Fall 2013: Gametheory, search optimization, parred sales analysis, exponential smoothing, and more

Economics of Strategy

Econ was my hardest class but extremely valuable and a great introduction to a career in consulting. We covered economic basics including: elasticity (how changes in price affect changes in quantity demanded), consumer and producer surplus (the difference between what consumers/producers are willing to pay and what they actually pay as measured between the demand and supply curves), shifts in demand and supply (how demand moves and is shifted according to macroeconomic effects, competition, and other factors), marginal rate of technical substitution (the cost decisions firms make between two or more inputs of production), and market structures (single firm monopoly, several firms in oligopoly, and perfect competition within low barrier to entry markets).

I was able to refresh my calculus knowledge as we determined profit maximization levels using marginal revenue and marginal cost.

We studied Porter’s Five-Forces which includes analysis such as mitigating buyer power by increasing demand for complementary goods, differentiating the product, price discriminating (for example Coca-Cola experimenting with using vending machines which charge more for soda during warmer times of the day), mergers and acquisitions, and creating switching costs.

I was introduced to Gametheory principles and felt quite legit. The Nash Equilibrium is a theory which supposes that competing firms will make decisions based on what is best for the whole group and not just themselves. The prisoner’s dilemma illustrates this point as it explains the logical decision of ratting versus not ratting. We explored other simultaneous games and how to identify dominant strategies. Sequential games were interesting to understand as a business strategy to employ when you must follow the decisions of a competing firm. It was awesome to learn about how companies have tacit agreements where they collude without communicating with each other and how tit-for-tat processes can use discount rates, and cooperation versus defect analysis, in decision making.

We studied oligopoly pricing strategy including standard Bertrand oligopolies where prices settle to marginal costs, differentiated Bertrand markets where pricing only partially determines where demand will go, Stackleberg oligopolies where the reaction function illustrates how a follower firm prices based off of a leaders lead time, and Cournot oligopolies where firms adjust quantity, not prices directly.

A highlight of the semester was seeing the economic research of classmates applied to various topics ranging from football game attendance to MLB salaries to testing center capacity. I was disappointed that my group didn’t want to research how parking affects businesses, apartment complexes, and BYU. I was interested to identify the economic value which businesses received from having strict parking enforcement.   

Marketing

This class was nothing but entertainment. I didn’t read the book and only went to class because the teacher always showed awesome YouTube videos and advertisements. I liked the guest lectures from Nike, Amazon, Google, and Matts Hot Dogs. Marketing is the fun side of business but not necessarily the most technical.

Marketing basics: Marketing mix includes price, promotion, place, and product; advertising can be cognitive (give awareness), affective (gain interest), or behavioral (promote action); and atmospherics in stores is critical.

Because we are BYU and we like entrepreneurs we learned about leveraging leverage (riding horses, going beta, landing anchors, building advisory teams, and seeking benefactors); crowd sourcing through Kickstarter and Equity.com; and marketing events, creating love fests, and feeding frenzies.

I learned that business to business type companies are where to make money, Click Thru Rates, 7% of Google searches go below the scroll down line, Amazon 1-click is genius which needs to be applied to savings money, that online it is all about driving traffic, and localized standardization is called going glocal. 

Real Estate Finance

By far my favorite class, real estate was taught by a Round Valley boy: Dr. Barry Slade. My world was opened up to new careers I am interested in: real estate development, real estate appraisal, REITs, county recorder’s office jobs, urban planning, commercial real estate jobs, and real estate law. I want to join the city councils zoning commission and also buy a house because of this class.

Property rights in the USA go back to Puritan leader William Bradford who realized consecration wasn’t working and that giving individual land rights was the only way to avoid famine. Today’s fee simple estate provides absolute ownership except for eminent domain (5^th amendment, government gives fair value and can take land if it’s for the greater good), escheat (if owner dies with no heirs then land defaults to government), police power (zoning for health/safety/welfare/moral character), and taxation (property tax, ad valorem).

We covered some interesting current events including the success of Wal-Mart and Target express stores, the rapid growth and returns on farm land, strategic default by homeowners buying foreclosed homes, and a proposed development in Provo where Geneva Steel used to be.

We studied lots of random real estate law items: life estate agreements where a buyer purchases land but allows the current tenants to remain until they die; liens by mechanics and contractors can be placed on property which they work; deed of trust laws vary quite a bit across state lines; refinancing is almost always the right decision; time value of money is now actually interesting to me; and plottage is to bring together while plattage is to separate.

