Trading At The Speed Of Light

What do the speed of light and stock trading have to do with each other? Actually, quite a lot. On September 18th, the Federal Reserve made an announcement that it would not scale back its support of the economy, an unexpected announcement. This type of news should move the market as a whole, and indeed it did. Looking at the chart below, taken from Yahoo! Finance, what time do you think the announcement was made public?

If you guessed 2 PM, you are correct. This chart shows that the announcement was a systematic event since the entire stock market moved, as well as the efficiency of the market in rapidly reflecting the new information.

However, several large trades made in Chicago are now under investigation. As you can read in the article, the Federal Reserve went to great lengths to ensure that the information was released to the market at exactly 2PM. Even with the Fed's safeguards, over $600 million dollars worth of assets traded in Chicago, all within 3 milliseconds after 2PM. Unfortunately, because of the physics related to the sped of light, it would have taken 7 milliseconds for the news to reach Chicago. In this case, it appears that someone in Chicago received the information early.

Rising Interest Rates Good For Ford?

People generally believe that rising interest rates are bad for corporations. After all, an increase in interest rates results in higher borrowing costs. However, Ford recently stated that an increase in interest rates may actually benefit the company. The reason has to do with Ford's pension liabilities. In order to calculate the present value of future pension benefits, a company must discount the future cash flows. As you know by now, a higher interest rate results in a lower present value. Since the discount rate used to calculate the present value of pension liabilities is based on a market rate, rising interest rates will result in a lower present value for these liabilities. When examining how any factor will affect a corporation, it is important to examine all of the side effects, not just one particular effect. Of course, one effect not mentioned in the article is that higher interest rates may negatively affect consumers willingness to borrow, reducing auto sales in general.

A Long-Term View On Interest Rates

In the textbook, we show a chart of long-term interest rates. For a slightly longer view of interest rates, Louise Yamada shows interest rates back to 1790. A difference in the textbook figure and the figure provided by Yamada is that the interest rates in the textbook, taken from Jeremy Seigel's Stocks for the Long Run, is that Seigel uses government bonds while Yamada uses corporate bonds. What may also be of interest to you is that Yamada discusses interest rates in terms of a technical analyst. She notes that interest rates have peaks and bottoms, bases, and states that a reversal is in order.

The Equity Risk Premium In Emerging Markets

Back for his second appearance as our guest blogger is Dr. Aswath Damodaran from the Stern School at NYU. Dr. Damodaran is a noted expert on valuation and publishes his own blog, Musings on Markets.  Here, he discusses the equity risk premium in emerging markets, a shortened version of his more detailed post. If you are interested in more on the U.S equity, check out Dr. Damodaran’s updated article on the U.S. equity risk premium.

As you have figured out from the textbook, estimating the U.S equity risk premium (ERP) is not a simple task. Things get even more complicated when we are attempting to estimate the ERP in emerging markets. In a recent discussion, Dr. Damodaran examines the factors that affect the ERP in emerging markets. The first factor is the sovereign credit rating and credit default spreads. A country with a higher probability of default on sovereign debt is more risky, and therefore would have a higher ERP as financial instability in the government would extend to the private market as well. Next is the country risk score, which measures economic, political, and legal risks in the country. Finally, the volatility of the individual country’s equity market as measured by standard deviation impacts the ERP. Using this method, Guinea, Sudan, Somolia, and Zimbabwe share the highest ERP, at 22.25 percent. In contrast, the ERP for the U.S is 5.75 percent.   

Acquisition Divestiture

In an acquisition, it is not uncommon for the acquiring firm to buy more than it is willing to acquire, either because the acquirer does not want all of the target assets, or regulators force the combined company to sell off part of its assets. Glencore announced that it was selling Dakota Growers Pasta Company (DGPC) for $370 million. Glencore had acquired DPGC in December 2012 when it purchased Viterra for $6.1 billion. Since the acquisition, Glencore has sold off several Viterra assets including some Viterra farm retail outlets, and parts of Viterra to Agrium Inc., and Richardson International Ltd. If an acquisition includes plans for the partial divestiture of target firm, be sure to include those cash flows in your analysis.

Lehman Bankruptcy Costs Rise

If Lehman Brothers hadn't already filed for bankruptcy in 2008, the company's bankruptcy costs may have forced the company to file for bankruptcy anyway. Five years after the bankruptcy filing, the costs of the Lehman bankruptcy have risen to $2.2 billion, almost three times as large as the next most expensive bankruptcy, which was Enron at $793 million. Consulting firm Alvarez & Marshall has billed $657 million in the bankruptcy, and law firm Weil, Gotschal & Manges has billed $484 million. Given that there is still about $32 billion to distribute to creditors, the cost of Lehman's bankruptcy is still rising.

Twitter Tweets IPO

Twitter tweeted that the company had filed its S-1 registration documents with the SEC, the first public step toward an IPO. Twitter's filing is somewhat unique in that it is confidential. Under the JOBS Act, an "emerging growth company" can file a confidential S-1 if revenues are less than $1 billion. The S-1 does not have to be released publicly until 21 days prior to the IPO. Private sales of Twitter stock lead to a valuation of about $10 billion on the company.