Financelab Magazine 8

MAGAZINE 8 - ISSUE SEPTEMBER 2013

Testing investing

to the extreme

The real Iron Man He’s testing human limits from his multi million labs - financed with his own money. Get a glance of the real Iron Man. Page 32

Rise of the machines An introduction to algorithms and high frequency trading Page 18

The Power Trader Page 27

INVESTMENT BANKING: 2013 rebound in the M&A markets?

Page 10

The biggest IPO’s 2013 Page 13

Private Equity Takeovers

Page 16

www.financelab.dk

mind

+

machine

+

money

=

magic

ELLIS Analyst, Operations Foodie/Photographer

WE CAN’T WAIT TO SEE YOUR OTHER SIDE. You aren’t defined solely by your degree.

Your experiences, talents and passions have all shaped who you are. So we’re interested in that other side of you as well. Because the life you’ve lived doesn’t just make you the kind of employee we want. It makes you the kind of person we want.

YOUR DEGREE ONLY SHOWS ONE SIDE OF YOU.

At J.P. Morgan, your personal pursuits will be a welcome complement to your professional development. And that means you’ll have more mobility, more choices and more ways to contribute than you might have ever imagined.

Visit our website to find out more.

We want what you’re made of.

jpmorgan.com/careers J.P. Morgan is a marketing name for JPMorgan Chase & Co. and its subsidiaries worldwide. © 2013-2014 JPMorgan Chase & Co. All rights reserved. J.P. Morgan is an equal opportunities employer.

FINANCELAB MAGAZINE

CONTENTS EDITOR’S LETTER

1 6

Editors note

Bonus caps in the financial industry - effects & consequences

8

M&A Snapshot 2013

10

Will 2013 be a good year for mergers and acquisitions

The Biggest IPO’s 2013

13

16

Private Equity Takeovers

THEME: Mind, Money and Machine

18 27

Algorithms and high frequency trading

5 reasons why I started trading the powers of nature

32

39 43 47

Elon Musk - testing investing to the extreme

FINANCELAB • ISSUE SEPTEMBER 2013

FED policy - what will happen to QE3 and the markets?

04

Eurozone Economy - where is it going?

The Effect of BoJ’s monetary policy on western markets

52

EVENT CALENDAR

Mind, Money & Machine Elon Musk - meet the multi inventor and investor

32

Mind Money & Machine Explore the magic of algo trading

18

Ready for the new FED policy?

39

Meet the Power Trader

“5 reasons why I started trading the forces of nature”

27

WHO IS FINANCELAB?

Editors note

The Investment Panel publishes research on our newly redesigned website, www.financelab.dk. The partnership with Nordnet, which started in February, entails that we now have 150,000 DKK in AUM and are able to publish on a regular basis. The articles are also distributed through their website to more than 375,000 readers across Scandinavia.

Nordnet is just one of the partnerships we are very proud of. Our focus on expanding our partnerships has resulted in a partnership portfolio consisting of some of the major national and international players in the financial in-

Contributors

dustry. By assisting in recruitment and branding efforts we are able to host tailored events to the benefit of both partners and members.

Our most popular and prestigious events are the Study Trip, Investment Camp, and Investment Camp Aarhus.

The 20 students we send to London in September have been hand picked by partners in the City, and likewise will the participants in both Investment Camps be chosen on the basis of CV. We strongly encourage readers to apply.

The fall is sprinkled with events in both Copenhagen and Aarhus. We continue to support members’ education with supplementary courses ranging from Trading to M&A modelling. Throughout the semester we have guest speakers from across the industry where we cover both theory and practice. This allows members to get a foot in the door of the company of their dreams.

Helping members bridge the gap between life as a student and a having

career in finance is the fuel that drives FinanceLab. There is plenty of reason to be bullish on the financial industry. Not only have the financial markets performed well over the spring and summer, but also there seems to be a stabilisation of the European credit debacle. However the future of Mr. Bernanke’s money printing still bring some uncertainty to global markets. The biggest worry is now less about risk and more about how to achieve an acceptable rate of return on all the extra cash.

In this issue of the magazine we will explore how technology is changing the industry through algorithmic trading, and how the large cash piles on corporate balance sheets are a driver for M&A. Furthermore we look at the global macro development through the lens of central banking in EU, USA and Japan.

Welcome to the recruitment season 2013/2014.

Thanks to

Maria Rosenstand Anders Brejner Abel Chernet Daniel Bertelsen Anne Karina Asbjørn Jonas Bovbjerg Mathias Schulte Matzen Amalie Christine Harsting

Joakim Lindboe Brüchmann Frederik Slot Petersen Christian Hendriksen Rasmus Viuf Bang David Hauge Philip Aarhus Martin Stavnsbjerg Jakob Lindegaard

Layout

Editors

Frederik Ploug Søgaard

Ole Bjørn Kolbæk

Thomas Jacobsen Steffen Tjerrild Marc Solberg Mads Villemoes Povlsen Christian Kolding Frederik Ploug Søgaard

Rasmus Daugaard Bentzen

FINANCELAB • ISSUE SEPTEMBER 2013

In this new edition of the magazine we are continuing the tradition of letting the Study Trip attendees write the articles. The research aspect of our organisation is one of the areas that have been growing most in 2013. Furthermore we have been focused on expanding our corporate partnerships and developing a strong pipeline of events.

FinanceLab is a non-profit, voluntary student organisation covering all major universities and colleges in Denmark with 1,300 registered members. We are the prime point of contact between the financial industry and the academic world.

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Bonus caps in the financial industry – effects & consequences

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t appears as if the days of high bonuses within the European financial sector could be coming to an end. In an attempt to prevent bankers from taking excessive risk based on skewed incentives, a cap on bonuses will take affect from January 2014 and onwards.

FINANCELAB • ISSUE SEPTEMBER 2013

The forthcoming regulation implies that an effected individual’s bonus may not exceed his or hers base salary. Under special circumstances, the bonus can be up to 200 percent of the base salary, but this requires a 66 percent majority of shareholders representing a quorum of at least 50 percent of the voting shares. Even if this requirement is met, the ratio of fixed to variable pay will still be lower than today.

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In wake of the financial meltdown of 2008, a number of regulatory reforms have been implemented to prevent excessive risk-taking amongst financial institutions. The logic goes that if the deregulated nature of the financial industry led to irresponsible behavior, then regulatory measurements should foster more responsibility. Now, with the so-called Capital Requirements Directive IV (CRD IV) package being implemented in Europe, policy makers are moving into an area previously untouched.

The European Commission describes the purpose of the CRD IV package as being to “[...] strengthen the resilience of the EU banking sector so it would be better placed to absorb economic shocks while ensuring that banks continue to finance economic activity and growth”. In essence, the package is based on the mindset that more regulation must imply a decrease in systemic risk. The question is, however, if this assumption holds.

Specifically, the cap on bonuses has caused a heated debate in the media.

President of the European Commission, José Manuel Barroso states: “The rules will put an end to the culture of

excessive bonuses, which encouraged risk-taking for short term gains.” and “There is a question of fairness. If taxpayers are being asked to pick up the bill after the financial crisis, banks must also make a contribution.”. In sum, the intention of the cap is to tackle the culture of excessive risk-taking, and to some extent implicitly “penalize” bankers for their role in the financial crisis.

On the other hand, Boris Johnson, the Mayor of London, referred to the bonus caps as “[...] the most deluded measure to come from Europe since the Diocletian tried to fix the price of groceries across the Roman Empire.”

Critics argue that the introduction of bonus caps is part of a political witchhunt against bankers, and that the caps will have unforeseen and even counterproductive consequences.

First, they argue that high salaries simply reflect the market value of the work performed. If high wages result from a global demand for skilled individuals, and European banks are unable to offer the same levels as American- and Asian banks, then the cap on bonuses will leave European banks in a less competitive position. Steven Ward of Deutsche Bank argues that such regulatory measures could lead to an increase in risk, as European banks will not be able to retain, and attract the right quality of employees.

Secondly, they argue that the potential loss of competitiveness will lead to European banks seeking alternative remuneration structures that comply with the new regulation. A number of people within the industry, including Douglas Flint, Chairman of HSBC, have signaled that one solution is to significantly increase base salaries.

This circumvents the intention behind the bonus caps, as a higher base salary will allow for a proportionally higher bonus as well. Moreover, financial institutions have been historically good at finding alternative ways to remu-

nerate their employees. It is therefore foreseeable that various creative solutions can appear in the near future.

If financial institutions decide to increase base salaries, their fixed costs will obviously increase as well. In a fast-paced and volatile industry, higher fixed costs will likely lead to more job losses during recessions. Hence, the increased fixed costs would make the banking sector less able to absorb economic shock, which is the exact opposite of what is officially stated to be the main goal of the CRD IV package. In other words, while the package as a whole is designed to reduce risk, the bonus capping proponent may be detrimental to the overall purpose.

Thus, the underlying assumption that systemic risk is reduced whenever regulation is increased does not necessarily hold. Instead of adding a variety of regulatory measurements to a legislative package, and then assuming that they all fit together, it is crucial to consider the actual consequences of individual components.

This does not mean that the idea of some kind of bonus cap is ineffective by definition, but that the current structure of the legislation seemingly has very little support within the financial industry. By trying to regulate in a forceful and non-negotiable way, banks will actively look for alternative methods, which ultimately can lead to a negative-sum game for all parties involved. It does not make sense to have a dialogue where bankers are constantly framed as irresponsible villains who must be punished for their involvement in the financial meltdown, while trying to actively improve and strengthen the banking sector to prevent any future collapses. Instead, it might be possible to find a compromise which could strengthen the resilience of the EU banking sector, reduce systemic risk, and maintain an efficient European financial center.

Become an active member.

It’s not the money.

It’s the magic.

ANNONCE

07

M&A

2013

The year when Buffett took the biggest bite of the food industry ever

USD 28B

SNATPSHOT

+

Although M&A activity levels are nothing like the heydays from 2005-2007, we have still witnessed a strong recovery since the crisis and billion dollar deals are still happening.

Deal sizes:

USD 16.7B

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EUR 7.7B

+ USD 6,5B

USD 8,7B

+ GBP 15B

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2009

USD 68B

+ 2010

+ +

USD 24,2B

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T

he largest deal this year and the largest buy-out deal ever in the food industry was announced February in 2013 when a consortium consisted of Berkshire Hathaway and 3G Capital entered into a merger agreement with H. J. Heinz Company. The total transaction value of the merger was a whopping USD 28 billion. The acquirers are each to put up USD 4.4 billion in equity and have arranged financing with J.P. Morgan and Wells Fargo. In

February 2013 an offer was made for Dell in what could become one of the largest private equity backed technology buyouts in history. Dell and the private equity firm Silver Lake Partners had signed an agreement to delist Dell to take it private in a USD 24.4 billion transaction. Typically, one key issue in these transactions is management, but in this buyout Michael Dell was already Chairman and CEO of Dell and had his own stake of USD 750 million.

