glenn Stevens, expresses the RBAs view that they expect a further rise in Australia's terms of trade. (Terms of Trade = Prices of Exports / Prices of Imports, hence Australia being a large exporter of commodities to hungry, growing nations, they expect a rise in the terms of trade.)

What's scary about this is that supply for iron or oil in the form of new iron ore mineral deposits or easily extractable oil wells are not in the pipeline, so to speak. In fact they're not even anywhere near the pipeline. Apparently, back when prices were low, we did not go exploring for these things, now that there's a demand again, exploration companies big and small are scrambling to find a lucrative node. Much of what's extractable however is in remote, farflung places. Sometimes located below nice pristine rainforests for example.

The same thing is apparently going on with food prices. We're now witnessing a market in disequilibrium as suppliers scramble to shift supply in response to a larger than anticipated demand.

Reuters.com is doing a special feature on rising food prices: "Agflation: The Real costs of Rising Food Prices"

The UN fears that if food prices continue to escalate, we're going to see more civil unrest. So where's the demand coming from? China and India mostly. But let's not forget to mention that farming isn't instantaneous, it takes time to produce that grain of rice, wheat, sorghum. It takes time to grow that chicken, sheep, cow. There's always a lag in supply response.

Also, let's not forget the market inefficiencies that government rules and taxes impose on prices. Prices are not going to smoothly adjust, they'll be sticky.

I got to thinking about the kind of trends that we can invest and trade on: I'm long emerging markets, so with the rise in incomes and wealth of the average citizen, then we can expect them to consume more meat, vegetables, milk, consumer food products etc. With the need to feed more people, basic inputs have to be increased as well. Stuff like fertilizer, feedstock, feedgrains, acreages etc.

In the mean time, I guess we as consumers have to put up with higher prices. Nothing comes for free, that's the price of progress.

From my C++ journal: Why its easier to think of the programmer as a runesmith

2008-04-20T20:14:00.006+08:00

Not sure how much programming gets done by analysts these days but judging by the way programming and algorithmic trading is progressing, it won't be long before knowledge of a major programming language would be a major plus point in the recruitment process.

Here's a page from one of my lecture notes on why I think programmers are best seen as modern- day runesmiths.

Should Ebay sell Skype?

2008-04-19T12:04:00.004+08:00

Over at FT.com, "Ebay considers sale of Skype subsidiary," says Richard Waters.

From the article:

Ebay will consider selling off its Skype internet phone subsidiary at the end of this year if it fails to find ways to use the fast-growing service to support its core e-commerce business, according to the company's chief executive.

The comments from John Donahoe, who took over at the end of last month, are the most direct indication yet that Ebay is thinking of scrapping the ill-starred acquisition. It paid $3.1bn, but wrote down the value of the business by $1.4bn last year after concluding it would not match earlier hopes.

Tech geeks at slashdot.org are divided: 1) purchase of Skype didn't make sense (Skype = internet telephony service, Ebay = auction/ecommerce site, so where's the fit? 2) Ebay CEO's being short sighted, Skype makes perfect strategic sense. So why's he thinking of selling a growing business with a great future?

Ebay's blog (http://ebayinkblog.com/2008/04/18/john-donahoe-talks-to-ebay-ink/) on the other hand reports the following:

Before we jump into the original conversation, however, I wanted to make sure I addressed a timely and critical discussion that has been given more fuel by a Financial Times story, that ran on the heels of the earnings news this week, that I felt needed clarification directly from John. So, the first question and answer below is from earlier today. The rest is the transcript of my conversation with him on March 21. I plan on sitting down with Skype president, Josh Silverman, in the coming weeks to get his take on the future. For now, here is my conversation with John.

April 16, 2008

Q. I read in the Financial Times that we may sell Skype. That if the synergies are strong, we’ll keep it in our portfolio. If not, we’ll reassess it. Is this true?

We have no plans to sell Skype… and why would we? As I said in the story, it’s a great business with a great purpose — enabling the world’s conversations. With a new president, our plan for Skype is to focus on providing the best possible user experience and continuing the incredible growth momentum we’ve enjoyed with Skype for the past four years.
To be clear, I’ve fully supported big investments in Skype, including removing the earn-out, and bringing over some top talent like Josh. I think this business has tremendous potential that we’ve only started to tap. Josh and I are both excited about the prospects … our job now is to make sure we continue to build on Skype’s successes and grow its passionate community of users

Is it me or does it sound like major media damage control are in effect?

I'm of the opinion that Ebay would eventually sell Skype to focus on its core business. Skype's undervalued at the moment, the rational decision is to wait till the market's more appreciative of speculative ventures before selling. Skype offers great service but it needs a better strategic partner.

On Friday 18 April 2008, Ebay closed at USD$31.71

Ebay's beta: 2.29

trailing P/E ratio: 101. 61

Link to eBay's google finance page: http://finance.google.com/finance?q=NASDAQ%3AEBAY

From boingboing.net: Fruit flies and Free Will

2008-04-12T18:17:00.006+08:00

First post at Boingboing.net: Matt sez, "A researcher at my University is working on modeling the behaviour of fruit flies. Turns out they have something like a Free Will, or at least they are not completely random in their flying patterns. Check out the video of drosophila in the flight simulator."

Their results caught computer scientist and lead author Alexander Maye from the University of Hamburg by surprise: “I would have never guessed that simple flies who keep bouncing off the same window otherwise have the capacity for nonrandom spontaneity if given the chance.” Previous studies have shown that in nature, flies do not buzz about aimlessly but forage according to a sophisticated search strategy (this is how they find our wine glasses). The new research now suggests that such strategies arise spontaneously rather than being induced by spatial cues.

Free will is seen in choices. Let's say you're given options A, B and C. Therefore, option A, B and C are pre-determined and offered by Grand Omnipotent Designer, the Unseen Systems Architect, the Super User, God as we know it. But instead of one of those 3 options, you come up and implement Option D. That's free will. The freedom to take on a gamble, and decide on a particular course of action, fate, if you will. It could be that Option D had been all along been pre-determined by God in some massive supercomputing mind of His, but the person knows it not, he has to take a gamble. He has to risk to know, to experience, to encounter and possibly die from the venture. That's free will. Free Will is therefore a Gamble.

Now to study free will, you can either study the aggregate actions of people or study it at the rudimentary basic level. The world of insects for example.

All along we thought Animals are basically ingenious, complex but highly useful robots. Given X, they perform Y; up to a certain tolerance and within a certain scope of operation. A goat can't breathe underwater, nor can a fish fly. But do animals have free will? Do they make choices other than that we offer them? If so how can we say that their choices are not simply random events? How can we imply, from the data, that the actions we see is not an aberrant behaviour?

One of the ways we can do that is to capture the data of movement in flight by insects and apply a statistical function to determine if this action is random or not.

Here's the link to the fruitfly study: http://brembs.net/spontaneous/

Excerpt from article:

Only after the team analyzed the fly behavior with methods developed by co-authors George Sugihara and Chih-hao Hsieh from the Scripps Institution of Oceanography at UC San Diego did they realize the origin of the fly's peculiar spontaneity. Using the so-called "S-Map Procedure" the researchers detected a non-linear signature in the fly behavior. Such a signature can only be found in systems whose indeterminate behavior is not due to noise but originates in their design. “This signature indicates that there is a function in the fly brain which evolved to generate spontaneous variations in the behavior” Sugihara said. “This function appears to be common to many other animals and could form the biological foundation for what we experience as free will”.

Its kinda nice to know that free will exists and that in the end we still have choices in our life. What is wealth, money, brains, beauty and brawn or even good health, if we don't have freedom and the will to use it.

From NYT: "The Face of a Prophet"

2008-04-11T20:20:00.003+08:00

George Soros predicts more sorrow (heh) for the US economy.

He also foresees a time when the US dollar won't be the dominant currency and that it will be a lot harder to borrow money.

I'd like to draw your attention to Mr Soro's market theory, called "reflexivity" in which:

"... people’s biases and actions can affect the direction of the underlying economy, undermining the conventional theory that markets tend toward some sort of equilibrium. (implied: there's no such thing as equilibrium, everything is flux.)
Mr. Soros said all aspects of his life — finance, philanthropy, even politics — are driven by reflexivity, which has to do with the feedback loop between people’s understanding of reality and their own actions."

To understand and to take action based on one's accurate assessment of present reality - sounds like a Buddhist tenet of seeing the true Reality of things.

Goldman Sachs Launches Tradeable Index for Longevity and Mortality Risks

2008-04-11T08:58:00.001+08:00

This is a finance blog with a penchant for interesting financial market events so rather than focussing on the rather mundane elements of retail insurance brokerage/ financial planning industry, I thought I'll point you towards an article from Business wire. Goldman Sach launched an index in December 2007 which attempts to benchmark a representative population group's mortality and longevity risk.

