Greed 1.0

Introduction to the Greed Series

     I am going to be exploring the concept of greed by writing a series of blogs and getting feedback from those of you reading as well as from the people around me. Through my recent readings of finance, economics, and the news I have begun to question whether greed is good or bad. Since I am pursuing Financial Engineering and have read many news articles about how bad and greedy Financial Engineers are, I have started to question the society we live in. So please feel free to read the first paper below and give your feedback.

This photo is courtesy of InvestingCaffeine.com

Greed - 1.0

     The word greed has a negative connotation. First we must define greed so that we can discuss the concept of greed. According to Merriam-Webster online dictionary, greed is “a selfish and excessive desire for more of something (as money) than is needed.” That definition is basic and easy to understand at first but the question then becomes what is needed? Is needed food and shelter? Or is it more than that? Is love needed? The question of needs can become controversial and we will therefore assume that it is food and shelter so that we can continue on our exploration of greed. Greed dates back to the biblical times and is condoned by Christians and many other religions as a sin. The question I would like to explore is why is greed bad? Can we all be greedy and be happy? Or is greed bad for a society?

What is Financial Engineering?

A financial engineer is someone who uses computer programming, finance, and mathematics to analyze financial assets. Many financial engineers specialize in specific areas of finance such as trading, risk management, asset management, and corporate finance. Some popular positions are algorithmic trader, derivatives trader, strategist, finance software engineer, proprietary trader, hedge fund managers, and risk manager. Risk management is a very broad area which could be a job for an investment bank, hedge fund, or any financial or corporate institutions who is looking to manage their risk in financial assets.

Financial engineering is relatively new and the father of financial engineering is Fischer Black. There are about 22 master programs in North America and data about these programs and rankings can be found on QuantNet.com. The field has been controversial in the news lately since most derivatives are created or transacted by financial engineers.

For anyone who is interested in learning more about the field I would recommend reading two books. The most influential book I have ever read is a book about Fischer Black called Fischer Black and the Revolutionary Idea of Finance. Fischer Black based his life on the CAPM model and the pursuit for knowledge. Financial engineering is all about creating new models and theories which can be seen in Fischer Black's life. If you are considering financial engineering and don’t eat, sleep, and dream about finance I would not recommend pursuing it. The average salary is fairly high and the growth potential is good but only for those who are dedicated.

The second book is My Life as a Quant by Emanuel Derman. The book is about Emanuel Derman’s life and how he became a quant. He like many financial engineers that helped start the field were from quantitative fields such as physics. He now teaches at Columbia University and has contributed to the field in many ways as a professor and practitioner.

The road to becoming a financial engineer is long and hard. A master is a minimum requirement for quant positions at investment banks and other financial institutions. The programs are getting more competitive every year as students from around the world are competing to become financial engineers. There are also more programs being created to meet the high demand for financial engineers but be wary since where you go matters just as much as what you know and who you know.

Please feel free to leave comments or ask questions.

Dimitri Bianco Update

Below is a copy of the letter that has been sent out to my close contacts about what I am doing in regards to Financial Engineering.

Everyone,

            As many of you know after graduating from WSU I have been pursuing a career as a trader on Wall Street. I applied to over 170 jobs and have networked with many people. I learned from many rejections as well as advice from network contacts that I needed more education in financial engineering as Wall Street shifts toward quantitative analysis. I applied to seven schools and have been accepted to the Claremont Graduate University and the University of Michigan. I will be accepting the offer from the University of Michigan and will be starting school July 2^nd.

            I would like to give a special thanks to those that wrote recommendation letters; Steve Matthews (family friend and corporate lawyer at PRS), Dr. Donna Paul (my corporate finance professor at WSU), and Dr. Gene Lai (my financial modeling professor at WSU). I would also like to thank Ron Vodika for changing the way I look at life and gaining a desired career; Nathan Soper for giving advice, a job interview, and helping me to create a great resume; Emanuel Derman’s book My Life As A Quant which has motivated me by his life as an example; Fischer Black’s life and ideas as portrayed in the book Fischer Black and the Revolutionary Idea of Finance which has been the most influential source on my outlook of life and education; my parents for a place to stay, a job, and for being my parents; my many networking contacts that have made impressions on me; and last the most important, my wife Arielle for supporting me and motivating me when times looked grim. 

Again thank you to everyone for helping me get to where I am in my journey. I will send out major updates as I progress.

For updates, my thoughts, and research please visit my blog biancomarketresearch.blogspot.com

Sincerely,

Dimitri Bianco

Arielle and myself at WSU.
Special thanks to Matt Holmes for the taking the picture.

Arielle and I are very excited to move to Ann Arbor, Michigan!

Irrational Financial Advisors

     An interesting approach that I have never thought about is the CAPM (capital asset pricing model) with a lifetime of investing. Typical financial advisors will tell you to load up on risk when you are young and then ease off of it as you get older. One might think this makes sense but it is a mirage. The concept that when you are young you expect to have more time and could make up a loss if one was taken. The question is why you would take that risk if no additional return is granted. According to the CAPM which is widely accepted, diversification of risky assets reduces unsystematic risk (the risk which an individual stock contains that can be diversified away. In contrast is systematic risk which is also called market risk and cannot be diversified away). So why should an investor stock up on risky assets such as stocks at a young age and bear more risk than is preferred? It would make more sense to develop a well balanced portfolio of stocks and bonds and hold a portfolio that matches ones risk preferences. An individual’s risk preferences might change over one's life but betting that markets will be positive long enough for you to recoup your losses is irrational. Investors, especially average people should not take bets that they do not understand. A market can crash at anytime and as Maynard Keynes once said, "Markets can remain irrational longer than you can remain solvent." Don't be fooled by high end investment banks.