The rationale behind the deal relates to a more effective execution of their corporate strategy in a private setting.

When the deal was announced it received strong opposition from some of the largest shareholders, including Southeastern Asset Management and T. Rowe Price, and the main issue was that the offered price was too low. In March 2013 Blackstone announced its interest in the buyout as well, but later withdrew its bid, arguing that Dell

No more gigantic pharmaceutical M&A? For several years consolidation in the pharmaceutical industry has been the driving factor for some of the largest transactions. Among these transactions is Pfizer’s USD 68 billion acquisition of Wyeth in January 2009.

In 2010 Novartis acquired Alcon, and Sanofi acquired Genzyme Corporation in multibillion-dollar deals. In 2011 there were four pharmaceutical and healthcare related deals above USD 10 billion and in 2012 there was only one, the spin-off of AbbVie from Abbott laboratories. Again this year, the largest pharmaceutical related transaction was a spin-off. So, is this the end of an era of pharmaceutical consolidation with gigantic M&A, or are the big pharmaceutical companies still digesting their huge acquisitions a few years ago, and could now be ready for the next round? This view could be supported by the fact that many of the big pharmaceuticals need to fill out revenue holes from drugs running out of patent and that several of the companies have been piling up cash. In January Bloomberg estimated that the five largest US based pharmaceutical companies had available cash in excess of USD 70 billion.

So far we have seen the USD 13 billion Zoetis spin-off from Pfizer subsequent of the IPO in February. The transaction follows the firm’s 2012 divestment of its baby food division to Nestle and continues the firm’s strategy to focus on core business. The CEO Ian Read commented on the deal to “better position Pfizer to focus on our core business as an innovative biopharmaceutical company.” In May, Valeant Pharmaceuticals and Bausch & Lomb announced that they had entered into a definitive agreement under which Valeant will acquire Bausch & Lomb for USD 8.7 billion. This year Actavis

has been quite in the spotlight quite a bit: first by rejecting a take-over offer from Mylan of USD 15 billion and according to rumors they were in talks with several other interested parties.

Finally, in May Actavis placed itself at the other side of the table announcing the definitive agreement to buy Warner Chilcott for USD 5 billion in stock to expand its branded drug portfolio.

Elan Corporation has also enjoyed a fair share of attention this year. In February the pharmaceutical investor Royalty Pharma offered USD 6.5 billion for Elan Corporation, which was later revised two times to USD 8 billion. The hostile bid was finally withdrawn in June after several defense strategies were pursued by the Elan Corporation management including “poisonous pill” acquisitions, i.e. acquisitions with the same effect as a “poisonous pill” making the company more expensive for the buyer. But these strategies were never engaged as they were defeated by Elan shareholders at a voting required by the Irish take-over panel. Alhough the “poisonous pill” acquisitions were voted down by Elan shareholders, they were still not supportive of the offer and Royalty Pharma withdrew their bid. Instead, by the end of July, Elan Corporation and Perrigo announced they had entered into an agreement of where Perrigo will acquire Elan Corporation for USD 8.6 billion.

eventually abandoned.

The largest telecom related transaction and the second largest transaction overall this year is Liberty Global’s acquisition of Virgin Media, creating the largest European broadband company. The transaction was paid in a combination of cash and stock and valued the acquisition at GBP 15 billion. The second largest telecom deal this year has been Vodafone’s EUR 7.7 billion recommended acquisition of Kabel Deutschland. Another deal, which has been popping up on regulators’ radar, is Telefonica’s announced acquisition of E-Plus from KPN Telecom, which is going to make the combined company the second largest provider in Europe by a number of customers.

One of the biggest deals of 2013 was made in the media industry when v bought out General Electric’s remaining 49 percent stake in NBCUniversal for USD 16.7 billion. Originally, Comcast acquired a 51 percent stake in NBCUniversal back in 2011 when the merger was approved. Due to clashing corporate cultures and other issues, the sales process of the remaining stake was sped up by both parties.

We have seen quite an exciting year with large complex transactions and several bidders. The next question is whether the next big deals will be driven by consolidation in the telecom industry or the pharmaceuticals are ready for a second round.

Is Consolidation in the European telecom industry the next big driver of M&A? Four of the top ten announced European M&A transactions in 2013 so far have been in the telecom industry. The industry has fought for consolidation as the industry has become increasingly competitive, which is reflected in a pressure on margins due to high capital expenditure needs, limited growth and regulatory resistance. However, consolidation has been held back by the European Commission, which is worried about reduced competition.

An example of this was the European commission’s regulatory opposition to the 2011/12 merger of Vodafone with the Greek Wind Hellas which was

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FINANCELAB • ISSUE SEPTEMBER 2013

was deteriorating quicker than initially expected. The activist investor Southeastern Asset Management is pushing for a higher price, and it will be very interesting to see if one of the largest private equity deals in technological industry will ever become a reality.

09

Will 2013 Be a Good Year for Mergers and Acquisitions?

A long-awaited rebound in M&A activity is taking its time to arrive Many had hoped that 2013 would be the year where M&A activity would finally start to intensify. However, with more than half of the year already gone, it seems the markets will have to remain patient for some time to come.

FINANCELAB • ISSUE SEPTEMBER 2013

The year came off to a great start with sev-

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eral mega-deals in early February but despite these few very large transactions, the first half of 2013 was the lowest level of activity since 2009. With deals worth a total of $ 876bn according to the Financial Times, the market was down 9% compared with the same period last year.

Nevertheless, with activity contracting in both Europe and Asia, not even a 63% upturn in Africa/Middle East/ Central Asia could change the fact that 2013 came off to a slow start for global M&A. In contrast to the low activity within M&A in the first half of 2013, the economic environment surrounding M&A could hardly be better. Firstly interest

rates are being kept at historic lows, resulting in very cheap borrowing costs for corporates, and private equity firms. This is not expected to be changing in the near future. Secondly with corporates having large amounts of cash on their balance sheets, financing definitely does not seem to be the bottleneck hindering deals. Furthermore, stock markets have been surging through most of 2013 – S&P500 is up 20.1% year-to-date – which historically has been a good indicator of the state of the merger market. So why are we still not seeing any improvement?

To some extent, the before mentioned factors seem to be partly to blame.

In the current environment, potential sellers are becoming more expensive and some companies are taking use of the cheap financing options to initiate stock buy-backs or issue large dividends. Combining this with recent

news that the Fed plans to begin a decrease of its economic stimulus makes large transaction a delicate topic in board rooms around the world. Potential buyers are becoming afraid of paying too much and 2008 is still in fresh memory. As Vito Sperduto from RBC Capital Markets said, “You get questioned if you don’t participate in the M&A cycle, but you won’t lose your job.”

However, not all players in the market are afraid to go big. The largest deal year-to-date was the $23bn takeover of HJ Heinz by Warrant Buffet’s Berkshire Hathaway and 3G Capital Partners. The deal, announced on February 14th, included a price of $72.50 per share equal to a total deal value just short of $28bn. The price represents a 20% premium over the closing price of the stock the day before the announcement.

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M&A in the Americas was up 4% compared to the first half of last year and the two continents represented nearly half of the total global value of M&A deals. In the US, a decrease in the number of deals was offset by six deals worth more than $10bn, compared to only three mega-deals in H1 2012. The key drivers have especially been the Technology, Media and Telecommunication (TMT) industry, along with the Pharma, Medical and Biotech industries.

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Both Berkshire Hathaway and 3G Capital put up $4.4bn in equity and the rest of the acquisition was financed via debt from JPMorgan Chase and Wells Fargo. It is evident from this deal, as with the other mega-deals, that there is still a significant amount of risk-willing capital in the market but few are willing to pull the trigger. Heinz was delisted from the New York Stock Exchange in mid-June.

FINANCELAB • ISSUE SEPTEMBER 2013

There has also been a shift in the industries in which deals happen compared to last year. Looking at the energy sector, M&A activity is down 28% compared to the same period last year where this sector alone represented more than one fourth of all mergers and acquisitions. This year, the significant industries globally are TMT and consumer goods with respective increases of 61% and 19% according to Mergermarket data. Also health care has seen significant increases com-

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pared to H1 2012.

Looking at the remaining part of 2013, there are certain indicators of a possible improvement in M&A activity. One of the sectors that could drive activity is the European telecom industry.

Telefónica SA’s acquisition of Royal KPN NV’s German mobile-phone unit in a deal worth $10.6bn, announced in July, could be an indication that the anticipated consolidation of the sectors is just around the corner. Including this deal, the sector has reached the highest value of M&A deals for the first seven months of the year since 2000 according to the Wall Street Journal.

Market conditions are making consolidation easier. Currently, the market is fragmented and highly competitive which has pushed down prices and profits. In the Stoxx 600 index, shares of European telecom companies have fallen by more than 74% since Feb-

ruary 2000. The index has overall declined by only 22% in that period.

Whether a wave of consolidation is near is also highly dependent on the European Commission’s view on decreased competition. They have earlier this year expressed concerns regarding, among others, the French market.

However, as previously mentioned, overall market conditions could hardly be better.

Lastly, it is worth noticing that private equity firms remained active despite concerns over high valuations of potential targets. Leveraged buyouts rose 33.8% for H1 2013.

It is safe to say that 2013 will hardly be as good a year for M&A as many had hoped but as Robert Eatroff, co-head of mergers for the Americas at Morgan Stanley, put it, “The market is a lot healthier than the numbers look.”

The Biggest IPO’s of 2013 – North America takes the bulk, Brazil and Japan tops the board largest cement producer, Votorantim Cimentos, contemplated an estimated listing to rake in a staggering $4.8 billion. However, sour market conditions and current shareholder claims of too large an adverse selection discount turned out to be fatal for the listing, which was scheduled in June. The withdrawal of the offering highlights the delicate balancing act facing firms looking to successfully raise equity capital in the emerging economies.

Promising returns and transparency are investor requirements in economies characterized by high inflation, increasing risk and substantial growth.

However, leading the Latin American trend of 2013, the aggregated YTD Brazilian IPO’s raised $7.3 billion compared to $1.8 billion for the entire year of 2012 – suggesting an increased investor appetite for exposure to these high-potential markets.

“Abenomics” sparks investor optimism in Japan Initiating economic reforms, central bank stimulus and coordinated government spending, Prime Minister Shinzo Abe, is desperately trying to conquer the domestic debt and growth challenges.

A sign of his potential success could be inferred by the major offering of Suntory Beverages & Food, one of the leading Japanese non-alcoholic beverages companies. Raising nearly $4 billion, the offering takes the place as the second largest IPO of 2013 and is the largest since Japan Airline’s $8.5 billion offering in 2012 – which came only second to Facebook’s spectacular giant offering.