Legal descriptions are interesting and we studied metes and bounds, rectangular survey, and lot and block systems. There are 5280 feet in a mile, 43,560 square feet in an acre, 640 acres in a square mile, 36 sections in a township, and Baseline Ave in Phoenix is the baseline for the valleys legal descriptions. Fun fact.

I spent hours and hours putting together a 31 page report on an investment property. This was extremely tangible experience which adds tremendously to my finance portfolio. It also convinced me that my parents renting out their basement is a really good investment.

We studied various mortgage types including: Adjustable Rate Mortgage (ARM; mortgage payments change every year depending on a baseline interest rate such as U.S. T-bills), prime conventional (loans which avoid Private Mortgage Insurance (PMI) premiums because they have a 20% down payment), FHA and VA loans which are government backed loans by providing insurance to lenders in the case of default, nonconforming jumbo loans (homes that are worth more than what Fannie Mae or Freddie Mac will insure and thus often have an interest rate higher than others), and reverse mortgages (provides same benefit as a home equity line of credit, the homeowner pays high origination fees in order to receive a loan which is secured by their home, when they die or sell the home they (or the heirs) have to pay off the reverse mortgage).

There are a lot of players in the home market. Essentially there are originators, servicers, and owners. Banks, brokers, lenders, mortgage backed securities, thrifts, depositories, and investment banks all play a role in the transfer of risk and responsibility.

It was fun to see the church pay $0.5 billion and buy land in Florida. I enjoyed a talk from President Hinckley which talked about how the church has private arms, and that the purpose of these arms is to be temporary players in helping the church achieve its mission. It was also interesting to learn from Nate Boyer a little about how the City Creek Mall is running The Gateway into the ground. I also liked learning that the church does not allow any restrictions (CC&Rs) on the deeds it purchases even if someone wants to give it for free (because they may decide not to build a church where the giver wanted to).  

The housing decision was a valuable part of our discussions and showed the negatives and positives of buying early. Discount points and origination points should be analyzed in conjunction with comparable interest rates. Borrowers should not pay points if they are planning to move out of the home fairly soon.

We spent a lot of time working valuation problems. I finally embraced a finance basic: the income approach (discounted cash flows and reversion analysis). The effective gross income multiplier was more interesting than the PE ratio ever was to me. Band of investment technique was more fun than WACC calculations which I did all of last year. And cap rates were much more effective than Sharpe ratios.

Going forward I want to become involved in real estate. I am excited for my first buying decision and then growing my wealth so as to become an investor on the side. When I retire I want to join 1031 exchangers and just put tons of money in exciting real estate projects.

Supply Chain Management

Supply chain management is an extremely simple idea, but one which it was fascinating to consider in-depth. The principles we studied in class were very straightforward, but they had a tangibility and application which often is left in want in other classes. These key take aways included: running Excel regression analysis on inventory levels; using moving averages to predict demand and order fulfillment; using weighting to overcome the effects of seasonalization; and applying exponential smoothing formulas in order to not overuse historical data. We covered expected value calculations where you multiply expected payoffs with the probability of them occurring. That grand ole statistical measure, the p-value, was applied to quality management and trends within normal distributions were evaluated in order to determine nonrandom events. 

We analyzed projects and their preceding tasks. We were introduced to Gantt charts and determining critical paths. I was introduced to MS Project software, which was extremely useful in determining project management decisions.  

The class was fairly relaxed and we had several days where we got to play games which illustrated principles. The tabletop game was useful in studying training effects, the rootbeer game illustrated mean reversion between different entities inventory expectations, the cougars and utes game showed the complexities of an efficient supply chain which connects factories, suppliers, distributers, salesmen and customers.

We studied many companies including Wal-Mart, Fed Ex, and Amazon. In addition, we studied Toyota which created the just in time (JIT) manufacturing process and focused on eliminating Shingo’s Wastes.

Logistics includes various theories such as cross docking, hub-n-spoke systems, consolidation warehousing, and break-bulk facilities.

Going forward, I suspect I will learn more about Six Sigma, MS Project, decision trees, and regression analysis. Our professor pointed out that it takes about 6 months to learn an industry and that was encouraging advice which got me excited to move into my career. 

Strategic Management

Another fairly conceptual class but with entertaining projects. I learned various strategy frameworks including diamond (arenas, vehicles, staging, differentiating, and economic logic) and Porters Five Forces.The Capsim simulation we did was enjoyable. It included making business decisions for a make believe company (R&D, finance, marketing, human resource, and production).

We studied a residential insulation company in Minneapolis and provided some useful consulting to them. The Matthew Effect is interesting: rich get richer, and poor get poorer. Overall a pretty bland class.  