Permalink to article: Goldman Sachs Launches Tradeable Index for Longevity and Mortality Risks

Link to the index: Qxx-index

From the index site:

QxX.LS index swaps are designed to allow market participants to hedge or gain exposure to longevity and mortality risks, providing reliable, real-time pricing information and execution

Yes, that's right, folks. You can now trade your way to wealth and riches by betting on when the market is wrong on assessing death rates in the population!

Longevity and mortality are the risks that realized lifespan differs from expected lifespan, creating an economic consequence, often a price change in an asset or liability.

Here's the useful bit in what kind of risks your typical insurance provider holds:

Holders of mortality risk -- typically institutions such as insurance carriers and reinsurers -- are economically exposed to a decrease in the lifespan of a pool of individuals

Holders of longevity risk -- pension funds, annuity writers, the social security trust fund or life settlement investors -- are exposed to the increase in the lifespan of a pool of individuals

Hang on, let me get my head around this:

Insurance companies face more risk if the population lifespan is FALLING. Therefore, it is in their interests to KEEP US HEALTHY AND ALIVE on this planet.

Pension funds and Social Security trust funds, (that includes Singapore's Central Provident Fund and Australia's Superannuation Funds) face GREATER RISK if the population's longevity is RISNG.

Does that mean its a good time to invest in general insurance companies like Warren Buffett did considering that we are all living longer?

Financial Planning Dilemma

2008-04-11T07:31:00.011+08:00

A good friend of mine joined the financial planning line a year ago. We used to talk everyday but ever since he sleazed up to me one day and said, "Hey, Andy... are you insured?" I've never spoken to him since. My worst fear in life is to be a retail financial planner - cold calling random people, peddling term and life insurance products.

I think the problem with insurance broking is that when you're 20 - 30 years old, thoughts of impending death is as far away from your mind as snow is in the Sahara. You're more likely to encounter such thoughts as you get closer to the terminal end of your life.

Sure, premiums are cheaper when you're younger, but are they really in relative terms? If your income is $2000 a month, and you're setting aside $100 into a policy with NO-growth in terms of returns, other than the fact that at some later age, you can now access all that money - well, its not really the most attractive of options.

We do have the option of buying into an Insurance-Investment Linked Product. You pay $100 a month or so (depends on your age and lifestyle habits really) and they guarantee some form of capital protection and some degree of investment returns as well as general life insurance. (that's not too bad.)

On the other hand, if you're relatively more senior and you're depending on your pension as your primary source of income, buying insurance to leave a little nest egg for the grandkids might not be that optimal choice considering that most of us are living longer and our pension incomes are likely to be lower due to inflation and higher standards of living.

Never fear, though, if you're of the age, and you're living longer, pinching together some pennies to ensure your grandkids have a little nest egg to carry with them when you're gone might not be such a good idea.

If you're a reasonably fit, grandpappy or grandna, there should be no reason why the rates can't be as competitive. Shop around. (If you've landed on this blog, congratulations!)

On the internet, there are sites which provide quotes or rates on life insurance. Based on a principal sum to be paid upon death, they'll get quotes offered by general insurers and tell you what your monthly outlay will be like to guarantee payment of X dollars upon death. They don't necessarily sell this products or underwrite them. These sites simply act as gateways for people who happen to land on their page looking for quotes, rate or general financial planning advice.

If you're over 60, and in the market to give something to your offspring why not just fill up a simple, anonymous form and see what kinda quotes they will offer you.

All links are brought to you by the people at profam.com

From Slashdot.org: HighWizard posts "Oil Deposit Could Increase US Reserves 10x"

2008-04-10T00:34:00.007+08:00

Occasionally you'll get a gem of a piece posted on Slashdot.org that has academic/trading/investment merit. This article is about the release of a report on the Bakkan Formation. There's lots of good stuff in the following Slashdot story thread.

HighWizard notes the upcoming release, on Thursday, of a report by the US Geological Survey on the Bakken Formation. This is an oil field covering 200,000 square miles and underlying parts of North and South Dakota, Montana, and Saskatchewan. A geologist who began surveying the field, before dying in 2000, believed it may hold as much as 1 billion barrels of recoverable oil. Later estimates have ranged to the hundreds of billions of barrels. Such a reserve would go a long way toward securing US energy independence.

Read more at Slashdot.org: http://hardware.slashdot.org/article.pl?sid=08/04/08/2111201&from=rss

If this is true, which companies are at the Bakkan formation?

Reader Itchyeyes (908311) contributes:

The people that have interests in the Bakken in North Dakota are not the majors. They are companies like EOG, Marathon, Kodiak, and Questar. These companies do not have refineries. They sell at the market price, they have no say in what their product goes for. They do not have enough reserves to make any impact on market prices even if they wanted to.

Also, he gives reasons as to why oil extraction from Bakkan formation is becoming a viable economic alternative due to high oil prices.

Of note is the following rant by Reader iq_in_binary (305246):

You, sir, are a complete fucking moron.

The big oil companies haven't been making their profit by virtue of artificially controlling the supply, they've been doing it by selling more than they've ever sold before. The profits reaped last year and the year previous wasn't because of raising their profit margins (I.E. raising prices to increase their profit margin), they've been doing it by selling more petrol than in any years previous.

Big Oil has has the same business infrastructure, organizational structure, and sales methods as they've had for 50 fucking years. They held a razor thin profit margin on gasoline for going on 25 years now. For every dollar on gas, you spend maybe 3 pennies giving them profit. So quit bitching about oil companies gouging the public, because they aren't. You want to know the real culprit for gas prices these days? Our own fucking government, they make about a dollar per gallon on taxes.

Where does that money go? Who knows any more. Just quit bitching about a company actually doing good business, because for the most part the petrol companies are. They have to deal with literally thousands of different mixtures of gasoline being shipped among this country, the different ways to refine them, and finally the shipping, and they're only pulling 3% profit. Fuck you for thinking that's out of line. Learn your economics, and then learn how the real world works. The price of gas being as high as it is is MORE the gov's fault for spending so much money on pork that it has to rape us on gas to compensate. Bitch at your governments for taxing gas so much, then bitch at them for making good companies spend twice as much as they have to for making a good product, THEN bitch at the gas companies for not making things cheap enough when they're only pulling a 3% margin.

This is a capitalist economy, damnit, it's what is responsible for this country's well-being. Think about the business first, then bitch.

To which, I say, AMEN to that!

From FT Alphaville blog: "Taking a bath - the shape of the downturn to come"

2008-04-09T13:29:00.005+08:00

I was looking for ways to visualize the US recession when I came across this post from FT Alphaville:

Now that US recession is a racing certainty, the debate has moved on to the shape of things to come.V-shaped, good: a short, sharp downturn with a speedy recovery. Those who were last year telling us that all was enduringly rosy have tended to move towards this letter of the alphabet in describing the forthcoming downturn. W-shaped: a double dip. U-shaped, or Martin Sorrell’s bath-shaped or even saucer-shaped variant: a more protracted period spent at the bottom.And most feared of all, the Japanese influenced L-shaped recession: a lasting period of stagnation, bordering on economic depression.

Summary: L, U, V, W, bath and saucer shapes. 6 economic downturn shapes to remember prior to purchasing stock.

To read more: http://ftalphaville.ft.com/blog/2008/04/08/12137/taking-a-bath-the-shape-of-the-downturn-to-come/

Real Options Spreadsheet in action: Foresight.co.uk "Exploiting the Electromagnetic Spectrum"

2008-04-04T18:33:00.004+08:00

Foresight.co.uk is the British government's efforts at tracking, spotting and managing technological and scientific development. To value the cost and benefits of 'Exploiting the Electromagnetic Spectrum' they used Real Option Theory and tasked University of Manchester to develop a spreadsheet to calculate option prices of completing certain project milestones.

Link to the main page: "Foresight Real Options Model"

Link to the PDF Manual.

Link to the Option Calculator (Excel Spreadsheet).

Crack open the PDF manual and they'll explain clearly what all the cells do and how they relate to each other. Very insightful if you are thinking of developing a Real Option spreadsheet of your own.

Need a free C++ textbook?

2008-04-04T15:50:00.004+08:00

One of the pre-requisites of NTU-CMU's MSc in Financial Engineering is a module on C++ programming. Rather than buying a book (that's cos I am broke) I thought I'd see if there's a downloadable ebook out there.

I found one at: http://www.mindview.net/Books/TICPP/ThinkingInCPP2e.html "Thinking in C++" by Bruce Eckel. It was recommended at the Codeguru.com forum.

I haven't started reading it yet but I'll post a review by next week.

From NYT: "To See a Stock Market Bursting, Look at Shanghai"

2008-04-02T13:04:00.003+08:00

About time this happened.