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t the very top of the leaderboard is the $5.6 billion offering of BB Seguridade Participacoes, the insurance unit of Banco de Brasil. Almost beating the runner up, Suntory Beverages & Food, by $2 billion, the offering is the largest in Brazil since July 2009 when Banco Santander Brasil raised $7.5 billion. A Brazilian trend in favor of dominating the 2013 IPO leaderboard emerged with the plans of yet another huge offering; Brazil’s

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The surging U.S. IPO market

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The U.S. IPO market has gained a strong momentum in 2013 and IPO activity in May represented the highest number of IPOs since November 2007. The growing IPO activity reflects the strong performance of the broader equity markets (although still volatile), positive investor sentiment and improving macroeconomic conditions.

Furthermore, North America represents 48.5% of global capital raised in first half of 2013. Three of the fifth largest offerings in 2013 are U.S. IPOs. The third largest IPO was the listing of PIMCO Dynamic Credit Income Fund, which actually was the biggest closedend bond offering in history and the fund raised $3.42 billion. The fund is a non-diversified closed-end fund and its main objective is current income.

It utilizes a dynamic asset allocation strategy among multiple fixed-income sectors in the global capital markets.

The IPO of Zoetis Inc. was the fourth largest IPO as the company raised $2.57 billion. Zoetis, formerly Pfizer’s animal health business, is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines. Zoetis became the biggest U.S. IPO since Facebook and the share price increased 19% on the first day of trading, indicating strong demand for the company. The fifth largest IPO was the listing of DoubleLine Income Solutions Fund and it raised 2.3 billion dollars. The offering was the second largest closed-end bond offering in history. The fund is organized as a

non-diversified, closed-end management investment company, and its primary objective is high current income, which it will pursue by seeking higher risk in the global fixed income market. Zoetis Inc. has showed a strong aftermarket performance whereas the PIMCO Dynamic Credit Fund and DoubleLine Income Solutions Fund have showed a poor aftermarket performance (see table). However, overall U.S. IPOs showed a strong aftermarket performance during the first half of 2013. Additionally, in the second quarter emerging growth companies now accounted for 77% of U.S. IPO volume, and this trend demonstrates investors’ surging appetite for high-growth companies.

Financials vs. non-financials With the exception of Seguridade Participacoes, the tendency is clear within the major IPO’s of 2013. The non-financial offerings are vastly outperforming the investment funds, being the only ones to show positive return

(IPO performance). This tendency reflects the overall trend of the industry performances (IPO performance by industry), where the IPO’s of the financial sector shows a disappointing 3% return compared to the entire IPO

market return of 11.43%. Consumer goods, both cyclical and non-cyclical, have shown superior performance following their IPO’s – a trend that is confirmed by the solid returns of Suntory and Zoetis.

Global IPO activity stabilized in the The biggest threat to a successful IPO second quarter of 2013 and is expect- in 2013 is overpricing, as investors are ed to pick up in the second half of the cautious about the performance. Thus, year. The global IPO window is again launching the IPO at the right price open and the outwith the right team look for the market “The biggest threat to a and the right story is is indeed promisAnother successful IPO in 2013 is essential. ing. Several trends trend we see is that are dominating the overpricing, as investors are financial services listglobal IPO marhave a universal cautious about the perfor- ings ket and the main appeal for investors drivers of the in- mance. Thus, launching the in 2013. Furthermore, creased activity are listings conIPO at the right price with domestic the improving intinue to dominate as vestor confidence, the right team and the right the majority of IPO (especially prevailinvestments are takstory is essential.” ing in the U.S., UK, ing place domesticalJapan, and parts ly and investors perof Latin America), ceive foreign IPOs as the stabilization of the economy, and more risky and expensive. Moving on the growing number of Venture Cap- to the regional trends, investors preital- and Private Equity-backed IPOs. fer the IPO markets of U.S., China and

Brazil. Especially strong momentum is expected for the U.S. market if the American economy is stable throughout the year, an issue that is the main concern of investors. IPO activity in Asia has been negatively influenced by the closure of Mainland Chinese exchanges to new listings. However, the IPO market is slowly rebounding and the main drivers of this activity are the Hong Kong, Japanese and emerging market exchanges i.e. Thailand, Singapore, and Malaysia. It will be interesting to observe when China opens the IPO market as many high quality companies are waiting to be listed creating momentum and sentiment that will position Asia favorably globally.

FINANCELAB • ISSUE SEPTEMBER 2013

Future outlook for the global IPO market

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Private Equity Takeovers P

rivate equity firms are characterized by making medium-LT investments in mature companies, usually with solid earnings, in order to further develop the business for a future sale. The private equity house takes a proactive role in improving the business and typically invests in a target industry or specific area where

they have expertise. The private equity market has as most of the financial world been subject to the credit crisis, and has experienced fewer deals compared to pre-crisis conditions. However, times are changing, and the trend indicates a future more keen on private equity takeovers.

Total global buyout deal value in 2012 lay within a relatively narrow range from USD 33 billion in the year’s first quarter to USD 48 billion in Q4, including buyout activity in Q3, which briefly was back to about where it had been in late 2010.

Strong beginning of 2013 led investor’s expectations: 2013 started off with a lot of deals not materializing, after years with limited private equity buyouts. The funds had trouble finding attractive investments

with the capital they got in the 2000’s where money was easily available. The majority of capital is found in North America, but the emerging markets

have received increasing attention, and actually surpassed Western Europe, as shown in exhibit 1.

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Exhibit 2: EV/EBITDA multiples paid in private equity transactions, 1985-2013

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The trend moving into 2013 was a decreasing price for private equity investments as shown in Exhibit 2. The EV/ EBITDA multiple for private equity transactions is back at the 2000 level, which indicate that 2013 is a very attractive time to make private equity buyouts.

Source: Thompson One Banker, Based on data on 1,144 published private equity takeovers

On the deal-making front, 2013 began with the mega-buyout of Heinz in February by Berkshire Hathaway and 3G Capital for $28 Billion. Together with improvements in the debt market, and low interest rates this deal set the stage for a year full of mega-buyouts.

One of the most important factors favouring a pickup in private equity investment activities in 2013 is the redeveloped frankness for business,

supported by faith from the global debt market. Unlike last year, when lenders remained sidelined due to the on-going worries caused by the sovereign-debt crisis, this year started with financing conditions being relatively more robust. In today’s market of sustained near-zero interest rates, investors of all sorts are hungry for yield wherever they can find it, which is a great advantage for the private equity companies.

The first quarter of 2013 had a total of 665 private equity backed deals announced valued at $86bn, which is the highest quarterly aggregated value since Q3 2007. However, the market slowed down, and Q2 2013 saw a 28% decrease in the aggregated value of the announced deals. Q1 and Q2 both followed the trend of 2012, having no specific sector focus in the largest buyouts.

What will the rest of 2013 reveal?

When Ben Bernanke earlier this year mentioned the possibility of the Fed tapering the quantitative easing the effects were obvious; stocks were plumping, and the index of commodities and bonds fell. However, the effect on private equity investments might be equally substantial. A tapering of the quantitative easing will result in higher interest rates, which will have two effects on private equity investments. First of all, it will hamper the attractiveness of new investments, as

the cost of debt will increase. Second of all, it will influence the return of investment of the existing portfolio companies, as the higher interest rates will make refinancing unattractive. Therefore, the tapering of the quantitative easing will have a huge impact on the future financing of private equity deals. On the other hand, if tapering of QE happens, it would most likely result in falling stock prices, which will enable private equity companies to engage in cheaper public to private deals. If we imaging this case, the rising price of debt would increase the attractiveness of equity financing, which would favour the funds with a strong equity position. Putting up more equity increases the risk for the private equity company, and does also deteriorate the IRR that the companies’ performance is traditionally measured on. The industry have seen a substantial change in the funding of deals since the 80’s and have gone from approximately 10-20% equity financing to about 40-60% equity finance in most deals today. Raising interest

rates might pressure the private equity companies to finance the deals by even more equity in the future, which would especially prove difficult for the smaller funds that are mainly financing their takeovers with leverage. This would perhaps also pressure the companies to re-evaluate their typical IRR target of 25% in 5 years, as it is very difficult to obtain with more than 50% equity.

The remaining of the year for the private equity sector is therefore full of question marks. Will the takeover of Dell prove to be the largest of the year? Will the private equity companies put their excess capital to work?

And perhaps most importantly, will Ben Bernanke raise interest rates and how would that affect the industry?

FINANCELAB • ISSUE SEPTEMBER 2013

The supposedly largest deal of the year has yet to occur, as the 2013 version of the Barbarians at the Gate battle over Dell is unsettled. Michael S. Dell and Carl Icahn’s struggle for the control of Dell have been going on since the beginning of the year, with the end looking near, as the shareholders voting should occur in the beginning of August. However, it is most likely the actions of Ben Bernanke rather than the result of the battle over Dell that will dictate the private equity industry in the remaining of the year.

17

Theme:

Mind, money & machine

Algorithms and High-Frequency Trading

By Steffen Tjerrild, Marc Solberg, Mathias Matzen & Daniel J. Bertelsen

FINANCELAB • ISSUE SEPTEMBER 2013

machine

18

money

mind

What is algo-trading and which purposes does it serve?

What happens when the “algo” loses its “rythm”?

How rich can they make you?

How often does the mind behind the machine get too tempted by the money?

How can you start your own HFT or algo business - do’s and dont’s?

Did you know?

Co-location (CoLo)

Copy trading

Copy trading platforms allows private traders to select a trading strategy or a trader and to automatically “copy” or “mirror” it. This type of algo trading is mostly used by private traders on popular websites such as etoro. com, where you can set your account to execute the exact same trades as the top5 traders on the platform. The method is also called social investing because it relies on openess. Everything you trade is public information - thus allowing everyone to instantly share eachothers market failures and success.

he human brain is indeed a wonderful thing but it has it limitations. Limitations with regards to the speed at which it can complete tasks and carry out strategic thought processes.

The processing ability of a computer supersedes a human’s decision-making process and this is

the reason to the increase of algorithmic trading.

Around 65% of the US equity trading is now dominated by algorithmic trading processed by ultra fast computers; even located as close as possible to the exchanges to minimize nanoseconds.

Algorithmic trading, % of total trading

FINANCELAB • ISSUE SEPTEMBER 2013

T

Co-location is the ability given by an exchange to high frequency firms to place trading computers directly beside the exchange’s computers in their data centers. The speed with which HFT machines can trade is governed by the speed of light, thus delayed (albeit by milliseconds) only by the distance the information is traveling. Firms will not only compete on miliseconds. Nano-seconds (1/1.000.000.000) may be the next battle field.