Life Money Outline

The Best Day: Life Money Outline

By: Jon Gillespie, B.S. Finance BYU 2013

You Gotta Make Money

            This article is going to be different than any other article on money that you have ever read. I want to emphasize something that most “get rich quick” books won’t emphasize: You gotta make money.

            Man was meant to work by the sweat of his brow. It takes money to make money; and it takes work to get that money. The good thing is that you are a creative,hard-working, and dedicated being who will make the sacrifices necessary to educate yourself, to expand your network, and to get experience which will be relevant to a steady paying career.

            There is no place in society for individuals who feel okay living their days off of subsistence provided by family or the government. Even President Obama said, “We need to steer clear of this poverty of ambition, where people want to drive fancy cars and wear nice clothes and live in nice apartments but don't want to work hard to accomplish these things. Everyone should try to realize their full potential.”                        Enduring personal satisfaction comes from self-reliance. Parents and the government are tempted to give fish, but the more our nation can teach people to fish, the more prosperity we will have. In the following pages I hope to provide some insight into how discipline and specified knowledge can give the tools necessary to bolster people’s confidence and self-reliance.

            The bottom line is that if a person wants to create a financial plan which causes them to not have to worry about money…well they are going to have to do something from nine to five which eliminates that worry. The most successful people are people who do what they love to do. Most people need to spend a couple years doing what others love them to do, but eventually successful people progress towards doing and excelling at what they love to do.

            The pursuit of money is not a life endeavor which will be pleasant to look back on. It is the pursuit of personal interests, creation, accomplishment, and the welfare of others which are worth our effort. Consequently these principles tend to have the nice side-effects of seeing your retirement funding as green or avoiding being a slave to debtors.

            Money, is critical to saving money.

Forming Years

            Parents are an un-substitutable guide to forming their children’s behavior. There is no doubt that the nurture a parent gives shapes the child during the moldable years of childhood. With this in mind, it makes perfect sense to implement basic habits relating to financial literacy into children.

            Growing up I always looked forward to turning 8 years old because it meant I could be added to the chore chart. A month after I turned 8 and spent Saturday mornings doing chores instead of watching cartoons, I began to reconsider why I was so excited for this step. The fact that I wanted to do chores shows that there is a desire, even at a young age, to have a certain amount of responsibility.

            My parents gave me a purple box with three compartments in it. One was for savings for college years, one was play money, and one was for charitable contributions. I was instructed to give 10 percent to charity and then to do whatever I wanted with the other money. I think it would have been good instruction to also save 10 percent for college and to have parents take my saved money and put it into the bank (and “bank” could even just be a box in their closet where I couldn’t touch it).

            The amount of money I but in my box was fairly minimal. Until a kid starts mowing lawns, babysitting, or making it big in the lemonade business, he will have limited income. Therefore, I think an allowance is an important tool in generating income for kids. I suggest having an allowance not tied to “expected” jobs like doing dishes, mowing the family lawn, cleaning a bedroom, or doing family chores. Rather, I see allowance being given for going the extra mile on projects.

            To make way for allowance money parents can require that kids pay for going to McDonalds with their friends or pay to buy that extra shirt. A slight investment in allowance money could go a long way for a kid and help develop their character.

            One option that many parents look into for children is buying a life insurance policy on them. Buying a permanent life insurance policy on a child means that they can get locked into good rates and maintain those rates throughout their life. Typically a policy will include an adjustable premium where the child can increase their coverage later in life without having to prove insurability.

            I don’t necessarily recommend life insurance policies on everyone but the concept of investing in your children’s financial well-being early will leave a mark on them. A life insurance policy on a child is essentially a savings plan you have created for them. Getting a child to contribute small portions to investment vehicles which will have fruition when they leave the nest is a good idea.

            The final product if you’ve stamped an 8-12 year old: A 12 year old who has started saving for college years, knows that his money needs to be distributed to things besides candy and yet realizes that even after taking care of needs, there will be money left over for candy.

Habit Years

            The major concepts introduced in the forming years will be slightly added upon in the intermediate years. If steps from the forming years were missed then they can and should be addressed between the twelfth to fifteenth year.

            More encouragement to work outside the home will direct the child to money making. There are many companies which will employ 14 or 15 year olds in part-time positions. To name a few ideas: Youth can work in restaurants, as janitors, pressing shirts at a laundry mat, or doing basic clerical work. Taking part in the family business or helping neighbors with theirs can go a long way for a kid’s low expense budget.