A whole bunch of comments were made by shellshocked Shanghainese investors which reminds me of what survivors of the NASDAQ crash of 98-99 said:

Suddenly, millions of small investors who were crowding into brokerage houses, spending the entire day there playing cards, trading stocks, eating noodles and cheering on the markets with other day traders and retirees, are feeling depressed and angry.

"These days my family quarrels a lot," says Zhang Liying, 55, a retired hotel waitress who with her husband invested all their savings in the stock market. “My husband asked me to sell; I wanted to hold for a while. Now my husband condemns me as so stupid that we lost our family’s savings.”

Si Dansu, 68, and a retired engineer, is even more distraught, but she blames the government.

“I devoted my whole life to the country. I went to the countryside after graduation, and worked as an engineer in a Shanghai factory until retirement. I invested almost all my savings and retirement fund in the market 10 years ago. But now I’m totally penniless. All my stocks went down.”

Other parts of Asia are as bad, or worse. In India, stock prices have plunged 31 percent in Mumbai; they are off 31 percent in Japan and a whopping 53 percent in Vietnam, another booming economy. Angry investors have burned a securities regulator in effigy in Mumbai, and some are in tears in Ho Chi Minh City, Vietnam.

“Some of them have cried,” says Nguyen Quang Tri, 74, a retired cement company manager who was visiting a Ho Chi Minh City brokerage house this week. “I have my own equity, but most of the people here borrowed money from the bank.”

Shanghainese were hoping that the Chinese government will not allow the market to fall months before the Beijing Olympics.

My next prediction is that Irrational Exuberance will be translated into Mandarin and swing back to the top of the Must-Read Investor Education books in China after this incident.

To read more: http://www.nytimes.com/2008/04/02/business/worldbusiness/02yuan.html?ex=1364788800&en=9037453730135cb6&ei=5124&partner=permalink&exprod=permalink

Blog entry from: Paul Wilmott's Blog

2008-04-02T06:27:00.003+08:00

From Paul Wilmott's Blog: "Science in Finance VIII: The Maths Sweet Spot"

Maths is fun. Many people reading this blog and the Forum get a real kick out of maths and problem solving. I’ve had many jobs and careers in the last three decades, and started various businesses, but the one thing that I keep coming back to is mathematics. There’s something peaceful and relaxing about an interesting maths problem that means you can forget all your troubles, just get totally absorbed in either the detail of a formulation, calculation or solution, or lie back and think of deep concepts.
I wonder if that’s one of the reasons quantitative finance is in such a mess.

I’m going to let you in on the big secret of quantitative finance, and you must keep this secret because if word got out then that would be the end of all masters in financial engineering programs. And universities make a lot of money from those.

Ok, the big secret...Quantitative finance is one of the easiest branches of mathematics.

After-work Activities: Should you Trade, Invest or Study?

2008-03-30T01:02:00.006+08:00

Among the perks of undergraduate living is that you are free to canoodle with spreadsheets.

This spreadsheet attempts to put in absolute dollar terms, the cost of pursuing 3 activities in one's adult life after work hours that doesn't involve liquor, women/men, social activities etc. over 1 year and excludes cost of living.

In this hypothetical case, Mr A Hardy either actively trades with a strict money management strategy, invest for the long haul (i.e. A Long-only investment strategy, but Mr A Hardy believes in careful allocation of funds across portfolios, so he insists on picking his own funds/ stocks/ bonds etc. No shorts or puts or speculative derivatives trading, however) or he can pursue his MSc in Financial Engineering. A course of study which opens doors and earns him the right to climb into a higher tax bracket. (or so he hopes!)

Here's a couple of non-surprising findings.

Trading is ok when one does it for a hobby, but it blows once you do it for a living. Take a look at line (L) of the spreadsheet. By far, investing gives you a much larger share of net wealth, and this is before Cost of Living mind you!

Also note, that these activities are over a 1-year basis. So the negative Net Wealth for Studying Option is amortised over the rest of your remaining life. Furthermore, you make up for that loss by moving into better paying jobs, or earn a higher salary.

Trading, some claim, offers an additional or alternative stream of income. This is true so long as the input less than the output. Consider how much effort,energy and time it takes to maintain one's shareholdings or trading portfolio? If you work in the office, and you work at home, is there space for your family? Is there space for your own interest?

The biggest attraction of getting into trading and investing is the vibrancy of one's after work life. People who are doing stuff with money seem very involved. Its a wee bit like footy lovers. All they seem to do is talk soccer.

It is my personal belief that people who say they trade to become richer are deluded. They trade for the thrill and for the pleasure of seeking something arcane and mystical that has opportunity for wealth. After work traders are modern alchemists.

How NOT to trade equity warrants.

2008-03-29T01:43:00.009+08:00

Last year, I made money and lost it again trading warrants. I was up $7000 in May, and in the months following the sub-prime crisis, saw my profits erode to nothing.

At the start of the year, I had already formed an idea of which sectors were in play. For Singapore in 2007, it was all about the IR industry, the property markets and the financial sector - specifically the banks.

I was fixated on this sectors and never went around to look at other companies. I was sure that these companies would report good earnings because the economic indicators and numbers looked good. Logically for me the best bet would be to go long on these stocks.

The earnings report were good. But being right does not guarantee profit.

(Stock prices are not a function of earnings alone, they're also a function of public perception of risk. People attach risk premiums to the risk-free rate of return and discount future earnings by a larger amount. Stock prices fall, system wide, when people perceive increased risk in the economy. that's why sub-prime crisis is such a bummer.)

On warrants:

1. As expiry nears, if the warrants weren't in-or-near-the-money already, then there's little chance for the warrants fair value price to move. Let it go if it doesn't fly.

2. Before buying a warrant, draw a timeline, figure out when the company will report earnings. Where possible model for Dividend effect and Earnings effect. As you draw nearer to that date, watch the warrants very carefully.

3. If warrants go down by 10%, exit position ASAP. Don't average down no matter how far away the date to expiry is.

On Trading:

1. Never trade with money you can't afford to lose.

2. Take small losses early.

3. Have a trading system. Back Test. Position size. And Keep good records.

4. Write down your Entry and Exit plan and stick to it.

5. Consistency is the key to Profits.

DIY Portfolio Analysis

2008-03-27T20:04:00.007+08:00

Had a poke around the net and found this company, Structured Data LLC, based out of NY. They have a website riskamp.com

They offer a free excel spreadsheet which allows you to model a portfolio. You do have to download their monte carlo excel add-in to use the spreadsheet.

The idea behind a Monte Carlo analysis is to model the results of a portfolio (can be actual or theoretical) by subjecting it to n random trials. You can then extrapolate the probability distribution functions, mean returns and figure out if you're committing too much or too little of your money into equity, bonds or money markets.

"Fuckyounomics: How Nobody in the World Knows Jack Shit Except Economists"

2008-03-25T05:25:00.006+08:00

This is how the average professional economist thinks of you lot, for all that you pay his wages; you’re a bunch of mugs who are incapable of understanding anything and just react like children to whatever’s dangled in front of your nose. It’s another of the many scandals of the profession, it is taught in the universities, and you can see it in more or less every popular book entitled something like “Fuckyounomics: How Nobody In The World Knows Jack Shit Except Economists”.

In Harry Potter novels, magic users call non-magic users "Muggles". Magic users are powerful, trade in information and are privy to the arcane arts.

Greg Mankiw likens the economist to the magic user of the Harry Potter world.

The truth is that the economist uses models to understand the behaviour of people and their interactions when exchanging one good for another by ABSTRACTION. We are however pretty much interested in how people decide between alternatives subject to limitations such as time, income. Lately, we've even begun to use economic tools of analysis in figuring out how much a dollar of clean air is worth.

We like to use the dollar value of an outcome not because (1) we believe in an Almighty Dollar, (2) are secretly in search of the Philosopher's stone, or (3) in league with Mammon. We express the "event as a dollar of something else" so that it becomes cardinal and vastly more interpretable.

The problem with media is that a lot of the underlying assumptions are not being communicated to the public. Furthermore, a lot of the work is unseen and not easily understood without prior study. Economists should do a better job of explaining themselves so as not to alienate the people they serve or wall themselves of in our ivory towers.

If Economists were wizards, than we should aspire to be more Gandalf than Saruman.

63 year old, former night watchman , now teacher at Bar Ilan University solves "Road Colouring Problem"

2008-03-22T03:12:00.010+08:00

A mathematical puzzle that baffled the top minds in the esoteric field of symbolic dynamics for nearly four decades has been cracked — by a 63-year-old immigrant who once had to work as a security guard.

Avraham Trahtman, a mathematician who also toiled as a laborer after moving to Israel from Russia, succeeded where dozens failed, solving the elusive "Road Coloring Problem."- Link to Associated Press.