These photos show the massive data centers in Carteret (Nasdaq) and Mahwah New Jersey (NYSE).

19

machine The

What is algorithmic trading? ”Algorithms” is a broad term describing computer programs that process data, analyse it and use it to execute trades according to some goals of the user.

This method of trading has many names such as quantitative trading, black box trading or algo trading. Algorithmic trading executes trades computed by

mathematical formulas, technical signals, and news headlines. These trading systems utilize mathematical models for decision making within financial markets. The mathematic algorithm is built around rules, which determine the correct entry/exit point and position size. They can be classified in four broad sub-categories as shown below.

MISSION: </> Conquer the markets

Recognizing an algo: Alpha Seeking Algo

Best Execution Algo

FINANCELAB • ISSUE SEPTEMBER 2013

Algorithms that trade to Best execution algos outperform the market by serves to provide the best buying and selling e.g. high average price on trades frequency trading (HFT)

20

The market impact algorithms are most often used by the buy-side to reduce costs of investing and limit the market impact when big orders are to be filled. Although the buy-side has used algorithms in the equity markets for a long time, there are still markets where the use of buy-side algorithms is minor - such as the listed futures market.

Best execution algorithms are often used by brokers, and are partly driven by regulation that ensures that the

Market Impact Algo

Cross-asset Execution

Seeks to reduce the Covers strategies which price-impact of big orinclude several asset ders on the market price classes for trading and hedging purposes.

client gets the “right” price. In Europe there is a directive for “best execution” (the MiFID directive), which requires managers to demonstrate that they got the best price for their clients. Automation makes this easier, and just as importantly, managers have an audit trail that supports the case that they obeyed these rules. In all markets there are rules about market manipulation, and trade automation helps managers avoid being seen as breaching those regulations. In addition, using algorithms rather than traders

makes compliance easier and more transparent.

For many years complex mathematical algorithmic trading models have been substantial profit generators for large investment banks and hedge funds.

Furthermore, it has become possible for retail investors and smaller funds to create algorithmic trading systems.

The most popular algorithmic trading platform for smaller traders currently is Metatrader4.

Buy-side futures algorithms Pension funds, insurance, and mutual funds have previously been circumspect in their use of algorithms in the listed futures market, as day-to-day volume had not reached a level that could justify the implementation of algorithms. However, recently a growing number of asset managers have begun to use algorithms in the futures market to fill their orders. The algorithms can be a combination of all schedule-based and more aggressive liquidity seeking strategies. An algorithm might be based on the executed volume, letting the orders be a percentage of the volume with an option to buy more aggressively if the algo-

rithm gets behind schedule. The algorithms can have special levels of aggressions depending on how fast the order should be filled. Steve Chivers, head of exchange traded derivatives at UBS, writes that UBS is seeing price improvements across all futures of about 10% while some clients report price improvements of up to 40% thus improving their hedges and their time-weighted average price. Chivers also highlights that these futures algorithms account for 10% of their business but up from 0% 18 months ago.

The growth in algorithms via buy-side execution management systems (EMS) has been significant – starting in the

equity markets and later spreading to futures markets. Going forward, new regulations that aim to get central clearing on more derivatives may open up new markets to implement these types of buy-side algorithms.

Finally, bigger clients will have more benefits from their fill prices and the anonymity algorithms can provide, but the benefits extend quite a long way down and the trend may well continue to the point where the common private investor has advanced algorithms at his disposal.

High-Frequency Trading: The villain of algorithms?

No other concept in the algorithmic trading sector has been subject to more controversy over the past years than high frequency trading (HFT). With its high level of complexity and black-box technology, it can easily seem impossible for the mortal person to comprehend the concept.

Hence, the level of complexity and difficulty understanding the underlying concepts and mechanics behind the

technology of HFT makes it a natural victim to blow the whistle on. But is HFT really all that bad? Do retail investors stand a chance?

From a positive perspective, these algorithms provide massive liquidity, and create narrow spreads. Another major pro of algorithmic trading is that you are able to program your strategy, which enables you to eliminate the

influence of your human emotions.

Trading with feelings is a doomed strategy and often leads to massive losses, commonly seen among retail investors. The speed of the algorithms makes it possible to simultaneously execute trades while technical events occur. Hence there are many advantages of automated trading.

“Algo” without “Rythm”

However, on the other hand, we have already seen some drawbacks such as the Flash Crash May 6th at 2:45 caused

by High Frequency Trading, a variety of algorithmic trading. The Dow Jones Industrial Average plunged about 9 % and recovered the losses within minutes. It was the second largest point swing in Dow Jones Industrial Average history. We have experienced massive volatility like this before, but not comparable to the pace of the Flash Crash.

This special class of algorithmic trading high frequency trading in which computers make collaborate decisions

to initiate orders based on information that is received electronically before human traders are capable of processing the information they observe. This has resulted in a dramatic change of the market microstructure particularly in the way liquidity is provided. Algorithmic trading may be used in any investment strategy including market making, intermarket spreading, arbitrage or pure speculation including trend following, the investment decision and implementation may be augmented at any stage with algorithmic support.

If you ask the experienced traders they will argue that theoretical finance has limitations; the extremes always break the models. While humans cannot intervene with the algorithmic processes the opposing factor is that computer models are unable to make rational decisions in situations where the circumstances have changed, for example a different market environment today compared to yesterday. So when big changes occur humans have to intervene. We are yet to discover a computer trading strategy that is able to successfully handle a stock market crash.

FINANCELAB • ISSUE SEPTEMBER 2013

The Flash Crash - May 6th 2010

,

Dow Jones Index

21

The Doomsday Machine HFT TIME TRIMMING TOWARDS 0 LATENCY

0

ms

You don’t have to look for long, to find articles and comments, which mainly criticize HFT, characterizing it as “The Doomsday Machine of Wall street” and other nicknames. People literally are finding the concept of having machines actively involved in the financial markets, to be somewhat non-trustworthy. However, as it is part of our natural instinct to fear the unknown – blowing whistles on HFT can probably be considered as a perfectly natural reaction for the unknowing individual.

Apart from creating controversy and mass hysteria among the population, the authors of this article sat out to

briefly investigate the more positive side effects of HFT and to put a counterweight to the criticism and blame which HFT has received. And it didn’t take long to identify the first positive effects of HFT – namely increased market liquidity and market efficiency.

One of the major advantages of computerized financial trading is that it enables traders to exploit tiny, lightning-fast price changes in the market.

Therefore, the trading computer with the shortest distance to the market information i.e. the stock exchange server has an advantage over other

traders since it can analyse and execute its trading strategies quicker. As the competition over the distance to the market information tightens, rivals within the computerized financial trading have been forced to be creative when coming up with new techniques to trim milliseconds and hence come closer to the market. This has initiated a race-to-zero among the different trading firms, where immediate market information, i.e. zero seconds in transferring time, is an optimal scenario - yet highly difficult to achieve.

Technological developments However, as new technology enters the market, the dream scenario becomes more and more realistic. The latest technology involving laser beams and microwave dishes has made it possible to lower the transferring time between London and Frankfurt by 40 % compared to the old fiber optic cables. As a result of data being transferred at the

speed of light to computerized traders many investors have blamed the Algorithmic trading for increasing market volatility and multiplying the risk of a market meltdown. According to Dr Richard Bentley, industry vice president, banking and capital markets at Progress Software, Algorithmic trading is being pushed out of the more estab-

lished markets such as North America and Europe and being pulled into emerging markets. Getco, one of the world’s largest computerized algorithmic trading firms became in March the first of the Western trading firms to get access to the Indian trading market the world’s fastest growing derivatives market.

FINANCELAB • ISSUE SEPTEMBER 2013

Arbitrage

22

The World Federation of Exchanges (WFE) just released a report on high frequency trading, which provides some interesting statistics. Based on its study, the WFE concluded that HFT is made up of a “diversity of strategies that primarily involve variations of market-making and statistical arbitrage strategies” that add to market liquidity and pricing efficiency, which in the end helps retail traders.

Secondly, as HFT-computers not only trade ordinary investment products, but also look for arbitrage opportunities, the more efficient the algorithms become at this, the less arbitrage will exist in the markets as they close these loopholes themselves. Hence, theoretically closing all arbitrage loopholes and squeezing out any price mismatches in the markets leaves the markets with a higher level of market efficiency. The theory of market efficiency, developed back in 1970 by

economist Eugene Fama, states that market efficiency is the degree to which stock prices reflect all available, relevant information in a given market. Hence, the fact that HFT uses complex algorithms to analyse multiple markets and execute orders based on market conditions, will leave the markets with a higher level of efficiency as all the relevant information, that the algorithms pick up and process, are reflected in the market prices.

money The

Shrinking Profits

Profits

- is HFT on a drawback?

Whether HFT is good for investors or bad can turn out to be a cumbersome discussion, but one fact that no one disputes is the actual drop in HFT profits over the past years. Market dislocations caused by the financial crisis of 2009 have given way to record-low levels of volatility in the financial markets.

Co-incidentally (or not?), HFT prof-

itability and revenue have declined dramatically. HFT took up 61% of the daily traded volume of shares traded in all U.S. stocks in 2009.

HFT profits peaked at just around $5 billion in 2009 before plummeting to a dismal $2 billion in 2010, and further down to just above $1 billion in 2012 – according to data from the New York Times.

Courtesy of N.Y. Times

Financial Transactions Tax High-frequency trade volume

Courtesy of N.Y. Times

Recent rumours and discussions have been airing the financial newspapers of 2013, discussing the incentives of a proposed Financial Transaction Tax (FTT) to be put on HFT transactions and profits. A recent article published

by Bloomberg, indicates how UK lawmakers urge a Tobin Tax on high-frequency trading, as an incentive to enhance the culture of long-termism and transparency in the market, opposed to the short-termism which makes up the fundament of HFT. It is interesting to consider the consequence of the FTT, as it may actually deliver a deadly knockout punch to most HFT-companies who barely manage to stay

afloat with the sinking profits in the industry. As earlier stated in this article, HFT profits appear to be diminishing, and adding a Tobin Tax to a sector whose market structure is converging towards “perfect competition” and closeto-zero profits, could turn out to carry fatal consequences. Not only is algorithmic trading constantly becoming more complex in order to stay optimized and efficient in the hunt for profit, squeezing the scientific - and financial engineering to its limits.

But passing on a transaction tax to go with it could mean the first step on a very cold, lonely and down-sloping pathway for the future of HFT.

FINANCELAB • ISSUE SEPTEMBER 2013

– the death to HFT?

23

mind The

Machine vs. Man Does this Financial Transactions Tax mean that HFT will disappear? No, certainly not. However, the game has shifted. No longer can anyone with a server, an algorithm and some capital enter the high-frequency trading space and expect to compete. It ap-

pears that the market will be dominated by larger organizations that have the ability to invest in technology and continually improve their strategy.