            Children shouldn’t be expected to help pay for expenses around the house but wouldn’t there be a sense of pride if they could tell their friends that they paid for and put in some flowers in the garden or that the ice cream which everyone is free to enjoy came from their pocket. Obviously luxuries like video games can be expected to be bought using their own penny.

            Families should discuss school and career goals. Children need to enjoy their childhood but they don’t need to be protected from making dreams about attending top universities or working in fascinating fields of work. Teach these youngsters that they are beginning to form who they will be as an adult.  

            During these years youth will have pride in the minimal amount they have saved and will start to realize the sacrifice it is to give charitable contributions and this will deepen principles of faith, sacrifice, and thrift.

Pre-Adult Years

            High school is a time when youth will start wanting to breathe independently. Gradually as pleasures increase so should expectations. If that 16 year old can borrow your car for a night on the town, well then that 16 year old can leave it with a full tank of gas. If that 17 year old is going to play three high school sports on your dime then he might have to miss the weekend camping trip with friends because he is going to help you put up a fence in the backyard.

            Allowance allotments should probably be nonexistent by now (and generally kids will feel ashamed if they still receive allowance at this age…even though that mindset reverts come college years). Most teens will begin to understand that money doesn’t grow on trees and will be more respectful of what they are given.

            Eighteen years old is an ideal age to get a credit card. Lenders don’t have to worry about minor laws and are more than happy to extend credit to the fresh meat. Because youth have been responsible their whole life (right?), they can understand the concept of only using credit cards to build credit, have convenience, and get rewards. It is vital that automatic payments are set up from a checking account and that the credit limit does not exceed monthly income. Credit agencies like to see high credit limits but low use off that credit limit; so it is important not to exceed 25 percent of your credit limit.

            In reality credit cards aren’t the best way to build credit but they do give you credit history and if you can have a line of credit open for 3-4 years with no negative blips then getting good interest rates down the road will be a lot easier.

            Cards which have rewards for things you already buy are good to get. Granted you don’t want to overspend on these items just because now you get 5% cash back. The other thing to look for is whether the card has an annual fee. If it does then you might want to avoid it because even if you get a $100 gift card for buying it, in year 2 you will forget about that and be paying for something which ideally you won’t use that much.

            Credit card companies aren’t going to be mad when you pay your bills on time and avoid paying their fees. They make their money on the things you buy with your card. If they extend you $2000 of credit and you are disciplined and only use $200 in a month on groceries (because that’s where your rewards come) then they will make 1-4% of that $200 because the merchant who accepted your credit card has to pay them for that. The merchant is fine paying that because they will gain a larger quantity of sells if they accept multiple forms of payment. They would rather pay Visa a little bit of money then miss out on you coming in at all because you wanted to pay with the convenience of a card. Credit card companies also make money from selling your information to advertisers. So pay your stuff on time and everybody is happy.

Young Adult

            Parents would be wise not to crush the aspirations of their newly graduated kids. While parents are benefited from life experience and the school of hard knocks, young adult ideals are just as credible.

            At this age, a new sense of independence typically has sprung in a young adult. They most likely will still be depending on parents to some degree, but will be opened up to the new world of personal responsibility. They will be responsible for finding their own housing, paying tuition, buying groceries, and the whole gamut of adult responsibility.   

            One of the most important things that college does is it teaches people how to learn. Often what one learns from classes is irrelevant compared to having the resources to know how to learn in the future. Whether education is formal or informal, it is critical to knowing how to increase brain power. The brain isn’t fully developed until around the age of 25, thus young adults should always feel their mind has the capacity to increase. Finances really can be fairly simple but if an individual is not increasing their general brain power, then their ability to understand the efficient frontier of investments or the terms of a home mortgage, will be low.

            Research also shows a correlation between education levels and income. In its purest form: educated people tend to have and keep more money. The days of getting a bachelor’s degree and getting a salaried job are ending and individuals are being required to get higher levels of formal and informal education.      

Marriage

            I once tried to teach my 15 year old dog Lady how to sit. She could barely hear and had little interest in doing the prerequisites necessary to get the food in my hand. I had a similar experience when I sat down with an older relative and went over his retirement planning. He had never internalized the habit of saving. As such, he was unwilling to even begin saving at his age. He wanted the $80,000 a year retirement but the old dog just didn’t want to change. Well I may have been merciful to Lady and given her the food, but my relative will be handed limited social security and will likely be on track to be drowned by medical bills.

            Why is it important for a poor newly married couple to save 10-20% of their income? Because if they don’t begin now than they are less likely to do it even when they make six figures. We are creatures of habit and if I can find a way to spend a dollar then I can certainly find a way to spend 10 dollars.