Having spent an evening on yongfook.com's pretty-boy blog, I was feeling disheartened by academic work. (Research is hard, it takes hours and it involves very little pay.)

For some reason, knowing that a Russian immigrant with a math degree has solved a problem in just 8 pages in pencil on a problem with real-world application, pleases me tremendously.

"First posed in 1970 by Benjamin Weiss and Roy Adler, the problem posits that given a finite number of roads, one should be able to draw a map, coded in various colors, that leads to a certain destination regardless of the point of origin. The 63-year-old Trakhtman jotted downin pencil in 8 pages. The problem has real-world implementation in message and traffic routing."

What’s the point of extracting implied probabilities from options on federal fund futures?

2008-03-22T00:38:00.002+08:00

I like telling fantastical story analogies. So here’s my attempt at explaining what’s the point behind extracting implied probabilities from option prices.

The story goes like this: Let’s say you worked for an arms and munition plant - R&D side of course. And that for some strange inexplicable reason you were caught in an airstrike while driving home one day. Now the missile that’s streaking across the sky is carrying 1000 high explosive anti-personnel bomblets designed to penetrate soft-skinned vehicles (like the one you’re driving for example). From your lab tests at work, and hours spent analyzing bomb dispersal patterns, you have a pretty good guess of the effective dispersal pattern of those bomblets. Given the missile’s trajectory (you had a sensor installed in your car which tracks the movement of Air-to-Ground missiles being fired), you can guess which areas, ceteris paribus, would encounter the greatest concentration of bomblets.

By analogy, the missile’s flight trajectory is the possible direction of interest movements – i.e. either it goes up, down or remains at the same level. Your market macroeconomic indicators are your missile/ interest rate sensors. That bomb dispersal pattern that I was talking about, are my implied probability distribution functions. I want to map out which levels are interest rates most likely to climb or fall to.

In this case I’m looking to map out the regions of probabilities that the interest rate would climb to levels A, B or C.

"How to succeed in evil" podcast

2008-03-20T18:39:00.006+08:00

Ever wondered what its like to be an Evil Efficiency Consultant? Follow the adventures of Edwin Windsor.

Link to "How to Succeed in Evil". Download free audiobook via Apple iTunes.

Laspayre's Index: What they don't tell you about the CPI

2008-03-19T22:48:00.005+08:00

Here's a doodle from a tutorial.

Vaguely, the tutorial was about Consumer Price Index and alternative measures. The one currently in use in Australia is based on Laspayre's Index.

To calculate how well off you are after a price hike, you compare 2 ratios: Laspayres Index and Money Income. To calculate Laspayre's index, you take this year's prices and multiply that with last years mixture of goods. Divide that by the base year prices and quantity of goods. Next, you compare that ratio with the ratio of money income (simply, take this year's prices X this years goods and divide by base year prices and quantities.)

If it so happens that your Money Income ratio is less than Laspayre's Index that means you're worse off.

The reason why you multiply it with last year's mixture of goods is because people 'prefer' their old consumption patterns and therefore find it hard to change. Its all part of revealed preference theory.

Anyway, to get the analogy across, economists spend a lot of time thinking about how to compensate people with enough income to leave them just as they were last year. They aim to compensate people for the loss in welfare due to a hike in prices.

Now what they don't tell you is that one of the key assumptions is that they've assumed that people are inflexible and rigid in their consumption patterns. Therefore, the goldfish with a frown in a leaky bowl. (See Diagram Left Rectangle.)

Now what if people adapt to higher prices and substitute away from old quantities of goods that have gone up in price and chose new quantities of goods. What happens to our measures of how well off we are after a rise in prices?

The goldfish with the multi level, worm-hole fishbowl has got choices and though water levels may fall (analogy to welfare falling) he can still get by and choose other modes of consumption.

So I wonder if instead of worrying about compensation for loss of welfare with price hikes, why not give a person more choices instead?

Extracting implied probabilities from options

2008-03-18T14:09:00.002+08:00

Link <http://www.bankofengland.co.uk/statistics/impliedpdfs/> to Bank of England's efforts at estimating probability density functions (pdfs) from the prices of option contracts traded on equity indices and interest rate futures contracts (see 'Notes on Bank of England Option Implied PDFs' for examples).

Thesis: Extracting Implied Probabilities from Options on Futures and OneNote2007

2008-03-15T11:55:00.005+08:00

Currently working on a dissertation. Started out wanting to do a paper on regional Tobin Q, ended up with another, more interesting idea: extracting implied probabilities from options on futures on Fed Fund rates.

Its been done before in the US, but my supervisor suggested I try doing the same for Australia instead.

The idea's pretty straightforward, but reading up on the math isn't. As I move along I'll blog about the entire process more. Its pretty much work in progress.

How Sensitive in Growth in Emerging Markets to a US Slowdown

2007-11-11T12:26:00.000+08:00

First seen on 'The Big Picture'

How Sensitive is Growth in Emerging Markets to a US Slowdown? - .PDF file (Deutsche Bank Global Economic Perspectives)

"...increasing exchange rate flexibility will tend to increase the sensitivity of EM economies to foreign developments. And financial market linkages, particularly co-movements across equity markets are becoming increasingly important.

Equity market capitalization relative to GDP in many EMs now rivals and in several cases exceeds that in industrial countries. Hence, the vulnerability of EMs to a US slowdown may be intensified via financial linkages, including both increasing flexibility of exchange rates (a possible appreciation of EM currencies against the dollar) and perhaps even more so via stock market linkages should the US market turn down significantly."

In other words if the US goes down, EM markets go down because of the transmission of shock through the stock exchange markets and forex markets.

hot blog alert: stockinsight.blogspot.com

2007-11-06T14:24:00.001+08:00

I was googling for articles written up concerning PetroChina's 1trillion dollar market valuation (Can you say, "Bubble"?) when I came across this blog. Its pretty interesting.

The perspective is relatively free from financial jargon. Blogger was in China and wrote about his experiences in the Red Hot Economy of the Century. So you get an idea of the kind of consumer experience one can expect in that country.

Real Option Valuation Spreadsheet

2007-11-06T13:56:00.000+08:00

URL: http://pages.stern.nyu.edu/~adamodar/

For all you MBAs, MScs, CFAs, finance undergrads/postgrads, whatever, I bring to you, the sourcebook, the panacea for all your valuation pains - Damodaran Online!

Checks its outs, yo, all your excel spreadsheets preconfigured with the formula so that all you've gotta do now is plug accounting numbers to relevant cells, do a bit of messing about with the numbers and voila! numbers for you to plug into that term report.

Damodaran is the man!

(Apologies for the slang; I don't quite know what came over me.)

Expectations Investing - (Sorta like Trading on Fundamentals, except with a fancier name)

2007-11-05T14:04:00.000+08:00

URL - http://www.expectationsinvesting.com

Kinda excited about reading this book actually.

From the site:

A revolutionary yet common-sense investment approach that reads the market's current expectations and provides the tools to anticipate future expectations.
A clearly written book on expectations investing written by valuation experts Alfred Rappaport—author of Creating Shareholder Value—and Michael J. Mauboussin—Chief Investment Strategist at Legg Mason Capital Management-and published by Harvard Business School Press.
A web site that serves as a resource for those wishing to learn more about Expectations Investing—and how to apply its powerful analytical tools.

Alright, I'm sold.

Everything 'Subprime Crisis'

2007-11-04T13:35:00.000+08:00

Got a term paper to write on an international financial crisis? Need a quick background on CDOs and the US Subprime Crisis but don't have time to read? Curious as to the spillover effects of a crisis in other markets?

Over the past 10 years or so, banks have been securitizing their debt obligations. What that means is that they've reduced their on-balance obligations and moved it off-balance sheet. These obligations are contingent liabilities. Basically, the banks lend only their reputations and names but the ultimate lender isn't them since they're just the middleman who brokered the deal. The bulk of all that risk is the person who bought that unit of securitized asset. The problem is that some banks have been writing cheques or using these debt assets as capital. In times of crisis, these kinds of securities are largely insolvent. To make things worse, we're not entirely sure who bought what and used what type of asset to back up those purchases.

In an earlier interview dated 31 July 2007, Satyajit Das replies to Stephen Long's comment:

STEPHEN LONG: The counter-argument is that that means that the risk is diversified, the risk has been spread so far and wide that the fallout won't be so bad.

SATYAJIT DAS: That ironically is what the central bankers have believed. It should be said that investment bankers and many pundits have been telling central banks that's the case. In fact, my view is exactly the opposite.

What has happened is that banks have essentially sold the risk out of one part of the bank to these investors, but there's other parts of the bank which have then used the securities which reference these underlying risks, and what they've done is lent money against that.