The industry definitely has become more algorithm-focused and quantitative, resulting in multiple of the very

short-term opportunities having been removed from the market. These machines will beat every day trader on a normal day when nothing is going on.

But when big things happen humans have to intervene and turn the computers off.

“They are, as a rule, secretive, stealthy, smart and relatively unknown.”

FINANCELAB • ISSUE SEPTEMBER 2013

When the master mind smells money

24

Their is little knowledge about the programmers, architects, engineers etc. behind the HFT-algos. As an AdvancedTrading.com article described HFT firms, “They are, as a rule, secretive, stealthy, smart and relatively unknown.” All we know, is that they represent an elite niche of computer science and sometimes their story and background are brought out in the light - mostly when the dark side of the master minds are uncovered.

</> Secret code

Trading algo theft Why would programmers steal the algos?

In most cases, the programmers come from modest circumstances and want to make their own fortune by using the codes in their own firm or at a new workplace, where the salary is higher. In other cases it’s about open source.

How valuable is an algo?

Algorithms underpinning the trading systems are closely guarded secrets, and can earn a firm hundreds of millions of dollars per year. Some HFTfirms will argue that the algos are valuable intellectual property used by the company. Theirfor, code theft may be considered a very serious violation of a firms trading business. However, some high-frequency trading experts say the code is intrinsically linked to the environment in which it’s being run, requires teams of programmers to maintain, and thus is of little use to another organization.

How often does code theft happen?

Cases of code theft is not rare. Employers have done it in such firms as Goldman Sachs, Societe Generale and even the Federal Reserve Bank of New York, according to a Wall Street & Technology report.

What NOT to do

Trading code theft sentences Sharing trading codes programmed by yourself or even a friend who’s an insider can have fatal costs.

Here is a few examples of the “don’ts”.

Who stole the secret code?

Sergey Aleynikov Russian programmer who earned nearly $400,000 a year in his job.

He left Goldman to join Teza Technologies, a competing trading firm which offered to triple his pay.

Arrested by FBI agents.

How did they steal it?

Aleynikov took code with him when he left Goldman Sachs for a new trading firm. He encrypted and uploaded 32 megabytes - 500.000 lines of source code - of data over four days and transferred it to a webserver hosted in Germany before trying to erase his tracks from Goldman Sach’s network.

What is the prison sentence?

8 years

Conviction overturned 2012. Trial still running.

“This code is so highly confidential that it is known in the industry as the firm’s ‘secret sauce,’ “ Manhattan District Attorney Cyrus Vance said in a news release August 2013.

Jason Vuu & Simon Lu Jason Vuu (26) worked at Flow Traders on Wall Street and Simon Lu, is a doctoral candidate in mechanical engineering at Carnegie Mellon University, and not a Flow Traders employee. Vuu and Luu are college friends from MIT (Massachusetts Institute of Technology).

Vuu shared proprietary information from Amsterdam-based trading house Flow Traders with Lu. Emailed material - including source code - to himself, sometimes altering the names of attached files in an apparent attempt to avoid detection. Vuu then obtained the information and shared it with Lu via Dropbox.

4 years Trial still running.

Agrawal was an analyst at the New York office of the French bank Société Générale.

Agrawal was caugth on cam while he was printing out the company’s proprietary high-speed trading code at his office desk.

Later he leveraged the documents into a high paying job with a rival firm. Printing the code transformed the otherwise intangible trading codes into a “tangible object” under the NSPA, and the securities traded via the stolen code satisfied the product and nexus requirements of the EEA (Economic Espionage Act).

3 years

The government calculated the loss of the code to cost SocGen $9.58 million, and requested that he be jailed for 63 to 78 months.

FINANCELAB • ISSUE SEPTEMBER 2013

Samarth Agrawal, 27

25

Getting started with your own algorithmic trading

By Christian Kolding

Tips from a data scientist and FinanceLabber who set out to learn algo trading from scratch Doing algorithmic trading with real money is not for amateurs. A single error in your code or a bad algorithm can mean that you lose all your money in seconds. Instead, you will want to learn it in a safe environment where you can make all the mistakes you want, without losing a single cent. Below, we show a simple roadmap for how to get started with algorithmic

FINANCELAB â&#x20AC;˘ ISSUE SEPTEMBER 2013

Learn Python the Hard Way1

26

Once you have learned the basics of Python, the next step is to think of an algorithm. Here, the possibilities are endless. Maybe you already have an idea of what you want to try. If not, donâ&#x20AC;&#x2122;t despair. If you are quick and have some spare time, you can join the online class in Computational Investing that started in the end August (https://www.coursera.org/course/ compinvesting1). If you prefer reading a book in your own pace, there are tons of books from which you can learn about algorithmic trading.

trading without using real money.

You obviously need to be able to program. While there may be tools out there, where you can point-and-click your way to an algorithm, you will just not have the amount of control available that is required if you truly want to be able to develop new algorithms.

Think Python2

The final step is to register at Quantopian (https://quantopian.com/). This is the ultimate playground for algorithmic trading. Here, you will have free access to minute-level data for all US stocks from 2002, an interface for developing your algorithms, a top-notch backtester, and an active community.

You should now be able to successfully implement an algorithm and see an estimate on how it would have performed based on historical data. In the images you can see an example of a report generated by the Quantopian backtester.

We recommend the Python language, since it is one of the most beginner-friendly languages. At the same time, Python is also becoming increasingly popular in the finance world.

There is an endless amount of free resources available for complete beginners. The links in the box show some of the most popular ones.

Introduction to Computer Science3

Since Quantopian only gives you access to minute-level data, doing HFT-algorithms is obviously not possible there. Another option would be to check out QuantConnect (https:// www.quantconnect.com/), where you will get access to tick-level data. The downsides, however, are a limited number of free backtests per month and that you will need to learn the C# programming language, which is a little less beginner-friendly than Python.

1) learnpythonthehardway.org 2) greenteapress.com/thinkpython 3) udacity.com/course/cs101

Meet the

Power Trader 5 reasons why

Power Trading at Neas Energy In this article Mehmet Kuyucuoglu, a former Finacelab member provides five reasons for making the move from FX options trading to power trading which also involved a move from Copenhagen to Aalborg.

FINANCELAB â&#x20AC;˘ ISSUE SEPTEMBER 2013

I started trading the forces of nature

27

1

A market in massive growth Having traded FX Options in Nordea Bank for a few years, I decided that I wanted to work in an industry that would grow for the next 10-20 years. While the FX market is the world’s largest asset class, it is not a market that is experiencing much growth. Most banks are simply trying to maintain their po-

2

Volatility, volatility, volatility!

Being used to 0.5-2% moves in FX spot markets switching to power trading is a huge change. One of the most profound characteristics of the power market is non-storability and that it is a 24/7 market.

To avoid blackouts supply and demand have to be in balance at all times. This means that changes in

3

International Focus

FINANCELAB • ISSUE SEPTEMBER 2013

While most Nordic trading desks will claim to be internationally minded this is only true for a handful. If you look at the actual activities and goals outside of the Nordic region, they are either very small or non-existent. Being “Best in Denmark” or “Best in the Nordic”

28

4

Visionary leadership If you look at most banks and trading houses, most are satisfied with maintaining their position or growing at mediocre growth rates. Very few have the kind of ambitious

sitions when it comes to FX, stocks or bonds. While the FX options space is more attractive due to being a more complex instrument, the opportunities for growth here are also limited due to automatization and increased competition.

While my experience was within FX options, something that I am good at, I did not feel like it was worth specializing further in a shrinking business. For that reason I started looking into commodities as an asset class, as this is certainly a

business area which is experiencing high growth. Especially energy stood out with relatively less developed markets with inefficiencies ready to be exploited. The fact that renewable energy sources are playing an increasingly important role also appealed to me as renewables is an inevitable part of the future energy mix – and unstable weather dependent asset inducing lots of volatility into energy markets.

the supply/demand balance can result in very high volatility scenarios. Having traded power less than two months, I have only experienced “calm summer markets” with daily volatility as high as 30100%. This kind of volatility brings great opportunity but also means that you have to be extremely alert at work.

where fundamentals matter as much as they do. This makes it a market where every bit of information is relevant for the price and in order to beat the market you really need to seek that extra information.

Another characteristic of the market is that it is very fundamentally driven, probably the only market

For somebody who wants to work in a high energy, high paced environment the power market is a perfect match.

simply didn’t cut it for me. Neas Energy is committed to becoming one the best power trading houses in Europe, which is apparent in the present market expansions across Europe and hiring of traders with different European nationalities and a mix of experience from the big utilities and London investment banks.

We want to be able to send power from Norway to Turkey within 2 years, which means growth in many new countries. Last month we received an additional four new trading licenses for countries in Central Eastern Europe and looking to expand much further. This requires internationally diverse and dynamic teams.

growth strategies which is the case at Neas Energy. We aim to be one of the leading players in the European power market. In order for this not to be an empty promise it is extremely important with visionary leadership.

is little time from idea generation to execution. Business cases are not discussed until the end of time but very quickly put into practice. I’ve been here less than two months, and I’m already involved in two major projects besides my primary responsibilities in trading short term power markets.

One thing that I really like about the company is the fact that there

Having worked in two large organizations in the past I was a bit worried that a small company may not have structures that make a company function properly. I was surprised to find that working in a small company gives amazing opportunities and a feeling of empowerment that I haven’t experi-

Leaving Copenhagen When I got the possibility to work for Neas Energy and after researching into the visions and the strategy the company has layed

enced anywhere else.

The average age is very low which is reflected in the culture where everybody seems extremely ambitious and driven. The company has a trading culture characterized by always looking at any opportunity, whether big or small.

Also the management encourages us to give each other feedback on a continuous and day-to-day basis

out, joining was not a hard choice.

Even though I love Copenhagen as a city I don’t want to be limited by any geographical location. Moving to Aalborg allows me the luxury of focusing on work with fewer distractions – and in fact the city of Aalborg is in a very positive development driven by a very expansive

“

so that any issues are resolved immediately. While it can be a bit intimidating to join a company with extremely talented employees who give you constant feedback, it also pushes me to be better at the job. I always feel that there is something that I can improve and that type of continuous learning really pushes me to perform better every day.

University and a good business environment The company has had a hiring spree and this year has added more than 30% to headcount. And we are still looking for talented people who are willing to go the distance!

For somebody who wants to work in a high energy, high paced environment the power market is a perfect match.