            As soon as a couple makes the decision to make a life together they should be ready to own their own house. The sooner you can start paying yourself instead of the landlord the better. There is extensive research which needs to be done in preparing to buy a home. The worth of a home can be determined by the level of crime in the neighborhood, the school system, distance to work, etc.. You should have a good idea what you think a home in a particular area would be worth from the intangible side and then consider the tangible benefits outlined by your realtor. Typically if you have determined the worth of a home before being introduced to a home, you will have a higher bargaining power then when you are confronted with price before weighing the worth of the options.

            Since buying your home is one of the biggest decisions you will make, it is worth investing time and money to research about. Visit with other homeowners, rent cd’s from the library on the subject, and do lots of Google searches. Rich people own businesses because the business will work for them. The logic is similar with home buying. Land appreciates over time and the sooner you get into the game the better. Renting is a dead end investment and so the sooner a down payment can be scrounged up and regular income be paying for a mortgage the better.

            When a couple decides to buy a home they can decide to make payments like a business would or like a Dave Ramsey would. Dave Ramsey says to pay a substantial amount down on a 15 year term and then pay ahead as much as possible. A business figures it can pay the minimum payments and reinvest the money otherwise put towards the house. There is something good about controlling debt in a household but corporate America has found that using a 4% loan to reinvest at 9% is a smart thing.  

            At this point in your life it should be clear that making money is not about what you do, it’s about why you do it. Companies thrive when they market towards a vision and not to a production line. What you do does not matter, why you do it does. Financial planning misses the mark if it is not geared towards accomplishing the deep values which you and your spouse hold.

Income years

            You willbe tempted at different times in your life to lend money to family. For the most part this is generally bad practice. This comes as conflicting news with entrepreneurs who are taught to order their capital requests from family, friends, and then fools. Remember you are at the family level and not the fool level. Realize that though it may cause a rough patch to deny a $20,000 investment in a unique idea, it will be easier to deal with that cousin then the awkward collection calls you will be making at your next family reunion. Even smaller allotments can put pressure on family which is undeserved.

            You will be presented many investment options throughout your career. Make sure you have a solid relationship with a financial advisor who can provide access to good products but also provide unique insight into market directions and building a strong financial plan.

            Diversification is something to start building: Not only diversification within a particular account but also diversification of accounts. If several buckets can be dipped into then there will be greater protection against market swings and liquidity issues. Different buckets might include Roth IRA, Traditional IRA, real estate, venture capital, permanent life insurance, cash, commodities such as gold and silver, or annuities.

            When family is in the picture it is important to protect against unlikely and unexpected events such injury, illness, disease, disability, and death. Any efficient financial portfolio will have necessary insurance in place in order to protect against event these unlikely scenarios.

Conclusion

            This short tutorial has lent ideas for financial planning ranging from youth to retirement. As I continue to learn about the later years I will provide future editions on how to use money in those years. I hope this has jogged some ideas and helped you in figuring how to provide financial peace to you and your family.    

Torts, cookie jar accounting, butterfly options, and the Fed: Winter Semester 2013

Introduction and Conclusion

            As lengthy as this article appears, it is in reality not a comprehensive list of things learned this semester and because it was pretty hastily typed it also could have some inaccuracies. Inaccuracy also is the result of me being a straight “A minus” type student. I have included information about business law, corporate accounting, advanced investments, and banking and so feel free to only read a section you are mildly interested in. I didn’t put sections in about my Judaism or Joseph Smith Translation classes mostly because of time constraints but also because these classes are guaranteed above A minus type classes and so I’m not too concerned about jolting my memory on their topics. I will say that my teachers in those classes were experts and I my testimony and knowledge grew immensely from the material portrayed in those classes. I hope these brief random explanations of random things I remembered learning this semester will be useful to you and feel free to check out last semesters blog entry too.     

Business Law

            A kid said an interesting thing in one of my classes the other day. He said that our generation commits less to memory because we are reliant on internet searches. Why actually remember what a tort is if I can just Wikipedia it? Well turns out that torts were something I had googled numerous times before this class, I think that kid is right. So stick this definition to your memory and don’t Wikipedia it down the road: torts are wrongs. They are the violation of protected interests. Torts can be intentional, unintentional (negligence), or derived from someone’s strict liability. Examples of intentional torts are assault, false imprisonment (i.e. Wal-Mart inappropriately holding suspected shoplifters), or misappropriation of the right to publicity (i.e. I can’t use Michael Jordan even if he was dead or unknowing). Unintentional torts are harder to identify and relate to actual and proximate cause. To constitute negligence a plaintiff will have to prove the defendant had a duty of care, that he breached that care, and that injury was the result. Examples would be a video game being blamed for a school shooting or fireworks knocking down clocks when wrestled from a person bringing boxes onto a train (inside joke). Strict liability is liability without fault and deals with products. Companies have a responsible to reasonably inform consumers of danger. If there are foreseeable misuses then that must be identified; this is why irons say, “Caution hot: Do not iron shirt while wearing the shirt.”