And the irony is the risk is now concentrated among very, very few banks, 'cause the people who do this, it's an activity called prime broking, are very, very few banks, less than ten.

Read the interview transcript.

URL: http://www.abc.net.au/worldtoday/content/2007/s1992847.htm

Also, Australian Broadcasting Corporation's 'Four Corners' program has good coverage as well as insight on this topic.

Watch the interview with Satyajit Das. Its a good exposure on an important finance topic about the transfer of risk exposure off the balance sheet - to be bought piece meal by investors who want exposure to this kind of risk.

URL: http://abc.net.au/4corners/content/2007/20070917_subprime/interviews.htm

Here's the teaser -

Video On Demand: "Mortgage Meltdown"

Last month an unfamiliar expression appeared in the Australia media. A "subprime mortgage crisis" was unfolding in the United States. Homeowners across America were defaulting on loan payments and economists warned of major financial fallout occurring anywhere from Paris to Beijing to Melbourne. But why should a foreclosure in Cleveland affect a hedge fund in Sydney?

As Four Corners reports, Australia, along with the rest of the world is at risk of a virulent economic virus thanks to financial globalisation where everything is interconnected through a sophisticated form of pass the parcel. And even more alarmingly, no-one knows just how bad it might get.

In "Mortgage Meltdown" Paul Barry reports on the fallout from the US subprime mortgage crisis and asks what impact it will have on Australia.

Calculating Cost of Equity for EM countries

2007-11-01T14:51:00.001+08:00

Again from Adrian Buckley's Multinational Finance pp 481.

Cost of Equity = Comparable Domestic Return + Country Risk Premium

Country Risk Premium = Default Spread for EM Country X (Std Dev. for EM equity market/ Std Dev. for EM government bonds.)

Default Spread = EM government bonds yields - Comparable Domestic government bonds.

This is the spread between the emerging market government bond yields and a comparable domestic bond i.e. US Treasury Bond.

Cost of Equity for Emerging Markets

2007-11-01T14:29:00.000+08:00

The following was sourced from Adrian Buckley's Multinational Finance, ch 24, pp 481 "International Investment: what discount rate?"

24.10 - Emerging Markets

[preceding this section was a discussion on the choice between an arbitrary extra risk premium when calculating discount rates for projects in EM countries and the International CAPM.]

Hooke(1998), for example, reckons that the cost of equity capital for emerging markets can be conceptualized as being equal to a comparable domestic return plus a foreign risk premium ranging between 5 percent and 15 percent.

Thus he recommends target returns for low-risk emerging markets, for example, Poland, the Czech Republic and Chile, at 18-20 per cent.

For medium-risk markets, such as Brazil, India, Indonesia and Mexico, Thailand and Turkey, he reports a recommended return of 20-25 per cent.

And for high risk countries, his cost of equity is between 25 and 30 per cent. Into this group, he categorizes China, Peru and Russia.

25 - 30 per cent Cost of Equity is a very large number to plug into your bog-standard Weighted Average Cost of Capital calculations. Unless you've got lots of debt in your capital structure, a 25 - 30% cost of equity, will discount your future cash flows by a lot. For investors, this means that Chinese and Russian stocks should trade at lower prices, given the risk they bear.

DIY Investing or Seek Financial Advisory

2007-10-28T14:43:00.000+08:00

I am off the age when peers are starting jobs, earning a decent salary, pursuing their dreams and basically holding a job. Last nite I had dinner with friends who were keen on investing.

Some had the view of doing it alone. Others believed that having a Financial Advisor helps because the advisor acts like a confidante and helps to hold in check speculative urges.

The awkward truths

Financial Planners in Singapore earn a Basic and a Commission based on a stream of future payments from the financial services that you purchase such as Insurance and Funds. That is true.

It is true that they make more money if they have more clients.

It is also true that they'll make more money if they sell more of a certain type of product.

So what?

Your job is to optimize your investment opportunities. In secure long term investment, your biggest enemy is yourself because:

1. You make all the final decisions. Therefore you determine the outcome. (You and the sum of your stupidity and irrational fears.)

2. You spend a lot more time thinking about investment opportunities rather than worrying about possible dangers.

3. You get emotional and irrational when you hear others are doing better than you in Fund/Stock/Investment Idea XYZ. You switch between funds and incur huge transaction costs when ideally you should park your money and let time do its thing.

Therefore Financial planners:

1. Offer you advise and counsel and can help you get up to speed on financial issues sooner.

2. They've got the tools to help you come up with an investment plan in a rational, logical manner which can act as a framework for future planning. (Its nothing more than an Excel spreadsheet based on Annuity calculations that you can download from the Net, but seriously, do you have the time and inclination to study the assumptions and work through the model and figure out why exactly Money has a Time Value and how that affects your returns?)

3. By going through a financial planner in an investment plan, you avoid OVERTRADING which increases the transaction cost of your investments.

Financial planners' advisory role dampens irrational desires to trade when you don't really have to.

After saying all that, if you still want to do it your own way you can start here: fundsupermart.com

Alternatively, you can drop me an email and I'll help you get in touch with a couple of friends who are dead keen on maximizing your wealth without sacrificing your sleep.

Donc.

Paybacks' a bitch: We haven't heard the last of the Subprime Mortgage Crisis.

2007-10-22T09:01:00.000+08:00

"The semiannual meetings of the world’s top finance and banking officials are predictable in one sense: Europeans and Americans often use them to lecture leaders of poor countries about the need to modernize their capital markets, promote transparency and adhere to sound investment standards.

What a difference a subprime mortgage crisis can make. Now developing countries are lecturing the West."

Tables Turned: Poor Countries Wag Fingers at Rich Ones - New York Times (21 October 2007)

Remember the Asian Financial Crisis of '97 when Thailand, Korea and Indonesia were bailed out by IMF and got an earful from Developed Countries as to how to run their economies?

Well, now, its America's turn with no end in sight for the subprime mortgage crisis.

"Collateralized debt obligations — made up of bonds backed by thousands of subprime home loans — are starting to shut off cash payments to investors in lower-rated bonds as credit-rating agencies downgrade the securities they own, according to analysts and industry executives."

Mortgage Security Bondholders Facing a Cut-back in Interest Payments - New York Times, (22 October 2007)

Bondholders who hold CDO bonds may face the possibility of having their coupons not paid.

"With such a re-evaluation, owners of collateralized debt obligations — investment banks, hedge funds, insurance companies and public pension funds — may be forced to write down mortgage investments beyond the billions they have already written off."

Oooohh kkkkaaayyy... *gulp*

One would think that a re-rating would be sufficient to sort out the entire problem but CDOs are a tangled barrel of worms. Its like having a pie made up of good and bad apples. The bad ones taint the whole lot.

Here's an insight into how complex the whole thing can be:

"A re-evaluation of payments by trustees who oversee the debt obligations is part of a long, complex chain reaction that is caused by the surge in mortgage delinquencies and home foreclosures. As more homeowners fall behind on payments and lose their homes, the pressure builds on large pools of mortgages that issue bonds to investors. Many of the riskiest of those mortgage bonds have been bought by the C.D.O.’s, which issue bonds of their own.

On Friday, Standard & Poor’s lowered the ratings on $22 billion in bonds backed by mortgages made to people with weak credit in 2006, citing the continued deterioration in the housing market. Another credit rater, Moody’s Investors Service, lowered a similarly large group of bonds earlier in the month.It is unclear exactly how many bonds will be affected and how quickly. Investment banks issued some $486 billion in debt obligations linked to mortgages in 2006 and the first half of 2007.

A majority of the bonds have high credit ratings, and the trustees of the debt obligations typically shut off lower-rated bonds first to accelerate payments to investors holding higher-rated debt.When ratings on the bonds directly backed by mortgages are lowered, it forces the trustees to discount the value of their holdings in a calculation performed once a month. Some C.D.O.’s also hold bonds issued by other debt obligations, so it can take months for ratings downgrades to work their way through the system."

Okay, so when will we see a bottom?

"Most mortgage securities have not yet had significant losses, which are only recorded when homes are foreclosed and sold. Up to two years can pass between a borrower’s falling behind on payments and an auction. Each mortgage security has a reservoir of excess cash to draw upon to pay bondholders when borrowers do not make monthly payments.

“As far as the security is concerned, it’s only once the property is effectively sold that a loss is recorded,” said Nicholas Weill, chief credit officer at Moody’s. “The process of foreclosure is a long process. It doesn’t just happen overnight.”

So there'll be at least 2 years of unfavourable investment conditions in the US.

So what are the banks doing to contain the problem?

"Problems with these investments has led big banks including Citigroup, Bank of America and JPMorgan Chase to develop a $75 billion rescue fund that could be used to buy risky mortgage securities and other assets from them, a move intended to ease pressure on an important part of the credit markets."

