Articles Flashcards
Two Pillars of Asset Pricing (Fama)
What is “bubble”?
“Bubble” - an irrational strong price increase that implies a predictable strong decline.
From Efficient Markets Theory to Behavioral Finance (Shiller)
What does in mean that markets are “micro efficient but macro inefficient”?
Across firms there is predictable future path of their dividends and other movements (correspond to EMH) but in aggregate these movements are hardly predictable due to excess noise.
Hedge Funds: Past, Present, and Future (Stulz)
Name 4 popular hedge fund strategies.
- Long-short equity (identifying over-/undervalued stocks)
- Event-driven (significant transactional events such as mergers, bankruptcies etc.)
- Macro (mispriced valuations in stock markets, interest rates etc.)
- Fixed –income (arbitrage in fixed income markets)
HOW DEBT MARKETS HAVE MALFUNCTIONED IN THE CRISIS
Why do haircuts rise in crisis?
Due to lower liquidity
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Functions of CDS
allow to sell debt short
Supposed to make markets more efficient
Provide information
Agency problems at Dual- Class companies
Major economic advantages of dual- class shares?
- Allows a company to grow (selling CF rights, while keeping voting rights), founders or owners of the company can retain control, thus, influence the development of the company;
- Prices of CF shares are lower è You can receive some benefits,
- In case you are not interested in the control, but just the cashflows from company’s operations;
Survey of corporate governance
The most common manifestations of agency costs:
- Managers resist takeovers (from the target’s perspective) to protect PBoC rather than defend the interest of shareholders;
- Managers overinvest rather than return money to investors (potentially in NPV
- When an executive (bad one) dies, then share price goes up (largest for greedy corporations);
- Privatizing at a huge premium (Russia);
The market reaction to cross-listings: Does the destination market matter?
Advantages of Cross-listing
liquidity (leads to lower cost of capital) market segmentation (overcomes international barriers; matters most for emerging markets) information disclosure (requirements, more attention from media and analysts) investor protection (legislation)
The Political Economy of Finance
Interventions in financial markets happen when…
How?
WHEN?
- There is a crisis
- Pressure or political interests of the intervening party
HOW?
- Case by case basis
- Policy level
U.S. Equity return premium (De Longe, Magin)
What is “equity premium puzzle”?
The gains from equity are significantly higher, yet investment in stocks remains disproportionally low.
Two Pillars of Asset Pricing (Fama)
What is Joint hypothesis problem?
We need to know WHAT the market is supposed to do to know whether it does it. If the test fail you can’t tell which of the part failed – asset pricing model or assumptions.
Two Pillars of Asset Pricing (Fama)
Why “bubbles” are based only on beliefs and have no evidence?
- Large swings in stock prices predict real economic activity
- ”Price corrections” of bubbles usually wiped out soon after
The Law of One Price in Financial Markets (Lamont, Thaler)
Name 2 main arguments why LOOP is violated.
- Behavioural biases
- Arbitrage isn’t perfect
Forensic Finance (Ritter)
How academia can help regulators and law officials?
- Attracting attention
- Looking at long-run trends
Forensic Finance (Ritter)
What has Sarbanes–Oxley Act changed?
Sarbanes–Oxley Act requires executives to report insider trades (including receipt of stock grants) within two days of the transaction (instead of 10th day of the following month).
Hedge Funds: Past, Present, and Future (Stulz)
What is the future of hedge funds?
- Worse performance (more of them)
- More instutionalized (institutional investors need more info)
- More regulated
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Problems with CDS
no need for monitoring
perverse incentives (drive into bankruptcy)
Survey of corporate governance
Drawbacks of being a large investor?
- Bear extensive risk due to lack of diversification
- Advocate own interests sometimes at expense of other investors
- Detrimental to efficiency
- Too soft
- Own agency problems
- Want to exit (failed to terminate their position)
The politics of Financial Development: Evidence from Trade liberalization
What is political economy?
- Looks at power balances that impact the allocation of social and economic resources (instead of looking GDP, other macro variables, we look at the power, who possess it, where, when, etc. )
HOW DEBT MARKETS HAVE MALFUNCTIONED IN THE CRISIS
Three areas crucial in all debt market decisions:
risk capital and risk aversion
repo financing and haircuts
counterparty risk
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
CDS (def)
insurance against default of a company
Survey of corporate governance
Various forms of expropriation:
stealing
transfer pricing (trade with manager’s affiliates)
private benefits of control (PBoC)
entrenchment
The Political Economy of Finance
2 goals of privatization?
- Raise revenue
- promote competition and economic reform
Private benefits of control: An International Comparison
How can we measure PBoC?
