Book Rules for Investment

The field of behavioral finance has helped us to understand that we don’t always make rational investment decisions. We often make blogpoor decisions because of our biases. And the designers of structured product are well aware of these “flaws” in investor behavior. So they structure products that exploit our flaws.

Few points to be taken in to account :-

  • Never buy an investment product if there’s a commission attached to it.
  • Only work with an adviser who offers a fiduciary standard of care.
  • Only invest in a product if the seller can demonstrate that they also are investing in the same product.
  • Never buy a complex product; if you can’t fully understand the nature of the risks and the costs, run as fast as you can because you can be 100 percent certain the complexity is designed to favor the issuer. In other words, you’ll be the patsy at the poker table who doesn’t know he’s the patsy.

Continue reading “Book Rules for Investment”

Clearing houses : The Risk With CCP Failure

Sharing an article from the Streetwise Professor –blog

Major banks are having major concerns about the risks associated with CCPs in the aftermath of a failure of  a Korean brokerage firm that resulted in the mutualization of losses on the KRX.  The firm failed due to a fat-finger error (puts? calls? whatever!) and its margins were insufficient to cover its trading losses.

This experience is making CCP member firms re-evaluate the risks of CCPs, the risk controls implemented by CCPs, and the incentives of CCPs to control risk.   They realize that CCPs do not eliminate counterparty risk so much as redistribute it.  They are concerned about the incentives that CCPs have to manage those risks unless they have substantial exposure to them (“skin in the game”).

But here’s the thing.  This particular sequence of events is exactly what CCPs are best suited to handle: the insuring of idiosyncratic risks.  In this instance, the idiosyncratic risk was an random operational error at a single brokerage. Continue reading “Clearing houses : The Risk With CCP Failure”

Derivative not toxic shock

swap-it-like-its-hot11They’rrrre baaack. It’s leveraged supersenior kids, but not as you know it. Specifically not as you know it because the new ones are not non-recourse on the leverage, so they have no gap risk for the seller. Now, there are some not-entirely-accurate statements going around about what is actually happening here, so let’s look.

How would you synthesize a leveraged supersenior position? Well, take the underlying CDO, and sell the junior for a fair price.
Then take the senior, put it in an SPV, and fund that vehicle by Continue reading “Derivative not toxic shock”

How to Price an Asset

All valuation classes teach the equity market correlation method so it would be interesting to hear your views. Equity exists in many forms. In imagessecuritization, equity is the tranche that takes the first loss and controls the deal. In a mutual insurer/bank/thrift, etc., the book equity is held by the dividend-receiving policyholders. The real equity is held by management, who actually control the place, because the dividend-receiving policyholders will not vote them out. In a credit tenant lease, there is the guy that owns the property, and typically he puts up a teensy amount of equity, because there is a “credit tenant,” one that has an investment grade rating, and the mortgage is secured by:

BASEL III – Risk Exposed

The final approvals for the BASEL III capital standards provided by US regulators. Was going through one of the article published in imagesAmerican Banker written by Clifford Rossi, opens up that implementing robust capital standards that give individual institutions sufficient buffers from extreme events and protect the system at-large has been a major challenge for regulators and the Basel Committee since the inception of risk-based capital charges years ago. However, over reliance on analytic methods that failed miserably during the crisis puts the entire system at risk while creating enormous burdens on institutions and regulators to closely oversee these models.   Continue reading “BASEL III – Risk Exposed”