A US$75 billion dollar fund to increase liquidity in the trade of CDOs by Citigroup, Bank of America, JPMorgan Chase. Would it be enough though?

What I did on the 20th anniversary of the Wall Street Crash of 1987

2007-10-20T18:48:00.000+08:00

I stayed away from reading any market related news. I read popsugar.com , slashdot.org and boingboing.net instead. Later, I chatted with my girlfriend and had a cup of coffee. I napped for half an hour. Woke up and thought, this isn't too bad. I took the time to reconsider my investment behaviour and reconsider my options.

I stopped trading a few months ago because I blew up my trading account during the sub-prime crisis. The spillover from that event propagated through the financial system and made a couple of my warrants positions finish worthless.

I had bet big on the warrants of Singaporean banks and Capitaland, largest real estate group on the island. Given the fundamentals, I thought they were safe bets. I was wrong.

When the crisis hit, the stocks wouldn't climb to reflect stronger earnings results due to all the negativity in the US market and prices remained depressed. I had committed funds too early in an attempt to average out the losses but by the time the market had bottomed out, I had invested too much money into each bet to make them good candidates for the ride up again.

Looking back I think I began trading in warrants because I was bored. From my lecture notes, I figure I am what Larry Harris, author of 'Trading & Exchanges' describes as a Utilitarian/ Gambler/ Futile Trader.

I'll admit it. I regret placing those bets. I regret them because I compromised on my ideals. That I won't chase the stock. That I won't play the market's game. That I won't be fooled by my schooling.

The more you know, the more you think you have an edge over everybody else in the trading game. The truth is that I am a nobody with little new information and the cost of gathering every little scrap of information just to make a few trades is too expensive for my taste.

Fund managers can trade because they get paid to do it. Brokers trade because they get paid to do it. They need to be on top of the news, they need to be on the lookout for investment opportunities. Its their job.

I don't have to. I have a life. Its Mine. I have only one life and to waste it all scouring the Net for information, prowling the Forums for a sensing on market sentiments - its just too much.

So on the 20th anniversary of the Wall Street Crash of 1987, I'm relinquishing my dreams of becoming an Active Trader and surrendering myself to the way of the Informed Investor.

Energy demand 'til 2030 projections

2007-10-19T16:22:00.000+08:00

Above: International Energy Agency energy demand projections from BBC News report, "World risks 'dirty' energy future" (link here) dated 7 November 2006.

They mention pursuing nuclear option. (Not a bad idea considering how much of it is left untapped and that it produces heck of a lot of energy. But the Greens won't like it though cos of the risk of radioactive contamination, not giving 'green' energy sources a chance, etc. But Australia and South Africa's got a lot to gain from an interest in yellow cake uranium mining.)

They mention growth in the use of biofuel as a transport fuel (Ethanol? Biodiesel?).

From the article:

The report also projected that biofuels were set to play an increasing role in road transport, providing up to 7% of the total consumption in 2030.

But here's the interesting bit:

But the WEO warned that the growing demand for food would limit the potential of the plant-derived fuel produced using current technologies.

So if there's expectations of increased demand for grains for food purposes and as an alternative energy source, where do you think the price of grains would go?

If grain prices are going up, which companies will benefit? I can think of one: Noble Group, listed on the Singapore Stock Exchange. How about agricultural themed stocks? Or countries with significant infrastructure in palm oil and grains?

The assumption here however, is that world economic growth continues. We hope that emerging markets continue their upward trend, with some occasional periods of volatility. Energy companies tend to be highly leveraged with a sizable fixed cost component which makes their net profits very sensitive to economic fundamentals. A downturn could have a material impact on their revenues considering their large capital outlay.

As of today, I'm bullish on energy themed stocks and funds.

Oil Prices: Huge Demand, Not Enough Supply; means Big Future Oil Prices!

2007-10-18T11:09:00.000+08:00

This is so obvious its scary. In the next few years we can only expect higher oil prices because there's no new major oilfields left for easy extraction. Most of it is locked up in 'difficult' countries. The uncertainty in supply as well as the world's rapacious hunger for oil has created this huge jump in oil price expections.

Dr Michael Smith of energyfiles.com argues that not only are OPEC producers overstating their reserves, he also claims that the data is highly suspect. Link to page [here]; Link to PDF article [here]. In this 2 year old paper he claims that assumptions of future oil demand of 12omillion barrels a day is 'untenable'.

Quoting from article:

"Predictions that oil demand will increase to up to 120 million barrels per day by 2020 allied to automobile and airline traffic growing at extraordinary rates are futile and damaging to policy makers."

Even 95 million barrels are untenable, he writes.

The primary implication is that we're likely to see a switch to Gas (will require more infrastructure to be built) and alternative fuels as higher prices results in a substitution effect.

A couple of trading ideas:
I thought of buying Coal and other alternative energy companies in anticipation of an increase in demand for their services. The more immediate goal is figuring out which Oil & Gas co.s are likely takeover targets considering that its easier to buy a company and its proven petroleum reserves rather than look for the stuff itself.

Beware of China's overly optimistic economic growth projections!

2007-10-11T09:32:00.000+08:00

Lester Thurow, MIT's professor of economics has written an article for the NYtimes warning analysts and investors to take the Chinese government's growth projections with a pinch of salt "A Chinese Century? Maybe it's the next one," - August 19, 2007 (link here)

Quote from article:

"Economic growth rates can be inferred from electricity consumption. In every country in the world, electricity use has generally grown faster than the G.D.P. Electricity is necessary for nearly all productive activities, and because of inefficiencies, consumption of electricity has generally outstripped economic growth. Rising energy costs have resulted in more efficient use of electricity, but especially in the developing world, economic growth has still generally lagged growth in electricity.

But if China’s official numbers are to be believed, there are provinces in China where the G.D.P. has been growing faster than energy use. That is unlikely, since the central government’s statistics also say that energy use per unit of G.D.P. is going up — not down, as claimed in provincial G.D.P. statistics.

Among the world’s 12 most rapidly growing economies over the last 10 years, the G.D.P. has grown only 45 percent as fast as electricity consumption. In the early 1970s, Japan was shutting down its electricity-guzzling aluminum industry. During this period, the G.D.P. grew 60 percent as fast as electricity consumption, the highest recorded level among industrialized nations.

Using those numbers as a guide, if we consider China’s actual electrical use, which is relatively easy to measure, and do a little math, we come up with this estimate: The G.D.P. in China has been growing somewhere between 4.5 percent (using the average for a rapidly growing country) to 6 percent a year (using the highest rate for Japan), not at the 10 percent rate claimed in official statistics."

Several lessons to be learnt here:
1. Whack 4.5% - 6% into calculating Terminal value growth projections of Chinese companies rather than 10% (or any higher Economic growth rate as a proxy for a company's growth!)

2. A method to figure out economic growth projections for a company in an emerging economy. Use Growth rates in Electric Consumption to estimate the economic growth rather than use the Government's stated economic growth rate.

An easy way of estimating single-stock beta

2007-10-11T09:24:00.001+08:00

I submitted an earlier post about calculating Singapore Press Holding's beta using daily and monthly returns. I came up with some ridiculous beta figure.

I made a lot of mistakes in calculating the beta of a single stock against a larger market index and I'd like to post some corrections..

1. To calculate single stock beta use Microsoft Excel's '=slope('%change of stock returns', '% change of market returns')

2. The idea is that Excel's slope function measures the gradient of a curve. Here, the Y-axis is % change of stock returns and X-axis is the % change of market returns.

3. Beta is then defined as the 'change in Stock Returns' for a 1% change in Market Returns.

4. Note that you should compare like against like. Therefore, if you collect daily prices and then determine daily returns, plot it against the market indexes daily returns as well.

Reverse Engineering Earnings Yield to Get Beta Values & The Case for SPH as a defensive stock holding.

2007-06-11T08:42:00.000+08:00

Over at 8percentpa.blogspot.com, Xtam did a feature on the Price-Earnings ratio. The inverse of the PER gives you the earnings yield. The earnings yield is also the shareholder's Expected Return. Once you know the Expected Return you can then reverse engineer the figure to determine Beta - which is a measure of the co.s stock return in relation to the broader stock market.

Here's a case study:

Above you'll see the 1-year price chart for Singapore Press Holdings.

According to POEMS Dataline, Singapore Press Holding's Historial P/E ratio is 16.7

The inverse of the P/E ratio gives you 6%. Therefore, E(R) = 6%

Let's say the risk free rate of return in Singapore which is based on the Singapore Treasury note of 3.25% p.a. and that over the past 12 months (from 8 June 2007 to 8 June 2006) the red-hot singapore stock exchange has delivered an astounding annual return of 49%. How did I get that figure? I took 8 June 2007 Index level of 3881 and divided it by 8 June 2006 Index level of 2338.

risk free rate = 3.25%
Market return = 49%

The CAPM model is E(r) = Risk-free Return + Beta (Market Return - Risk-free Return). Solve for Beta.