Power your career

FINANCELAB • ISSUE SEPTEMBER 2013

5

Start-up culture

29

TRADING DIPLOMA COURSE More than 1000 students have learned the basics of trading from us Join the next course on financelab.dk/all-events

You will acquire the skills to trade Forex confidently Learn to trade stocks & CFD’s and profit in an up or down market Improved trading techniques to increase your earnings Learn to read and interpret live charts using a variety of technical analysis tools Learn our exclusive filtering system to find high probability trades

THEORY

FINANCELAB • ISSUE SEPTEMBER 2013

Equity investing, CFDs, Forex (FX) Overview, FX Calculations, 3- Way orders, Trading Tactics, Trading Guide, Commodities Overview, Technical Analysis etc.

30

The No winn rdic er Tra s tick din e gC t om

PRACTICE

TESTING

Place trades in real market conditions, while we coach you through the whole process.

Mini exam & trading competition

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04 - 05 BØRSMÆGLER FOR ÉN DAG

t to mp the n etit e ion xt ±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

Computerne er klar og parate. Det samme er de 15 deltagere, der har kvalificeret sig til turneringen Nordic Trading Competition. Fordelt på fem hold skal deltagerne se, hvem der i løbet af dagen kan få 100 millioner virtuelle kroner til at yngle mest. Bag konkurrencen står Financelab, der er en studenterorganisation, som er bygget op omkring medlemmernes fælles interesse for at handle med aktier.

Deltagerne i konkurrencen er dog ikke medlemmer af foreningen, men derimod studerende fra CBS. Fire en halv times aktiehandel skal nu afgøre, hvem der har bedst styr på dagens kursudvikling. Frederik Ploug

Søgaard er formand for Financelab og er en af initiativtagerne til konkurrencen. Han byder velkommen til deltagerne og giver dem en kort ”market briefing”. Det vil sige en orientering om begivenheder, der kan få betydning for udviklingen på dagens marked. ”Konkurrencen er dog bevidst lagt på en dag uden de helt store begivenheder i finansmarkedet. Det er gjort, så det er de deltagere, der er bedst til at bruge de analytiske redskaber, der vinder”, fortæller Frederik. ”Release the bulls” råber han ud til forsamlingen. Konkurrencen er nu i gang. Deltagerne i dag har alle deltaget i de tradingkur-

ser, der blev holdt i foråret. Vinderne ved hver af disse kurser er de 15, der er her i dag, og de er dermed de bedste af de 200 oprindelige deltagere.

Skal finde de bedste af de bedste ”Today is about finding the very best of the best”, som Wayne Walker siger. Han er underviser på trading-kurserne og har flere års erfaring med aktiemarkedet efter at have arbejdet som trader tidligere i sin karriere.

Han har store forventninger til deltagernes kunnen, og sammen med sin kollega Ole Quistgaard er han dommer ved konkurrencen

AF SAJEEV SHANKAR / FOTO CASPER BALSLEV

Nordic Trading Competition

31

Elon Musk mind

+

machine

+

money

=

Musk

Profile of an inventor and investor In this article we demonstrate why Elon Musk may be the ultimate combination of mind, money and machine, revolutionizing 4 industries from Internet, renewable enery to outer space.

Starting as a programmer by the age of 12

FINANCELAB • ISSUE SEPTEMBER 2013

I

32

f you admire Steven Jobs for being the mind behind the Apple, you should also admire Elon Musk - the mind behind Pay Pal, Tesla, Solar City, Space X, and Hyperloop. He’s not only a great inventor; he’s also a daring investor.

Musk bought his first computer at age 10 and taught himself how to program; by the age of 12 he sold his first commercial software, a space game called Blaster, for $500.

Musk obtained two bachelor degrees, one in Business and another in Physics. After just 2 days on his Ph.D in Physics he dropped

out to pursue his dreams of solving three “important problems” of mankind.

By the time he reached the age of thirty-one Elon Musk was a multi-millionaire thanks to his creation of the company that became PayPal, the popular money-transfer service for Web consumers.

Today he’s known for making challenging technologies commercially durable. He’s also known for being a leader who loves to indulge in the technical levels of his electric car or space projects.

The guy who inspired the Iron Man movies Jon Favreau, director of the Iron Man movies, describes in his article how Musk was the inspiration for Favreau’s film depiction of genius billionaire Tony Stark.

The SpaceX factory was used as a filming location for Iron Man 2, and Musk has a cameo in the movie.

Introducing Elons million dollar route to revolution

Zip2

Internet city guide

Financials:

Zip2 developed and marketed an Internet “city guide” for the newspaper publishing industry. Musk obtained contracts with the New York Times and the Chicago Tribune. Zip2 enabled companies to post content on the Internet, such as maps and directory listings. Compaq bought Zip2 for $307 million (in cash), which was the biggest sum paid for an Internet company up to that time.

1995 1999

Buyer: Compaq Altavista Price: $307m in cash Returns to Musk: $22m

$10m

investment

Internet payment service Financial events: Entry: Exit:

1999 2002

Buyer: eBay Price: $1,5bn in stock Returns to Musk: $165m in stocks

$100m investment

PayPal started as an online financial service called X.com. Musk served as the company’s chairman and obtained $25 million in funding from venture capital firm Sequoia Capital. The company began offering services to the public in December 1999 providing Internet checking accounts and cash cards. X.com was renamed PayPal and rapidly expanded in 2001 primarily as a result of its use on eBay. In 2002 it was offered as a publicly traded company and was acquired by eBay.

Spacecraft developer Financial events: Entry: Exit:

2002 not yet

IPO expected in 2013/2014

Elon Musk founded x.com, which later became the popular online payment service, PayPal.

SpaceX designs, manufactures and launches advanced rockets and spacecrafts. The company was founded in 2002 to revolutionize space technology, with the ultimate goal of enabling people to live on other planets. SpaceX was awarded a $1.6 billion NASA contract on December 23 2008 for 12 flights of their Falcon 9 rocket and Dragon spacecraft to the International Space Station, replacing the Space Shuttle after it retired in 2011.

Continued on the next page

Musk views space exploration as an important step in expanding—if not preserving—the consciousness of human life.

FINANCELAB • ISSUE SEPTEMBER 2013

Entry: Exit:

The company was founded with Musk’s brother Kimbal Musk shown below.

33

Musk has said that multiplanetary life may serve as a hedge against threats to the survival of the human species. Musk’s goal is to reduce the cost of human spaceflight by a factor of 10.

Making life multi-planetary.

Elonc Musk: The Case of Mars

SpaceX is known for making space travelling commercially durable compared to traditional methods. The price for a Space X rocket ranges from $56m to $135m.

Musk’s space lab

Testing investing Testing investing to the extreme

In Musk’s space lab you’ll find the Merlin Engines. A family of engines, which may help our grandchildren, colonize Mars.

The primary objective, according to Musk himself, should be establishing a self-sustaining civilization on Mars.

Elon had $300,000,000. Just barely enough for three test launches. The first failed and he came under government cross fire over safety concerns. So he raised the money to buy his own island and launched from there again. The second rocket also blew. Then he bet pretty much his last penny on the last launch and it flew.

3 reasons FINANCELAB • ISSUE SEPTEMBER 2013

why Elon’s rockets are considered unique compared to similar technologies

34

1) They are relatively affordable 2) They are reusable 3) They can fly backwards

Let’s commercialize electric cars

FINANCELAB • ISSUE SEPTEMBER 2013

Let’s commercialize space travel

35

$70m investment

Financial events: Entry: Exit:

2004 not yet

IPO price: $8 (2010) Latest price: $160 (10/9/2013) Market cap: $19,5bn Elon is reported to have a 32% stake in Tesla.

Electric car manufacturer Tesla Motors is named after electrical engineer and physicist Nikola Tesla. The company had a hard time during 2008 financial crisis. But in mid 2013 they demonstrated break even, which have made Tesla the highest rising stock on S&P500.

The carmaker is expected to “dramatically accelerate” their network of supercharger stations, across North America and Canada.

Elon envisions Tesla as an independent automaker, aimed at eventually mass-producing fully electric cars at a price affordable to the average consumer.

Since college, Musk’s primary goal was to commercialize electric vehicles.

Consumer solar panels Financial events:

FINANCELAB • ISSUE SEPTEMBER 2013

Entry: Exit:

36

2006 not yet

IPO price: $8in January Latest price: $36,58 Market cap: $1,76bn Size of stake: 28%

$

investment unknown

Musk observing an assembly demo at the reopening of the NUMMI plant, now Tesla Motors in 2010.

SolarCity is succeeding where many other solar companies have failed and is today the largest provider of solar power systems in the United States. Elon’s underlying motivation for funding both SolarCity and Tesla is to help combat global warming. SolarCity and Tesla Motors are collaborating to use electric vehicle batteries to smooth the impact of rooftop solar on the power grid. SolarCity’s solar lease solutions can allow some homeowners to pay less each month by adopting solar power they previously bought from the utility company.

Solar City is a familiy business co-founded by Elons two cousins. Here’s the family at their Nasdaq IPO.

New projects 2013

HyperLoop High speed travel Financial events: Entry: Exit:

not yet not yet

$6b

total funding requirement

“Hyperloop is a “cross between a Concorde, a railgun and an air hockey table.”

Elon Musk has been teasing an exciting idea for a new form of transportation for the last year - the Hyperloop. An airlifted train or a vacuum-sealed tube buried underground that would zip across the country and get people to Los Angeles from San Francisco in just 30 minutes.

No investments in the project have been confirmed. However, R&D costs are being spent. From late 2012 until August 2013, an informal group of engineers at both Tesla and SpaceX worked on the conceptual foundation and modelling of Hyperloop, allocating some full-time effort to it toward the end. The first sketch has been published (see below) and a prototype is said to be on its way.

Drawings published

by Tesla Motors and Space X August 2013:

“I like to be involved in things that change the world”

“An asteroid or a super volcano could destroy us, and we face risks the dinosaurs never saw: An engineered virus, inadvertent creation of a micro black hole, catastrophic global warming or some as-yet-unknown technology could spell the end of us. Humankind evolved over millions of years, but in the last sixty years atomic weaponry created the potential to extinguish ourselves. Sooner or later, we must expand life beyond this green and blue ball—or go extinct.”

End of Theme:

Mind, money & machine

“It’s okay to have your eggs in one basket as long as you control what happens to that basket. The problem with the Silicon Valley financing model is that you lose control after the first investment round”

FINANCELAB • ISSUE SEPTEMBER 2013

Our Top 3 Elon quote picks:

37

May the market force be with you...

FED POLICY - what will happen to QE3 and the markets?

by Jakob Lindegaard & Joakim Lindboe Brüchmann

QE3 announcement and expansion

A

s QE1, QE2 and a near zero interest rate had not provided the desired stimulus to the US economy while inflation remained low, on Sept. 13th 2012 Chairman of the FED Ben Bernanke announced that the third round of the quantitative easing program would be initiated (QE3). With monthly purchases in mortgage-backed securities and Treasuries of $ 40 billion financed by expanding the monetary base, the QE3 program should contribute to further

stimulation of the US economy by putting additional downward pressure on long-term interest rates through an injection of liquidity into the markets.

Unlike its predecessors QE3 is open-ended, meaning it has no expiration date – nor a maximum amount of funds to be used for the program.

The market responded well to the announcement of QE3 and several benchmark indices, and commodities rose to the highest level since 20071.

On Dec. 12th 2012 the QE3 program was expanded to monthly purchases of $ 85 billion, while it was again confirmed that the interest rate would be kept near zero for the foreseeable future. For the first time, covenant-like requirements were set to the unemployment rate (6.5%) and inflation (2%) for increasing the interest rate.

This expansion again caused indices to rise, while the dollar depreciated due to the increased printing2.

Google Finance

FINANCELAB • ISSUE SEPTEMBER 2013

Figure 1: S&P500, DJI and RUT reaction to announcement and expansion of QE3.

39 1) http://www.bloomberg.com/news/2012-09-13/fed-plans-to-buy-40-billion-in-mortgage-securities-each-month.html 2) http://www.bloomberg.com/news/2012-12-12/dollar-declines-as-fed-adopts-more-treasuries-buying-stimulus.html

Announcement of planned reduction What had been described as a consideration in the close passing months was confirmed on Jun. 19th 2013, when Bernanke announced that the response in FED policy to improved macroeconomic data recently could be a gradual dialing down of the QE3 beginning in late 2013. Bernanke emphasized that this was conditional on

the strength of the economy while he assured that interest rates would be preserved at present levels. Therefore, it would be implemented only if incoming data continued to show signs of a strong recovery.

mistic on the economy, the markets responded negatively by sending down the S&P500 Index with almost 3.5 % within the next three trading days with the Dow Jones Industrial Average and Russell 2000 indexes following.

Instead of focusing on the good news that the FED had become more opti-

Figure 2: S&P500, DJI and RUT reaction to announced tapering of QE3.

Google Finance

Interpretation of the announced reduction Even though it was promised that monetary policy would remain expansionary, with a Federal Funds Target Rate kept on 0.25 % until mid 2015 and considerable amounts of balance sheet actions left over from the FED,

the announcement had a huge impact on the market. Thus, investors were signaling fear of standing on their own two feet. Undoubtedly, the motivation behind the announcement was in favor of bullish markets; namely signs

of a bettering of the economy with declining unemployment rates, or in other words, a reduced need of extensive life-support from the FED.

FINANCELAB â&#x20AC;˘ ISSUE SEPTEMBER 2013

Figure 3: Unemployment rate, seasonally adjusted.

40

This positive development was clearly overshadowed by the negative short run effects on stock markets, facing both rising interest rates (see Figure 4 on next page) and greater uncertainty regarding future tapering.

Figure 4: YTM 10-year bond reaction to announced tapering of QE3.

Furthermore, the reaction from the markets to the speech on Jun. 19th showed that the imminent tapering was unanticipated as investors expected the QE3 to remain unchanged for a longer period.

Outlook on the QE3 FOMC-meeting 17-18th of September 2013

Employment situation 4th of October 2013

Same old track... ...different outcome

FINANCELAB • ISSUE SEPTEMBER 2013

In the press conference after the markets. For example, a decline in the FOMC3 meeting on July 31st, no sur- unemployment rate might have an imprises were given as a continuation mediate negative impact on the marof the QE3 at current terms was an- kets by increasing the likelihood of an nounced. In addition, the target in- approaching tapering of the QE3. This terest rate - as expected - was kept at contradicts within intuition when it 0.25 % due to a level of unemployment should be perceived as being positive, well above the threshold of 6.5 %. The and vice versa. reaction from the market was moderate on the speech, as On the long run, the general consensus economists expect “a decline in the unem- further cuts on the among economists had been that the FED ployment rate might have purchasing prowould not implement gram in the second an immediate negative the cut in QE3 before quarter of 2014, September, thereby impact on the markets by while increasing beexpecting no big news increasing the likelihood of lief points towards for the press conferthe QE program an approaching tapering ending in third ence in July. quarter. As the of the QE3” These expectations markets should alentail a huge attenready reflect these tion to the announcement from Ber- beliefs, some adjustments regarding nanke on September 17-18th, which future tapering should already have again makes upcoming releases of taken place. Therefore, future monemacroeconomic figures crucial (espe- tary policy with regards to QE3, should cially on inflation, GDP and unemploy- in theory only have severe impacts on ment rates). the markets if the size or the timing of these deviate from the expectations.

As the tapering of QE3 is heavily depending on these key-metrics, the release of new numbers might possibly have ambiguous effects on the

41 1) Federal Open Market Commitee

Outlook on the US economy With recent revisions of the growth forecasts for 2013 by the IMF, to lower levels, and Japan as the only positive surprise this year, the global economy is still facing considerable challenges.

However, the US economy appears to be in better shape than most other major economies, as the housing market seems to have regained momentum supported by low interest rates through the purchases of mort-

gage-backed securities in the QE3.

Moreover, housing affordability has improved while consumers have significantly cut their private debt. On the other hand, the economy is currently doing badly compared to the extensive level of monetary support it receives.

One explanation to this could be the drag on growth that the tight fiscal policy implies due to the large public sector deficit.

Although unemployment is still lagging behind, the economy is back on track as real GDP has gone above pre crisis levels, in contrast to the euro zone struggling to recover properly cf.

Figure 5.

Figure 5: Real GDP, Index (100 = ‘above’ past pre-recession peek)

Source: Presentation made by Danske Bank

FINANCELAB • ISSUE SEPTEMBER 2013

The big question...

42

The big question is: is the US economy ready for monetary tightening or has the recent improvements been ‘artificial’- solely driven by FED policy? A possible answer to that question will be revealed when the tapering is soon

announced by the reaction of the markets. This results in the public awaitingfor a move by Bernanke on QE3 to see these reactions, thereby determining the future destiny of the US economy or at least bringing some answers.

profit-driven or FED-driven?

Eurozone economy – where is it going?

Investors have had their eyes on the euro collaboration since the debt crisis in 2011, and markets have still to stabilize.

Increasing volatility on equities, high rates of unemployment and a weak euro have been some of the issues in the last few years. The question now is how and when this financial turmoil will end, and how politicians and central bankers will con-vince the markets not to fear for a total eurozone breakdown.

A

est and the yield spreads in the south were severe, yet the ECB President promised to hold his hand under the economy. Did Mr. Draghi succeed?

FINANCELAB • ISSUE SEPTEMBER 2013

year ago, President of the European Central Bank, Mario Draghi, gave his famous “Whatev-er-it-takes”speech in London to preserve the euro and calm the markets. At this point in time the debt crisis was at it’s high-

43

Source: Bloomberg

Source: Bloomberg Since the speech, the yields on government bonds have decreased significantly in GIIPS countries with drops of more than 200 basis points on yields on 10-year government bonds in both Italy and Spain. The effect has been amplified by the fact that investors pay a high price for placing their money in safe havens like Denmark and

FINANCELAB • ISSUE SEPTEMBER 2013

The

44

“A-team”:

Germany, and the hunt for high returns has thus moved capital towards the periphery countries in the south.

This change in behaviour has resulted in even lower yields in the GIIPS countries, so the speech might have initiated a flight from the safest bonds. In countries like Germany, Denmark, UK and US we have seen increasing yields

The

on bonds, while yields in GIIPS has experienced opposite movements. The Euro Stoxx 50 have gained more than 19 %, and the euro has strengthened 8 % to the dollar. In the short run this speech might have been very effective monetary policy.

“B-team”:

The long run

The

“C-team”:

In the long run, the eurozone still has a long way to go. Unemployment rates are at their highest level in over 20 years and lies at 12,1 %. At the same time, trend and level of GDP for the major economies in Europe is not convincing.

France, Europe’s second largest economy, is yet again in recession and so are Italy and Spain.

The German and UK economies are moving in the right direction, but not enough to outweigh the downfalls in the rest of Europe’s large economies. This will take years to turn around, especially as initiatives are practically at a standstill as Germany has its presidential election in the fall. A positive aspect in the eurozone economy is the inflation rates. EU annual inflation is down to 1,4% in April 2013, which is the lowest in three years, and that means that the ECB still retains the possibility to keep policy rates at a minimum for a prevailing period of time.

Some of the greater economic challenges in the eurozone are low levels of demand and high levels of debt. This limits national governments fiscal stimulation of the economy; and does not support economic activity.

These issues require policy actions, both at a national and at European level.

Source: www.markit.com

FINANCELAB • ISSUE SEPTEMBER 2013

Will tight fiscal policies and structural reforms be the change that

Source: Eurostat

45

will give the European economy a rise in the forthcoming future? Before that question can be answered, we must pinpoint some of the diseases that caused the sovereign debt crisis in the first place.

In the years leading up to the global financial crisis huge increases in external imbalances were reality in some of the modern economies like the US, however not in the eurozone area as a whole with a surplus at around 2 %.

Sadly this was a truth with modifications. The GIIPS countries had major problems with increasing government deficits and the households fur-ther contributed in a negative manner with increased borrowing. Portugal had a deficit on their current account at more than 12 % of total GDP in late 2008. In Greece this number peaked at almost 16 %. These imbalances can have a major impact on rapid adjustments on capital flows and exchange rates. Together with a high level of sovereign debt, this turned out to be a very bad combination.

Partly as a result of the imbalances, a debt crisis became a reality in Europe.

Loan agreements were concluded with Greece in May 2010, Ireland in No-

vember 2010, Portugal in May 2011 and Cyprus in March 2013, making the countries able to function and avoid bankruptcy and at the same time trying to help Europe as a whole with stabilization of the markets. Unfortunately, the loan agreement to Greece was not enough to secure a sustainable debt reduction, and the huge debt level has resulted in a substantial rise in the yields on long-term government bonds. The object to calm investors wasnâ&#x20AC;&#x2122;t fulfilled either. With the recent loan to Cyprus, the universal deposit guarantee scheme was tampered with, and created uncertainty in the markets.

At present, European economy shows little signs of improvement, but dark clouds hang heavy in the horizon. According to the latest projections from the IMF the growth in real GDP in the eurozone will remain negative at -0.3 % in 2013. In 2014 the growth rate is projected to be 1.1 %. Due to rigid labour markets this positive change is not reflected in unemployment rates, which will remain high at 12.3 % in both 2013 and 2014.

The tensions on the financial markets are declining in Europe, and this is reflected in the narrowing of yield

spreads, however markets are still nervous, which was evidenced by the turmoil surrounding the loan agreements this spring. Confidence in the economies has to be re-established in order to increase consumption and keep financing of real investments at a minimum. Furthermore it is essential that firms and households find a balance between a steady reduction of debt and a moderately balanced cash flow return on investments.