Fischer Black

The inspiration for this article is based on the thoughts of Fischer Black. For those of you who don't know who Fischer is, he is the father of financial engineering and one of the brightest minds the world will see. He was many generations ahead of his time in the thoughts he produced. He is still very controversial due to his forward thinking. He is also the only person I know that believes as I do in a general equilibrium. I hope that this article makes you think twice about your investing practices.

Economic Thought

As Adam Smith states specialization is key to increasing productivity. The real question is how far should this idea be taken? As globalization increases and economies continue to grow larger and larger should specialization be divided by country, state, city, or corporation?

My thoughts on this topic are as clear as most economics. I feel as globalization occurs and economies continue to grow the spectrum of specialization should continue to narrow. If one was able to graph this idea it would look like a concave function. As civilization began and many people never traveled outside of their village I can see the idea of corporations or families trading or individuals within families trading due to specialization. As economies grew and globalization started to progress countries could benefit from trading those goods that they were good at. Many factors could dictate which goods or services a country was efficient at but the main factors being raw materials and available labor. Now as globalization continues and the movement of goods becomes cheaper and more efficient, specialization at the corporate level seems to be more efficient than other spectrums. I am not stating that only one spectrum is present but the most efficient form of specialization seems to occur more at the present time and in the future with corporate specialization.

This theory seems accurate to me but is my graph right or is it different? Maybe it cycles.

Is Wall Street Trading Illegal?

A recent article the Financial Times (http://www.ft.com/cms/s/0/2924dd32-9c2e-11e0-acbc-00144feabdc0.html#axzz1Px5XUpW8) is about JP Morgan being sued for misleading investors. The SEC claims that that JP Morgan along with other financial institutions sold CDOs (Collateralized Debt Obligations) to clients but were misleading their clients. Also mentioned in the article was the case where Goldman Sachs was sued by the SEC for basically the same thing but Goldman’s case was based on mortgaged backed securities. Goldman Sachs won the lawsuit but had to pay a bunch of money in the end (http://www.marketwatch.com/story/goldman-sachs-beats-the-sec-2010-07-15 ).

Now the real question is whether or not financial institutions were wrong. CDOs and CMOs (Collateral Mortgage Obligations) are basically large pools of either debt or mortgages that are broken into tranches. The first tranche will receive payments first and once the first tranche is paid off then the second tranche will receive payments until they are paid off. As you can see the first tranche has the least risk and therefore is more expensive than the last tranches which are the riskiest but are also cheaper. With expensive versus cheap realize that the more risk you take (more risk equals cheaper) the higher the expected returns. Regardless of what information was given you can see that CDOs and CMOs are risky assets compared to standard stocks and bonds. Whether the information was accurate comes down to valuation methods which I think are irrelevant because the types of investors that bought these CDOs and CMOs are other financial institutions who should understand that CDOs and CMOs have higher amounts of risk and therefore have higher returns that other forms of debt such as bonds. Something else to consider is that the institutional investors make up about 95% of the market where individual investors make up the remaining 5%. Do you really think that institutional investors who have bought CDOs and CMOs don’t understand what they are? If they don’t understand the general risk they shouldn’t be purchasing the assets.

At the end of the day companies like JP Morgan and Goldman Sachs are in the right. They are buying and selling assets just like they should be. No financial institution should be sued for taking a bet against risky assets regardless if their clients bought them or someone else’s clients bought them. Many people view Wall Street as a bad place where people make bets and in reality anyone who makes an investment is making a bet. Wall Street is a place for economic growth and any company is subject to risk whether it is a start up or a 100 year old company. The idea that investors who lost money are trying to sue the other investor who sold it is outrageous.

In conclusion new regulations such as the Dodd Frank Bill and frivolous lawsuits are hurting the US economy by restricting free markets because investors are taking on risk, losing money, and then complaining that they didn’t win. For every investment there is a winner and a loser. If people feel that the markets are too risky and not regulated enough I suggest you stick with fixed income assets such as bonds or CDs. Wall Street should be allowed to take on risk and let the free markets determine who survives.

Is Gold an Irrational Exuberance?

Gold prices continue to rise due to bad economic news globally. In May gold reached a record of $1,518.10 an ounce. Is gold going to continue to rise and is it overvalued? Gold is not an investment but a tool for speculation and wealth storage. As investors have been weary of the equity markets and with the expectation that debt market rates will increase investors are moving their money to gold and silver.

            Gold is overvalued due to the global economic crises. To start, Greece is bankrupt and talk of a second bailout package seems very likely but European officials are saying it is not certain that this second package will happen. Even if the second package is granted, it is far from certain that Greece’s economy will recover. Along with the Greece crisis the US economy is growing slow and equity markets have been declining since April 29^th. The slow growth has also been affecting China’s growth since China sells a large amount of the goods they produce to the US.

            Gold might have a high price now but investors are weary that as global markets improve gold prices will drop. One sign that also points to gold being overvalued is that silver’s price has not been increasing as fast as gold. Silver is similar in that it can be used for speculation and wealth storage but it has not been increasing drastically like gold has. Gold has been increasing due to investors looking for a quick gain and the more gold prices have increased the more investors desire to invest as prices continue to increase. Investors that are now buying gold are either taking great risk in speculation or are poor investors since they will be buying high and selling low.

            Gold may continue to rise and as markets worsen but markets will get better as investors start to forget the past credit crisis and as other global crises cool down. From the evidence presented earlier in this post gold is clearly overvalued. Due to such an overvalue gold is clearly an irrational exuberance.