6% = 3.25% + Beta (49% - 3.25%)

SPH beta = 0.06

This means that a 1% rise in the stock market would lead to a 0.06% rise in SPH stock return.

Beta can also be calculated in the following fashion:

Beta = Corelation Factor X Std Dev (Market) X Std Dev (Stock)

If the Beta of 0.06 is correct, then just by plugging in a few numbers, you can get a rough idea of how little SPH stock moves with STI in the long run.

The question is: How reliable is this estimate of Beta?

Here's a chart of Singapore Press Holdings against Straits Times Index. The blue line ending with code T39.SI refers to SPH and STI of course refers to the Index:

If you look at the left column, it clearly states that the 1-year return for the STI is in the ballpark of 50% zone while that of the SPH is in the low 4-6%. If this is true, then the beta estimate is reasonably accurate.

Voila Instant Beta! No need to sign up with expensive data supplier!

Here's my thoughts:
According to the chart, against a bullish economic backdrop it appears that SPH hasn't really performed. Could it be that SPH is the perfect defensive stock?

Let's look at what SPH has to offer. An almost complete monopoly on a captive market in News and Media. Co-owner of MediaCorp. Owns Paragon Shopping Centre. Chaired by Dr Tony Tan himself.

Hmm, I'd say at present market value, SPH is affordable and a useful hedge agst a falling market. Its always useful to know where all your Defensive stocks are and to buy into them to protect your portfolio's core value. If you've got money idling in the CPF OA account and you need something to accumulate earnings in, try SPH.

Thanks for reading!

Declaration: I, the author of this blog (and many other blogs) do hereby declare that I have holdings of SPH Call Warrants in the hopes of capitalizing on increased market interest in SPH over the coming weeks. SPH investor relations recently annouced that they will be re-valuing their prime Orchard Road property - Paragon Shopping Centre and will be releasing their earnings report sometime towards the end of July (me thinks.) The author has every intent to put his money where his mouth is by shifting some of his hard earned cash into the underlying stock as soon as his warrants trade makes him enuff to think defensively, SIR!!!!

Trading on Expectations.

2007-04-21T17:10:00.000+08:00

Firstly, an Expectation is the Average Payoff after taking into consideration the likelihood of a desirable outcome, payoff and the cost of invesment. You would do something if an expectation is positive. (i.e. a positive bet.)

E(x) = p(x). payoff - cost of investment.

Found this insightful synopsis on the various types of expectations traders (investors?) form when they buy and sell commodities in Moosa, "International Finance: An Analytical Approach", 2nd Ed. Ch. 4 pp. 107

Moosa quotes Pilbeam's[1] research concerning expectation formation mechanisms:

Extrapolative expectations mean that the exchange rate is expected to rise if it rises in the current period, and vice versa. (If ER rise now, it will continue to rise in future.)

Adaptive expectations mean that if exchange rate rises in at least 2 of the last 3 periods, then it should be expected to rise in the coming period. (If ER rising for past 2 out of 3 periods, then it will continue to rise in future.)

Regressive expectations mean that the exchange rate is expected to rise if it falls in the current period, and vice versa. (If ER is falling now, then it will rise in future.)

Rational expectations mean that expectations is formed on the basis of all available information. If this information is reflected in the forward (i.e. type of derivative) spread, then a currency that sells at a premium should be expected to rise, and vice versa. (If Forward Spread indicates rise, then a currency that sells at a premium should rise in future.)

Heterogenous expectations occur when the trader follows the majority signal. (Monkey see, monkey do.)

Contrarian expectations occur when the trader follows the opposite of the majority signal. (Monkey see, monkey do opposite.)

So as an investor with an element of speculation in you, how do u form your expectations?

[1] K. Pilbeam, 'The Profitability of Trading in the Foreign Exchange Market: Chartists, Fundamentalists and Simpletons', Oxford Economic Papers, 47, 1995, pp. 437 - 52.

Books to read for Financial Statement Analysis

2007-04-19T13:41:00.000+08:00

This may sound obvious but if you would like to learn how to perform Fundamental Analysis on a stock the best place to start would be to get your hands on a university approved textbook for any module teaching Financial Statement Analysis.

I am using Stephen H. Penman's "Financial Statement Analysis and Security Valuation".

The textbook I am using is clear and succint and the maths isn't too complex. Just a series of Present Value calculations. (Remember Arithmetic progressions and Geometric progressions in A. Maths? Yup. its along those lines!)

Forget about spending $20 - 30 on those skimpy 300 page paperbacks that tells you how to read and analyse financial stocks. They don't have the exercises and supplementary notes and in my opinion the detail necessary to help you gain any insight into what's going on in the financial statements.

You can get cheap copies of these textbooks on University noticeboards, especially towards the end of semester. I got mine for $50. Best value for money ever.

Everything Probability.

2007-02-21T01:40:00.000+08:00

After months of searching high and low for a primer on Applied Probability (I like stuff with Gambling involved cos its immediately applicable!), I did a search for Spread Betting on Google and came across this site: bethelp.com

In their "Learn-to Win" segment I came across several links to Probability as applied to betting:
Mathpages - The Gambler's Ruin
Probabilistic Thinking
Probability Theory
Saliu - The Fund. Formula of Gambling
Saliu - Theory of Probability

Tikam-tikam trade.

2007-02-13T17:34:00.000+08:00

Any form of activity dependent on the vageries of the market is a gamble because the outcomes are uncertain. Therefore its best to just go with your gut feel and hope that you have lady luck on your side!

Vested in:
5 lots Aqua-Terra Supply Co. @ $0.545 - Ship Chandler
3 lots HGMetal @ $0.415. - Metal Distributor
1 lot City Spring Infrastructure Trust IPO @ $0.89

Exciting times ahead!

Life is Random.

2007-01-21T02:45:00.000+08:00

I have been doing a lot of thinking on trading.

The more I look, read and think about the market the more I believe that the market's actions are completely random. Its behaviour is unpredictable, and that no single reason predominates.

No matter how convincing the argument, the outcome of the choices we make is uncertain. Whether we use TA, FA or a combination of both to forecast the price movements of a warrant or stock, it is only a guess.

When we risk our hardearned money on a trade with an uncertain outcome, it is in fact a gamble.

Therefore more thought should be directed at generating good trading signals, determining the optimum amount of wager per trade and the risk undertaken for a winning trade.

Blog: etfxray.wordpress.com

2007-01-14T00:37:00.000+08:00

ETFs are all the rage these days.

Found this blog at http://etfxray.wordpress.com that offers the goss on ETF funds. Who's buying and why. How it works that sorta thing.

Check it out.

Back from a Long Break!

2007-01-09T00:13:00.000+08:00

Sorry for the delay in updates, coming up with new entries for this post took a back seat while I sorted out my life.

I am very excited to share with you readers an interesting email I received from SGX-MAS Research Incentive Scheme detailing upcoming free seminars as part of SGX Investor Education programmes:

NLB-SGX COLLABORATION

Jan 10 "Learning about Investment Products: What are Exchange Traded Funds?"
Speaker: Ms Christine Huang
Vice President, Lyxor Asset Management

Date/Time: Wed, 10 Jan 07, 7-9pm

Venue: National Library, Level 5, Possibility Room, 100 Victoria Street

- Introduction of Exchange Traded Funds (ETFs)

- Benefits of investing in ETFs

- Overview of SGX Listed ETFs

- Investment strategies using ETFs

- Commodities ETFs

- Upcoming ETFs

PLUS - find out more about IRIS (Investment Resource Information Service at NLB). Enjoy FREE access to SGX archive information going back 10 years, ShareInvestor's market data and trading tools, NextView Advisor's investment dashboard including charting and analytics tools and Standard and Poor's credit ratings and investment research information)

Admission is FREE.
For more information on this seminar contact the National Library or SGX on 1800- CALL SGX (2255 749).

Why I am going.

Firstly, I want to know more about ETFs as a tool for accumulating wealth by an investor.

ETFs are wonderful devices to lock in your wealth while at the same time preserving it from the ravages of inflation. I am interested in getting some ETFs cos I want some exposure to blue chips which tend to do better in bullish economic cycles.

But I was thinking the other day, if you can buy blue chip stocks such as SIA, DBS, etc in Odd Lots using POEMs Unit Share function to keep your accumulation costs low. Why bother with ETFs at all?

Secondly, NLB (National Library Board) and SGX have collaborated to create this platform called the IRIS (Investment Resource Information Service at NLB). Key: Enjoy FREE access to SGX archive information going back 10 years

There's a gold mine of information right there for you. We used to have to pay to get that data, now they're offering it for free!