Europe and the eurozone is on a recovery, however it takes time, and hangovers from the rally in the last decade requires politicians to take actions with necessary reforms concerning debt, unemployment and economic activity.

FINANCELAB â&#x20AC;˘ ISSUE SEPTEMBER 2013

Now letâ&#x20AC;&#x2122;s have a look at Japan >

46

The Effect of BoJs monetary policy on western markets

by Anne Karina Asbjørn & Mads Villemoes Povlsen

Introduction

I

n the last two decades, Japan has been suffering from no growth and periods of deflation. This is rooted in the big economic downturn in the beginning of the 1990’s and lack of political action in the aftermath. Shinzo Abe won the election in December 2012 by promising to stimulate the economy through fiscal policy, monetary policy and structural reforms. Previously there have been attempts to stimulate the economy, but growth has remained low. This is because Japan has been stuck in a balance-sheet-recession, where high savings rate and deleveraging caused lack of consumption and investments. This article will focus on the effect of the monetary policy on the Japanese economy and investigate how it might affect the economies of the western countries.

Monetary policy Figure1 shows the relationship between the monetary policy in an economy and the global economy. Monetary policy affects entities’ expectations and the global markets through a variety channels, e.g. by stimulating the positive movements that have started to appear in the economic activity, inflation expectations and financial markets. This has allowed the Nikkei index to climb more than 30% in local currency since the victory of Abe. But if Abe’s plan is to succeed, loans need to pick up further.

FINANCELAB • ISSUE SEPTEMBER 2013

Figure 1 – Monetary transition

Source: Danmarks Nationalbank

47

In February 2013, Abe appointed Haruhiko Kuroda, governor of Bank of Japan (BoJ), to implement a more loose monetary policy. The plan was to increase the monetary base with an annual pace of 60-70bn Yen (JPY). This affects the

money multiplier, which is based on the size of the monetary base relative to statutory reserves. By this plan, BoJ will exceed both the Fed and BoE in the relative size of money multiplier.

FINANCELAB • ISSUE SEPTEMBER 2013

Figure 2: Kuoda BOJ seeks to overtake Fed and BOE

48

If the money multiplier worked optimally according to normal economic theory, it would lead to an unprecedented inflation rate of 480% in Japan, which has not been the case.

Instead of having the money in bank accounts, entities prefer to buy Japanese Government bonds (JGB) in spite of zero interest rates, leading to a shortage of JPY available for lending. The monetary expansion will be ineffective as long as agents neither borrow money nor consumes, which has been the case in the last attempts in monetary stimulus. Therefore a key indicator to show if Kurodas plan works is the movement in financial assets and financial liabilities of households and non-financial corporations.

The broken line illustrates the household sector’s net savings, where a positive figure shows financial surplus. It shows that since 1998, with the exception of 5 quarters, households in Japan have paid off debt and thereby stopped borrowing. The recent development is only slightly positive.

Figure 3 – Financial asset and financial liabilities of Japanese households.

Figure 4.1: Consumption and consumer-confidence growth 5,5

6 4

Millions

However, an indication of the positive effects from the changes in Japan is observed in the consumer confidence and the very recent development in loans.

5

The consumer confidence has risen, which normally increases domestic consumption; additionally loans have increased, which can lead to a change in the financial assets and financial liabilities of Japanese households.

The non-financial corporate sector has followed a similar pattern, but much more drastically. Japanese business has been forced to undertake painful balance sheet adjustments. The companies wrote down large quantities of financial assets while paying off a tremendous amount of debt in the years from 1998 to around 2003. In the years after 2003 there was a positive movement in the economy, this ended with the global financial crisis in 2007-8 (GFC), leading to another 5 years of deleveraging. But the latest data for the end of 2012 shows a growth in financial liabilities making Japanâ&#x20AC;&#x2122;s non-financial corporate sector becoming a net investor. If this tendency continues it would offer evidence that Japan has well and truly emerged from its balance sheet recession.

2 4,5

0 -2

4 -4 -6 1995

1997

1999

2001

2003

2005

Loan Growth Y/Y

2007

2009

2011

2013

3,5

Outstanding Loans(RS)

Figure 4.2: loans of consumer 50 45 40 35 30 25 2003 2004

2005

2006

2007

2008

2009

Domestic consumption growth(RS)

2010

2011

2012

2013

10 8 6 4 2 0 -2 -4 -6 -8 -10

Consumer confidence(LS)

FINANCELAB â&#x20AC;˘ ISSUE SEPTEMBER 2013

Figure 5 - Financial asset and financial liabilities of Japanese non-financial corporate sector

49

The monetary policy’s influence on western markets It is too early to conclude whether or not the plan of Abe and Kuroda is a success. But in the following paragraph we will investigate how the policy affects the western countries.

Focus is at the channels in Figure 1 where the wealth channel has been boosted by increasing stock markets, the bank-lending channel is improved through small increases in loans from both consumers and non-financial corporates and with the growing inflations expectations the Interest channel is also affected. The most direct way that the policy influences the developed markets is through the Exchange channel, which both has ef-

fect in monetary terms through capital movements and through the movements of goods Import and Export.

One way of measuring the effect is through the latest development in earnings expectations for companies in the US, the EU and Japan. When Abe was expected to win the election, the financial markets raised their earnings expectation for Japanese companies

The increase in expected earnings for Jap- Figure 6 shows the earnings expectations (index 100=01.10.2012) anese companies might be a result of a growing confidence in the balance sheet recession ending. First and foremost the monetary expansion integrates in the real economy by boosting consumption and investments, which brings a better fundation for increasing earnings. Another effect is depreciation of JPY, which increases the competitive advantage of the Japanese companies. The depreciated JPY makes it less expensive for Japans’ trading partners, the western countries, to import from Japan instead of producing. Hence Japan might take some market share from EU and US production companies. The possible loss of production and increased competition can explain some of the lower expected earnings for EU and US Conversely, the Japanese economy fact that export to the US and EU in companies, which might extend the low has been suffering from a too ap- decreased 4,1% and 4,2% as seen in growth in the western economies. Motor preciated currency since the FED Figure7(RS) since their monetary exvehicles are one of the main exports to US and ECB started their monetary pansion. So Japan is actually just reand constitutes 19,9 % of the overall exexpansion just after the GFC. Fig- turning to the previous equilibrium; port. This might increase because the low ure7(LS) shows that the USD/ JPY otherwise you could see the US and JPY makes it attractive to substitute westlevel in 2008 was 105 and that it is EU retaliate on the monetary expanern produced cars with Japanese cars. currently 100. The effect of the Ex- sion of BoJ. change channel is supported by the

Figure 7.1: Export % of total export

Figure 7.2: exchange rate USD and EUR vs JPY

FINANCELAB • ISSUE SEPTEMBER 2013

140

50

250

130 200

120

140 130 120

110

150 110

100

100 100

90 80

50

90 80 70

70 60 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 USD/JPY

EUR/JPY

Nikkei(RS)

0

60 2003

2004

2005

2006 EUR/JPY

2007

2008

2009

2010

USD/JPY

2011

2012

2013

Source: EcoWin

As previously pointed out the exchange channel also gives rise to changes in capital movements between the countries. For instance the zero interest rate and lower JPY might give rise to carry- trades, e.g. taking a JPY loan to invest in higher yield currencies to get a positive interest rate return; or using the loan to make other investments.

Especially expansion of the monetary

base in US has historically been a factor in changes in access to finance for companies and households in other countries.

Indicators as savings rates, consumer confidence and the development in loans, shows Japan might be able to emerge from the balance sheet recession, which makes the monetary

policy effective. Earnings in Japan will probably increase but it will likely be at expense of the western countries’ earnings. The depreciation might increase global competition, change access to finance, and might yield low growth for western for some time to come.

Does a kick-ass company, need a kick-ass website?

FINANCELAB • ISSUE SEPTEMBER 2013

If you ask the famous investor, Warren Buffett or take a look at his website, BerkshireHathaway.com, the answer is very likely “no”.

51

The events we’re hosting SEPTEMBER 2013 13 - 22

16

FINANCELAB STUDY TRIP 2013 09:30 - 19:00 (22) London Event Type: Career

LIKVIDITETSPRÆMIE ELLER -STRAF? 15:30 - 17:30 Copenhagen Business School, Solbjerg Plads 3 Event Type: Education

18

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18

FINANCELAB • ISSUE SEPTEMBER 2013

19

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ASSET ALLOCATION FOR THE 21ST CENTURY 15:00 - 19:00 Fiolstræde 44 Event Type: Education

EQUITY ANALYSIS: ROCKWOOL A/S WITH SYDBANK AND INVESTMENT PANEL AARHUS 17:00 - 19:00 Auditorium E2, Campus Fuglesangs Alle, Aarhus Event Type: Education

THE WORLD ECONOMY WITH STEEN JAKOBSEN, CHIEF ECONOMIST AT SAXO BANK 18:00 - 21:00 Copenhagen Business School, Solbjerg Plads 3 Event Type: Education, Social STUDENT SOCIETY DAY 09:00 - 16:00 Copenhagen Business School, Solbjerg Plads 3 Event Type: Social

21 - 22

FINANCELAB M&A DIPLOMA COURSE 09:00 - 17:00 (22) Copenhagen Business School, Solbjerg Plads 3 Event Type: Education

22 - 23

BASIC TRADING COURSE COPENHAGEN 09:50 - 17:00 (23) Copenhagen Business School, Solbjerg Plads 3 Event Type: Education

OCTOBER 2013

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OPEN MEMBERS NIGHT: BREAKING INTO FINANCE 18:00 - 21:00 Copenhagen Business School, Solbjerg Plads 3 Event Type: Social INVESTMENT CAMP 2013 (All Day: Saturday) Copenhagen Business School, Solbjerg Plads 3 Event Type: Career

NOVEMBER 2013 3-4

BASIC TRADING COURSE AARHUS 01:00 - 01:00 (4) Campus Fuglesangs Allé, Aarhus Event Type: Education

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OPEN MEMBERS NIGHT: TALES FROM THE VAULT 18:00 - 21:00 Copenhagen Business School, Solbjerg Plads 3 Event Type: Social M&A COURSE IN COLLABORATION WITH ADVIZER 01:00 - 01:00 Campus Fuglesangs Allé, Aarhus Event Type: Education INVESTMENT CAMP AARHUS ‘13 IN COLLABORATION WITH FACCA (All Day: Saturday) S-Building, Campus Fuglesangs Allé Event Type: Career

DECEMBER 2013 5

OPEN MEMBERS NIGHT: BUY SIDE VS SELL SIDE - LONG TERM CAREERS IN FINANCE 18:00 - 21:00 Copenhagen Business School, Solbjerg Plads 3 Event Type: Social

FINANCELAB • ISSUE SEPTEMBER 2013

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