Two ways:
- Control Premium approach (looking at the private negotiations where controlling blocks are sold, typically, for a premium, the question is, what premium do they sell at?);
- Voting rights approach (dual class shares and voting shares trade at a premium that includes probability of a control contest premium for control);
Leveraged buyouts and private equity
What is special about Private Equity from financial perspective?
Mgmt. incentives (give stock, make mrg invest) – equity illiquid, has to perform
Leverage – pressure not to waste money (reduces AC), increases value through TS, but can’t be too high
Agency problems at Dual- Class companies
What are the ways to allianate (expropriate) outside investors?
- Increase compensation
- Acquisition
- Invest in negative NPV projects (not favorable by all shareholders)
Capital Asset Pricing Model (Perold)
Is expected return influenced by internal company characteristics? (e.g. CFs)
E(r) is not characterized by internal company characteristics
Agency problems at Dual- Class companies
4 channels of how the difference between Cash Flow rights and insiders control rights lead to lower shareholder’s value?
In other words, how managers of the company can decrease shareholder’s value?
- Engage in value destroying activities;
- Demand excessive remuneration;
- Misuse corporate cash reserves;
- Make poor capital decisions;
Coase Versus Coasians
What is coase theory about?
What is coasians theory about?
- Coase- when there is a well defined property rights, transaction costs are zero, there are no taxes ==> you don’t need any intervention from the government. Rather market participants will organize their transactions in ways that achieve efficient outcomes
- most securities transactions involve private arrangements to achieve efficiency, need contracts. Effective and complicated contracts need effective judicial enforcement. (main assumption: judges must be able and willing to read complex contracts!!!!)
U.S. Equity return premium (De Longe, Magin)
Why equity premium is predicted to decline in the future?
- Institutional changes:
- removed constrains on investing in equities
- easier to invest
- rise of mutual funds (easier to achieve diversification benefits)
- More long-term oriented market participants
From Efficient Markets Theory to Behavioral Finance (Shiller)
What is meant under “Biased self-attribution”?
Individuals attribute events that confirm the validity of their actions to their own high ability and attribute events that disconfirm their actions to bad luck or sabotage.
Corporate ownership around the world
What are the proposed solutions for the problem of ownership concentration?
- Radically improve laws (make expropriation more difficult);
- Improve disclosure requirements;
- Change in structure of board of directors;
- Mandatory requirement- one share –one vote;
From Efficient Markets Theory to Behavioral Finance (Shiller)
Name 4 reasons why mispricing can’t always be corrected (EMH argument)?
- Rational expectations bubbles (still make sense to invest in overvalued stock because you know that stupid people will still invest and price will continue to grow)
- Noise trader risk (if I short it right now there is a risk that irrational investors will continue to increase the price)
- Switching between asset classes (other style classes still give rational investors decent returns and there is not so big incentive to correct the mispricing)
- Limits to short selling (some markets are super restrictive, expensive and have other barriers)
Forensic Finance (Ritter)
What is meant by “Spinning of IPO’s”? Why bookrunners and executives do it?
Under-priced IPOs were allocated to top executives of corporations. Typically initial offer price is less than 1st day’s closing price.
Why do book runners do it? - “Soft dollars” from commission payments.
Why do executives do it? - Agency problems + bribing
Capital structure
pecking order theory (Description)
internal CF->borrow->equity (assumes perfect markets, but investors don’t know the true value of their assets)
issue of stock only if overvalued (if undervalued – wealth goes from existing to new s/h) -> no issue when undervalued, because issue drives down prices
debt – not so big info asymmetry – price falls by less
internal financing – no loss in value
explains why profitable firms borrow less
From Efficient Markets Theory to Behavioral Finance (Shiller)
What is “macro inefficient”?
Macro inefficient – there’s excess volatility in the stock market and this holds even when we account for:
- Dividend smoothing
- Time varying discount rates
The Corporate Governance Role of Media: Evidence from Russia
What affects the decision to commit a corporate governance violation?
A manager’s expectation of the likelihood the relevant players will learn about his decision and in such an event how harshly his decision will be judged. After the decision has been made, however, what determines the probability with which this decision is reversed is the actual realization of those costs, which is greatly affected by the coverage in the media.
Capital structure
M&M Theory (Describe)
financing doesn’t matter, if perfect and frictionless capital markets; Cost of capital constant
Taxes – tax shields, but depend also on individual taxes of investors
CREDIT DEFAULT SWAPS AND THE CREDIT CRISIS
Disadvantages of OTC
Disorganized clearing process
Tailoring
Unknown counterparties (exposure) – don’t know who bought/sold
Leveraged buyouts and private equity
Describe all steps in a process of leverage buyout
buy a firm with premium above stock price
financed with debt (60-90%)
new mgmt. team, that also contributes to equity
take company private
improve performance
sell after 6-7 years to
strategic buyer
another PEF in SEO
IPO
Survey of corporate governance
The essence of agency problem?
separation of ownership and control
- financiers need manager’s human capital to generate returns
- manager needs financiers’ funds as he doesn’t have enough or wants to stay away
THE ECONOMICS OF STRUCTURED FINANCE
Problems with vulnerability of investors’ position
Overlap in geographical location => high default correlation and systematic risk
Deteriorating credit quality of the borrowers + “fire-sales”
CDO2 magnified effects the errors
Rank Honda Dio ZX.
Capital Asset Pricing Model (Perold)
Why does sub-optimal diversification still exist?
- Irrational investors
- Behavioural biases
- Transaction costs
Two Pillars of Asset Pricing (Fama)
What is the main issue for EMH and all asset pricing models?
MOMENTUM!
Overvalued equity and financing decisions
Arguments for rising more capital when overvalued:
Market inefficiency => exploit investors and market errors
Catering investors’ expectations- Pressure to prove that indeed there are growth perspectives
Project scale economies - Invest in large-scale projects
Investor short-termism - Overvalued equity financing is more attractive
Forensic Finance (Ritter)
Are mutual funds harmed by late trading (lower returns)?
No, because they get something in return (e.g. hedge funds investing in mutual funds with high fees)
Capital Asset Pricing Model (Perold)
How risks and expected returns are combined in CAPM?
Risks are combined nonlinearly (diversification effect) while expected returns are combined linearly (weighted average)
Survey of corporate governance
Why do investors, being informed about agency costs, etc. still rely on managers?
- Firms and managers have reputations to secure external financing;
- Investors are naive and overoptimistic (ponzi scheme, railroad);
The politics of Financial Development: Evidence from Trade liberalization
Determinants of financial development:
- Political economy
- Legal origins
- Legacy of colonization
- Culture and religions
- Social capital endowments
The Law of One Price in Financial Markets (Lamont, Thaler)
Name 3 assumptions of Law of One Price. Are they realistic?
- Transactions are costless (unrealistic)
- Competitive markets
- No barriers of trade (unrealistic)
Overvalued equity and financing decisions
Effect from High equity share in new issues
low aggregate stock returns
Agency problems at Dual- Class companies
When the CEO’s compensation is higher?
- Firm size is large;
- Leverage is lower;
- Volatility (risk) is greater;
Capital Asset Pricing Model (Perold)
CAMP empirical performance is weak, evidence show it doesn’t work, but why still used?
- Useful benchmark
- Predictor in low friction markets
- Easy-to-use
- Does give us a viable prediction about what we are moving towards to – PCM
Agency problems at Dual- Class Companies
Two classes of stocks in Dual- class companies?
- Superior- multiple votes per share, usually not publicly traded;
- Inferior- one vote per share and is publicly trade;
Should We Fear Derivatives? (Stulz)
Name 5 risks associated with derivatives
- Hard to understand & value (exotics are complicated)
- Liquidity of derivative markets (some exotic derivatives are illiquid)
- Transparency & reliability of accounting (you can hide some things away with derivatives – they are not reported)
- Perverse incentives (not punished for loses but rewarded for gains)
- Systematic risk (derivatives are very effective but if you lose you lose a lot, and whole market can lose)
Credit default swaps and the credit crisis
List benefits of CDS
Risk is borne by those who can do it
Obtain financing that otherwise is not available
Better credit risk information
Market efficiency and transparency
“Naked position”
Corporate payout policy
Benefits of own Stock Repurchases
Flexibility (can’t reduce dividends, can do only 1 repurchase)
correct stock valuation (repurchase before appreciation, procyclical, not just to exploit investors – nobody would sell)
remove low valuation stockholders (avoid takeovers)
allocation of voting rights (remove threatening blockholders, increase mgmt. ownership, remove LV investors)
increase EPS (just less shares, repurchases associated with productivity growth)
stock option plans – option values decline due to dividends, but not repurchases
transaction costs saving (less s/h)
Private benefits of control: An International Comparison
What PBoC dependent on?
- firm characteristics- size&maturity (more products you sell, the more you extract benefits)
- Whether controlling block is traded (whether one can buy a control)
- Bargaining power of involved parties
Fiduciary duties and equity-debtholder conflicts
Case of Delaware:
In 1991, Delaware Court issued a ruling, under which: if a firm is in the zone of insolvency (financial distress), directors owe duties not only to shareholders(s/h), but also to debtholders (d/h).