            The stages of litigation are fairly interesting. It is funny our “business law” class started off talking about criminal procedure of murder, assault, and rape cases. The syllabus is definitely rigged to suck us in and then punch us in the face with contract law and agency formation after the add/drop deadline. In accordance with Jesus Christ’s teachings (“agree with thine adversary quickly”) well over 90% of cases are settled before they come to trial. Pre-trial includes pleadings (complaint filed, answer, affirmative defenses, cross-complaints etc.), and discovery (subpoenas, interrogatories, mental examinations etc.). If settlement is not reached, or neither motion for summary judgment or motion for judgment on the pleadings is made, then trial ensues. Trial includes jury selection, opening statements, direct and cross examinations, closing arguments, jury instructions, deliberation and verdict, and then entry of judgment. Then appeals follow chains through state and federal courts. Interestingly enough a judge can enter a judgment notwithstanding the verdict.

            Latin probably should still be taught to youth. I have been heavily exposed to it in medical classes and suspect I will get more than a small dose of it in law school. A couple good ones are stare decisis (let the decisions on previous courts stand in future ruling, related to common law) and res ipsa loquitur (as opposed to the plaintiff carrying the burden of proof, a defendant must prove their innocence, examples being malpractice situations where a patient was unconscious).

            I had never made the clear distinction between civil and criminal procedure. Criminal courts can give punitive damages (i.e. throw you in jail) while civil courts only relate to giving money (i.e. Jesus’ teaching about “eye for an eye” related to damaged eyes having monetary value tied to them).

            One of the few pieces of legislation we were introduced to was Sarbanes-Oxley. This law stipulates that officers (i.e. CEO, CFO, etc) in a company must put their stamp of approval on financial statements, personal loans are prohibited to officers and directors, evidence tampering is more scrutinized, and securities crime committer’s can be barred from serving on boards and as officers.

            Something good to know is that minors can always disaffirm a contract unless it is related to a necessity of life. Therefore a minor can buy a video game and return it after the printed due date and Wal-Mart must offer a refund. It is the risk of companies to sell to minors, let’s take advantage of this law a little more people.

            Individuals shouldn’t take advantage of fiduciary relationships and persons in certain positions need to be wary of exercising undue influence over subordinates. I will sue the caretaker of my grandma if it turns out grandmas will somehow got changed to give her inheritance to the caretaker. And I will sue my broker if he doesn’t act in my best interest.

            I missed the problem on exam 1 about quasi contracts. Quasi contracts are implied in law contracts and in reality not contracts at all. They are used to create equality and right wrongs. It is like restitution for a wrong someone did against me in a contract.

Corporate Financial Reporting

            This class had my favorite professor and so it is a shame that this section will be a little smaller than the business law section. Fact is there was just a ton of numbers stuff in this accounting class and that is hard to portray here. Dr. Drake performed a lot of case study for us and we got to learn interesting things about companies: Facebook sucks at avoiding taxes, Ryanair relies on ancillary revenues (i.e. flights into weird airports) and major cost cutting, Boston Market used franchising to a degree which made them profit more from franchising then from selling chicken, Microsoft has an gaudy amount of “cash” and is getting big returns on this asset because it’s actually being invested, and lots of other interesting things which make these companies unique in their approach to financial reporting.

            Arthur Levitt was the chairman of the SEC and called for regulation crack down on earnings management. His calls went unheeded and the auditing mess of the early 2000’s ensued. The encouraging tone of his initiatives illustrated to me that there are great moral people in the business world. His “Numbers Game” address was related to selective disclosure (private news preceding public release), transparency, big baths (pile on losses if one year will actual have losses), comparative acquisition (expense purchased R&D), cookie jar reserves (recognize cash as unearned revenue until there’s a down year on revenue, mess with your bad-debt expense, overestimate bad-debt allowance), materiality (round and accidently alter seemingly insignificant numbers which push EPS or other numbers to normal levels), and revenue recognition.

            Financial analysts need to pay attention to net income, comprehensive income, and other comprehensive income numbers. Other comprehensive income includes unrealized gains and losses on certain investments, foreign currency items, and certain pension liability adjustments. These numbers are important to review because according to GAAP only net income has to be reported although I think a note is needed for other comprehensive. Comprehensive has more variability to it might unfairly report a firms well-being.  

            Inventory theory is pretty fascinating. If there is an increasing tax rate and inventory was cheaper to purchase in the past then it’d be useful to use a FIFO strategy with inventory. If prices of inventory are inflating and you are looking for high profit margins then it’s good to use LIFO. LIFO generates income tax saving in times of inflation. LIFO isn’t allowed by IFRS because it lowers inventory costs on the balance sheet (assuming inflation). There are a surprising amount of inventory strategies but average cost is the last one worth mentioning. Earnings management is possible through inventory layers. Alright this is already getting pretty boring.

            I was interested in the pension portion of class because I like retirement stuff. Pensions are classified as being either defined benefit or defined contribution. Defined benefit plans usually are huge liabilities for companies and the investment risk falls on the company. Defined contribution shifts investment risk to employees.

            Bankruptcy can be predicted using Altman’s Z-score analysis. This fairly straightforward equation can be applied to companies to find if they are close to trouble. We used the WRDS website to look up financial data and saw the progression of Borders Books towards bankruptcy. The equation includes very well-known balance sheet and income statement numbers but is quite accurate in deriving a z-score which indicates probability of default.

            The statement of cash flows is the most useful financial statement. The balance sheet and P&L are merely items needed to make a statement of cash flows. Cash is king and the SCF shows where money is flowing within a company. The SCF reverses accrual accounting. The SCF is broken down into operating, financing, and investing sections which will give good indicators of company strategy. 

Advanced Investments

            A derivative “derives” it’s worth from an underlying asset. This class was fairly exciting because it took us pretty close to ground zero of the financial crisis. Examples of derivatives are options, futures, forwards, and swaps.

            Futures and forwards are fairly similar with a notable difference being that in forward agreements delivery of the underlying good actually occurs. Forwards have their roots in farming where farmers hedged against the risk of a bad crop by getting into a contract which stipulated the price they would be able to sell their goods, whether or not demand and supply changed the actual price of that good. Basis risk refers to the difference between the spot price and futures price of a forward or futures contract. As the maturity date approaches the basis risk naturally lessens.

            Options can be written or bought on a stock. A call option is the right to convert and buy a share at a given strike price. A put is the right to sell a stock at the strike price. Strategies with options include bull spread (buy a call or put with low price compared to and offsetting position in a higher priced call which you sell; executed if price jump expected), bear spread (opposite bulls strike prices), and butterfly spread (buy high strike, buy low strike, sell 2 of an intermediate strike; executed if very little price movement expected. There are combination strategies like straddles, strips, straps, and strangles which I won’t bore details on.

            European options are exercisable only at the contracts end date and American options naturally have more freedom and can be exercised at any time during a maturity window. Long and short positions are fairly well known, if you are long then you expect upward movements and have the buying position. If you are short you have the selling position and suspect that prices will be going down.

            Basis points is an important financial term. 100 basis points is equal to 1%. This is an easier term to use when analyzing small changes in rates. Saying a 20 basis point change occurred is clearer than saying 0.2 % change.

            We gained more insight this semester on the use of risk-free rates. LIBOR is the interbank lending rate of banks in England. These banks lend their excess reserves to each other at this rate; it is a market driven rate. LIBOR is used for short-term derivative trades. To derive present value using the CAPM or in many other situations a historical US Treasury rate is used.

            We memorized the Black-Scholes formula. Black, Scholes, and Merton were some dudes who made a break through on valuing options. They got a Noble Peace Prize (well Black didn’t cause he was dead) for their formula and thirty years later I got a headache memorizing and applying it.

            You have probably heard bad things about Credit Default Swaps. Let me tell ya just a little about them: They essentially are the insuring of one company against the risk of its borrowers defaulting. One bank pays premiums to an investment bank and the i-bank bails them out if the underlying asset defaults. Bad thing is that the investment bank sometimes gets bad information about the default probability and usually doesn’t care because it has already packaged up its CDS and divided it up to unknowing investors.

            Currency swaps exchange principal at the beginning and end of a contract and speculate, hedge, or arbitrage based on the appreciation of a certain countries currency relative to another countries.

            Interest swaps involve one party wanting to get out of a fixed interest agreement and move to a variable rate situation. An intermediary usually banks a little one orchestrating this exchange and both sides come out even (kind of).

            I will start a brief insight into the 2007-2009 financial crisis with a little insight into collateralized debt obligations (CDO). Loans are given to several homeowners. These loans are combined and sold as a Mortgage Backed Security (MBS). The MBS is divided into several tranches (senior, mezzanine, equity). When default occurs the equity tranche is affected first and the investors in that tranche possibly do not receive an return on their investment. Rating agencies therefore will give equity tranches a lower rating and the expected return of these securities, given their high risk, is higher. A sneaky thing which investment banks did was complicate this process by dividing the mezzanine tranche into its own senior, mezzanine, and equity tranches. The chance that the senior level of the mezzanine tranche got paid was extremely good and so rating agencies would go head and give AAA ratings to these levels. Problem is that when house prices drop and defaults skyrocket, well AAA rated securities go bunk and AAA rated securities aren’t supposed to do that. This played a large role in the financial crisis.

            Who is to blame for the financial crisis? You, me, and everybody. Homeowners bought beyond their means, mortgage officers gave bad loans, banks hid information from investors, government forced the American dream, rating agencies worked for money and not correctness, people lost foresight, and everybody but Goldman-Sachs hurt because of it. Greed was the underlying principle which cause this eye opener.

Money, Banking, and Business

            Manec 453 was a macroeconomic class. It is interesting that while we would talk for a half hour about local restaurants and the Marriott School dean search, I actually still found it to be my most useful class.

            Our first group assignment required us to gather historical data on the consumer price index (CPI), stock market, unemployment, inflation, money supply, and compare these to GDP. We ran regressions and found which factors had a strong correlation to GDP changes. Using p-values below .05 and t-stats over 2 as our test of significance we found that money supply two quarters previous had a strong positive effect on GDP change in the current quarter. We also found that inflation four quarters previous had strong negative effects on GDP this quarter.

            We also gathered CDS premium spread data and compared seven different countries on the changes to these spreads. We matched information releases with large changes in CDS premiums. The 2012 Euro Crisis happenings caused interested things to happen across the world and actions taken on by the European Central Bank (ECB) did a good job of stabilizing these prices.

            I was introduced to quantitative easing. QE is the federal reserve’s using of unconventional means to control money supply and interest rates. Because the federal funds rate is below the deposit rate the Fed is having a hard time keeping the interest rate down solely using normal means of control. Normal policy tools to reach their target federal funds rate includes adjusting discount rates, reserve requirements, and through open market operations. QE-3 is a reference to the latest batch of MBS purchases which the Fed made. Banks are still hesitant to use their influx of money to lend and thus it has been fairly ineffective.

            We had a mock FOMC meeting and I now understand the federal reserves structure a little better. There are twelve regional reserve banks which have input onto who is on the board of governors and FOMC committee. The FOMC meets to determine its target lean for inflation or for growth and its target federal funds rate. The reserve in New York is the most powerful and is where the discount window is open for trading. The Fed is the bankers bank and the governments bank and sets reserve requirements which therefore effect the lending which big banks do to each other in order to keep their reserves in line.

            I enjoyed our daily requirement to read the Wall Street Journal. My understanding of articles is up to 68% which is over a 100% increase from the previous all-time high of 31% comprehension. All indications are that by December when I graduate I will be comprehending at a 93% rate.

            We executed carriage trades which essentially involve a trader obtaining a countries depreciated currency, investing in its high interest rate and also getting gains from its appreciation relative to another country. In the end you exchange back into a certain currency having made gains both off of interest differences but also the change in the exchange rate.

            We debated whether over the counter (OTC) derivatives should be regulated more and moved onto exchanges. We were assigned the side which proposed moving to exchanges and though it wasn’t our true position we defended it well and mopped the floor with our unprepared opponent. Our argument centered around OTC derivatives effect on the financial crisis including the ability of dealers to enlarge counter-party risk and the volatility of the industry.

            Our final will include determining the effect of the money multiplier. This is an interesting concept which illustrates that one dollar lent out by the Fed will eventually trickle down to the creation of many dollars because banks will lend. This is how the Fed affects the money supply in our nation.

            This class will someday be called Financial Economics and joyously the finance students had to do extra work over fellow classmates. We were required to complete weekly excel modules and though I appear to gripe now, they actually were fairly useful and exciting to complete. The particular ones I enjoyed learning were efficient frontier, discounted cash flows, residual income, and Monte Carlo analysis. We learned cool hot keys, how to extract data from FRED and other sites, interesting formulas like RCH get element, and how to “give it a little formatting”.