Stock Selection Criteria: High Dividend Yields

2006-11-08T13:51:00.000+08:00

When selecting stocks, do not overlook Dividend Yields. I admit that there are tax implications when you receive dividend income but there is a co-relation between better managed firms and dividend payouts which should not be overlooked.

Assoc Professor Julia Sawicki of NTU Business School presented a paper at my uni entitled, "Changes in Corporate Governance and Dividend Policy Prompted by the Asian Financial Crisis" [URL][PDF], she cites the work of LaPorta(2000) in which she establishes the case that 'better governed firms pay higher dividends.'

Do a stock screen of companies paying dividends of between 5 and 10%. The average dividend yield in Singapore according to POEMS stock screen is 2.4%.

Stock Market Bubbles, Market Corrections & Bear Markets

2006-10-30T15:16:00.000+08:00

The more you learn about investing, the scarier it gets.

I've been reading about stock market bubbles and trading psychology - the Tulipmania of 1636, the South Sea Bubble, the Great Depression, Black Monday 1987, Asian Financial Crisis and the Dot.com Bomb of 2001 - and my god, I've never been more fearful of the present state of things.

We're not just talking about market corrections here, we're talking of stock prices going down for long periods of time. Stock markets are also a leading indicator of economic activity and if the stock market points south, the entire economy is likely to go down as well!

Its easy to pick a winning stock during a bull market, but what happens in a bear market? Every stock is going down and they're all equally likely to keep going down.

Sooner or later, there'll be a major stock market correction. And I need to be prepared.

My investment focus right now is to increase income (for future investments) and protect net wealth against losses. I should look for companies that pay high dividend yields. I should stick the money in the money market or t-bills to protect. Since I am on the lowest tax bracket, I should be earning as much as I can.

Sharejunction.com

2006-10-23T21:26:00.000+08:00

I was checking out a company which I felt had good prospects. However, I felt that the prices it is trading at today is nearing its peak and I want to get in at a lower price. I don't want to be logging on every other day to check on this stock. I want a service that sends me an email when the price hits a certain low.

So I figure surely my online brokerage service would offer me this service for free. I was wrong. They want me to pay SGD$52 for Stock Alerts which I feel should be given away for free. I say screw them.

A fellow blogger recommended sharejunction.com. Its Singapore's First Online Stock Portal and I must say, they've got a pretty sweet setup. It has useful contents (active forums with lots of people talking about this or that share), userfriendly features, clean and simple design, easy to use. I love it.

They offer a comprehensive list of Financial ratios and Technical analysis snapshots of all the company's listed on the Singapore Stock Exchange to help you figure out if the stocks are worth buying or not.

Their online portfolio valuation incorporates brokerage fees so that you're always aware of how much the middleman is getting from you.

I'm signing up only because of their free Stock Alerts via Email feature.
Best thing is: Its all Free. Thats money saved for the next stock buying spree my friends!

Snapshots:

How to develop a penny stock portfolio

2006-10-20T13:38:00.000+08:00

1 way to get started in stock investing on a budget without a huge capital outlay or having to borrow money is to develop a penny stock portfolio.

I recommend developing a penny stock portfolio because its a good way of developing your instincts as an investor and business acumen. The aim is to make consistent and sound investment decisions that allows you to grow your money over time.

Small Stocks are very sensitive to the Market trend. They have among the largest Betas in the market. Betas are a measure of uncertainty - it also measures the tendency of a stock to move in relation to the market. A positive beta means the stock moves with the market. The size of the beta determines the magnitude of the move. When Market is up by 1%, a stock with a beta of 2 would deliver 2% return. Conversely, when the Market is down by 1%, small stock would be down by 2%.

The rules are:
1. 3 - 5 year time frame.
2. Buy and Hold strategy.
3. Dividends to be retained and accumulated for future investments.
4. Preference for Value over Growth. Defensive. Be very defensive.

Portfolio Performance Measurement:
1. Year-on-Year returns
2. Year-to-Date returns
3. Because your holdings are so small, you could have put the money in a money market fund and earn on average 3% return. You win if your portfolio returns more than 3%.

Stock Selection Criteria:
1. Share Price: $0.01 - $0.30
2. History of Dividend Payments
3. Dividend Yields: 5% - 20%
4. Operating Margin: More than 20%

Valuations:
1. Good management.
2. 'Deliverable' Earnings - that means they've got customers, and income booked.
3. Competitive Advantage.
4. Promising future.
5. Transparency in business activities.
6. Business is linked to major market trends - aging population, growth of China, increasing energy and oil demand, Integrated Resort development.
7. Determine share price Fair Value (Take Company's Market Cap (printed in end of year report) divide by Outstanding Number of Shares. Use this Price as Default Price. Buy the stock when it is trading less than this default price.

Timing:
1. Buy when everybody else is selling - usually in December or June! Identify the trend, determine market sentiment and be patient.

When to sell:
1. Definite sell: When a better investment arises.
2. Maybe sell: When you lose confidence in Management.
A business is only as good as its Leaders. No matter how good a product, or profitable a business is, or how smart the managers are, if the bosses are unethical, and behave inconsistently with how good business leaders should behave the earnings stream becomes very questionable.

Think Long Term. Form your own judgments. Trust your instincts.

Keeping track of investments.

2006-10-16T00:47:00.000+08:00

To track the performance of my stock investments I need to know:

The price I paid for the share
The amount I paid in brokerage fees
The date when I bought the share
The amount of dividends I received
The date when I was paid the dividends

I've also got a spreadsheet to capture all of the above information for easy reference as well as to track the cash inflows and outflows. I also note down the following in my PDA Calendar function:

The company's financial year
The release dates of their quarterly and annual reports
The forecasted dividend payment dates

I prefer to keep the money earned from dividend payments separated from my daily expenditure. The Changes in Share Price (i.e. Capital Gains), Dividend Payments and Transactions Costs are all taken into consideration when I review the stock's overall performance. I use a stock's annual return as a measure of the satisfaction gained from holding the stock.

Next time I'll blog about the spreadsheet functions you can create to keep track of all this data in a coherent manner. Very useful if you need to make a snap decision as to which stock to liquidate in the event of a real need for immediate cash or to pursue new investment opportunities.

Need data? Join a library!

2006-10-15T03:54:00.000+08:00

Members of the general public have a very difficult time gaining access standardized financial data for companies.

It's a Herculean task to standardize financial data. It takes a lot of time and energy to trawl through annual reports and translate those financial figures into an Excel spreadsheet for each company. Don't forget you also have to maintain the data for relevance and accuracy.

What I want is standardized financial data for the Asia Pacific Region done by people who know what they're doing cos they're getting paid for it. I found a data supplier: bvdep.com

They have this product called: ORIANA. Problem is they want you to pay per view.

The work around: I went to visit NUS Library website and did a search on their databases for standardized financial data. Voila!

The link: http://www.lib.nus.edu.sg/lion/hlb/companydata.html

Of interest is Orbis (Orianna Coverage)
"Orbis (Oriana coverage) provides balance sheet items, profit and loss account items and ratios, security and price data, ownership information of public and private companies in Australia, Bangladesh, China, Hong Kong, India, Indonesia, Japan, Malaysia, New Zealand, Pakistan, Philippines, Singapore, South Korea, Sri Lanka, Taiwan, Thailand and Vietnam."

There's one slight problem: If you're not a student of NUS i.e. if you don't pay fees at the Uni, then you're out of luck.

Not a problem... all you gotta do is pay $300 for annual subscription to the library. Small price to pay considering that you gain access to not only the database but also to technical search expertise and latest financial data.

If you're thinking of signing up, here's the [link]

Libraries are now my new favourite hang out places!

Googling your Stock

2006-10-10T22:53:00.000+08:00

Did you know that Google has a dedicated section for each listed company's finance? Its a beta version called Google Finance.

They offer a Summary, Key Ratios, News as well as related Companies.

Screen Capture:

Recommended Free Tools for the Beginner Investor

2006-10-10T14:16:00.000+08:00

SGX and the Monetary Authority of Singapore have introduced a new feature on SGX.com called the SGX-MAS Research Incentive.

Clued-in investors can now gain access to the latest broker and financial analyst reports for free. Brokerages receive $5000 per company reviewed and in return they publish their findings on SGX.

All you have to do is register a USERID and password and you're all set. Here's the [link] to the Research Reports on SGX.com

The cool thing about it is that they offer RSS feeds of the latest reports.

Personally, I hate the layout and appearance of SGX website - its untidy and counterintuitive, so what I did was download an application for the Firefox web browser called Sage Feeds which automatically loads from my list of saved RSS feeds sources onto a single page. Here's the [link] to Firefox SAGE feed browswer.

Screen Capture: