Capital Magazine #2

EDITOR-IN-CHIEF Sibo Wei HEAD OF RESEARCH Farzad Khoshnoud HEAD OF RESEARCH TEAMS Rasmus Wiman ART DIRECTOR Rui-Xin “Xinga” Li CONTRIBUTORS Louisa Brandt Hampus Engsner Annika Eving Daniel Fodor Alexander Gustafsson Johannes Hultling Jacobsen Elena Khramova Johan Källmark Lukas Magnusson Rice Mi Edward Ofori Boamah Ali Sangari Samuel Siddique Kjetil Stiansen Lennart Wang Henrik Xu Steven Zhao SALES Astrid Gustafsson WEBMASTER Lukas Kikuchi WEBSITE www.capitalmagazine.se CONTACT editor@capitalmagazine.se DISCLAIMER Opinions published in Capital Magazine do not necessarily represent the opinions of the editorial staff or KTHFS PRINTING HOUSE Wikströms tryckeri AB

O

ne might wonder how a few barren islands in the Pacific Ocean can trigger a crisis with the magnitude of the one we see today between China and Japan. The problem is that these pieces of land are significant in terms of natural resources, geopolitics, and, perhaps most significantly, national prestige. In the Modern Age, China and Japan have often had a history of hostile coexistence, and many old scars have been cut open in this recent dispute. The sad truth is that this dispute is no longer confined to the diplomatic field, where conflicts constantly erupt and die quickly. Instead, it is now also having a negative effect on financial and manufacturing transactions between the two countries. One can only hope that the two parties reach consensus sooner rather than later, for the well-being and stability of China, Japan, and the World Economy. Page four provides you with a briefing on the situation and the historical reasons behind it.

Speaking of China, the BRIC countries (Brazil, Russia, India, and China) have been important growth engines in our current global economic slowdown, and will most certainly be as important for years to come. However, sub-Saharan Africa is a highly dynamic emerging market that is gathering pace that has somewhat flown under the radar. On page 26, we give you an overview on this relatively unknown and exciting market.

If you find finance, economics, and/or corporate strategy exciting, then a summer internship at a relevant firm should be of interest. In that case, it is high time to apply.

With application deadlines approaching, applicants are hurrying to write CVs, cover letters, and online applications. With that in mind, this issue of Capital Magazine has a section dedicated to ‘career in finance’.

Here, we are first and foremost proud to present to you an exclusive interview with Annika Falkengren, CEO of SEB, where she shares some insights into her impressive career. We are delighted to have had the opportunity to meet Annika, and hope that you find the article interesting.

We are also very glad to present our first guest article, coming all the way from the University of Oslo, a very well written piece on inflation in the Eurozone. Make sure to visit their website equilibriummagazine.no.

There are many more pieces to be read and digested throughout the magazine, and unfortunately, I do not have enough space here to introduce all of them. I will therefore now leave the magazine to you to explore and read. So, without further ado, welcome to the second issue of Capital Magazine, and hope you enjoy it.

Sibo Wei Editor-in-chief

2 Contents

Contents

11

18

15 11 Annika Falkengren 15 London Banking - From Trainee to CEO Week - A Report

18 Interview: How to Break Into Finance

Exclusive interview with Annika Falkengren, one of the most influencial business leaders in Sweden.

How to break into finance? After three successful internships, Tiantian Kullander shares his experiences.

A travel report from London Banking Week with KTH Finance Society.

4 The Pacific Island Dispute 6 Europe: Inflate It 20 Energy & Commodities 24 BRIC 26 Sub-Saharan Africa 2.0 30 CDOs 32 The Notion of Risk Contents 3

THE PACIFIC ISLAND DISPUTE How a conflict over five barren islands threatens global economic recovery

4 Macro

T

he Senkaku Islands (known as the Diaoyu in China and Tiaoyutai Islands in Taiwan) holds wider importance than just rights for fishing waters, shipping lanes and even oil and natural gas extractions.

The issue is a sensitive one, as bilateral ties between Japan, China and Taiwan has been strained for decades. The region’s history is still a sensitive topic, and the Senkaku Island dispute has become the focal point of unresolved historical issues, as citizens channel their anger, frustration and sometimes xenophobic views through the dispute. There is no easy way to resolve the conflict, and its timing could hardly be worse.

Over 100 years of disagreement With a total area of seven square kilometres, the five uninhabited islands and three rocks in the East China Sea had served as an unofficial border between Chinese and Japanese rulers ever since the 19th century.

At the end of the century, Japan officially annexed the islands during the First SinoJapanese War. The islands were under Japanese control until the end of the Second World War, when Japan surrendered to the Allied forces. The peace treaty required Japan to surrender Taiwan and all islands belonging to it. There is still disagreement whether or not the Senkaku Islands were implied in that treaty. Between 1945 and 1972, during the occupation of Japan, the islands were under US administration.

China and Taiwan started making claims on the islands in 1971. Eventually, leaders in all three countries decided to bury the issue, hoping future generations would be better suited to resolve the sovereignty dispute.

Later, the islands’ importance increased due to fishing waters and shipping routes but mostly because of oil and natural gas resources. During the 21st century, boats and navies from each of the three countries have clashed in the conflicted waters.

Large-scale protests have erupted in major

cities of China, Japan and Taiwan regarding the status of the islands, especially after private Japanese owners sold the islands to the state of Japan in 2012. The state bought the islands in order to prevent them from being sold to the nationalist mayor of Tokyo, thus averting an even more serious crisis. The official Chinese response to the purchase has not been mild and protests in the country quickly turned violent. In October, when the International Monetary Fund (IMF) was holding their annual meeting in Tokyo, China decided not to send any representatives. Japanese products and companies are currently being boycotted in China. Most of the public anger is nationalistic, but geopolitical implications are the main reason why the countries are not able to resolve the conflict by simply splitting up the territory. With China on the rise, Japan is afraid that if it allows China to take control of the Senkaku Islands, it will only be the first of many such territorial claims. China, on the other hand, is in the middle of a shift of power in the ruling Communist Party. Having shaped and encouraged nationalism amongst the people, Chinese leaders are now facing brutal criticism if they back down on their territorial claims.

Trade is hurt

Anti-Japan demonstrants protesting in China.

Besides boycotting Japanese products, violent protests in China have caused Japanese companies such as Canon and Nissan to close down Chinese factories.

Evidence of a slowdown in trade between the countries can easily be observed.

Thousands of flights between the nations have been cancelled, Japanese car exports in China are down by almost 50 percent compared to last year and according to J.P. Morgan, an investment bank, car exports to China may be down by 70 percent from the third quarter to the fourth this year.

In September, Japanese exports to China had fallen by 14 percent from one year ago and chances are that Japan’s GDP will decline, as Japanese exports to China make up almost 20 percent of total exports by value. In fact, the Japanese economy has been catastrophic this September, as the dispute with China, high energy prices and low exports to the Eurozone countries have caused Japan to experience its first September trade deficit since the oil crisis in the 1970’s.

China, already worrying about growth stagnation, will suffer from Japanese manufacturers leaving the country, although the huge Chinese retail market will undoubtedly prevent Japanese retailers from exiting the market despite any shortterm violence. The increase in Chinese workers’ wages is also contributing to this trend: the importance of China’s consumer retail market is growing whilst production in the country is slowing down.

Data on bilateral trade between China and Japan suggests that Japan has the most to lose in a trade battle since China is buying a much larger part of Japan’s exports than vice versa. China also controls a huge part of many rare earth elements, a hugely demanded commodity in the Japanese hightech industry. Regardless of what country comes out on top in this dispute, the world economy will suffer. Today, weakening world exports to Chinese supply chain businesses is only part of the problem, as the Chinese retail market has become even more important for companies relying on export. East Asia is now one of the most important markets for global luxury goods companies, as the growth markets have offset declining demand in North America and Europe. The prosperity of the region is also important since it now holds a significant part of the US government debt obligations. According to monthly US Treasury data, China, Japan and Taiwan hold almost half of the amount owed by the US to foreign countries.

By some statistics, East Asia has been the most important region for economic growth for almost five years. In their October report on the World Economic Outlook, the IMF warned that the “risks for a serious global slowdown are alarmingly high”. At this point, the global economy can hardly afford any additional slowdowns in trade. With the US unable to solve its looming fiscal cliff due to a political stalemate, while the European Union is struggling for its survival, growth in Asia is more important than ever. If the countries are unable to settle their maritime disputes, the growth that the world so desperately needs right now will hardly come from East Asia.

Writers Daniel Fodor / Annika Eving / Samuel Siddique / Steven Zhao Photo Getty Images

Macro 5

Guest article

Inflate Europe, It G

ermany has a history of money printing. The German hyper inflation of the 1920s still serves as the textbook example of the dangers of a fiat currency gone amok, while the stagflation i much of the western world of the 1980s serves as a reminder of the costs of driving down inflation in modern economies. However, if the European Union and its locomotive, Germany, are to get serious about solving the euro crisis, without a messy breakup or continued suffering in Europe’s periphery, the virtues of active monetary policy must be embraced. Europe needs inflation.

Origins of the Crisis The story of the euro zone crisis is not just a story of profligate sovereign governments borrowing unlimited amounts of money to pay for wild spending sprees during the good years, asking Germany to foot the bill once it became impractical (although Greece might fit this description to some

6 Guest Article

extent). The euro crisis is to a large extent a balance of payments-crisis. Huge capital inflows to the euro zone’s periphery fuelled rapid wage growth and asset price bubbles, leaving periphery countries uncompetitive and with a large private debt burden once the bubbles burst. Due to bank bailouts and automatic stabilizers, this soon translated into increased public debt and a crisis of confidence in the euro zone periphery’s ability to service their debts, leading in turn to skyrocketing yields on sovereign bonds forcing Greece, Ireland and Portugal to ask for bailout packages from EU and the IMF. With those bailouts came conditions for spending cuts and tax increases, which added to the private debt burden by reducing private demand and stifling growth.

Balance of Payments. Eurostat 2012 The Project of Internal Devaluation Among the greatest victims of the 2008 financial crisis was Iceland. Iceland’s

banking sector amounted to several times Iceland’s GDP and the attempted bailout by the Icelandic government brought the country to the brink of bankruptcy.

However, Iceland has rebounded, boosting solid GDP growth for several years, and fast approaching its pre-crisis peak. An important explanation for this turnaround is Iceland’s independent currency. Iceland’s Krona has devalued greatly relative to the euro, thus reducing labour costs relative to its main trading partner, the EU. In addition, defaulting on its debts allowed Iceland to focus on economic growth, rather than assuaging international investors about its credit rating and meeting interest payments.

Ireland was in a situation not very different from Iceland, but being part of the euro zone has instead forced Ireland to regain competitiveness through the process known as internal devaluation.

Internal devaluation means in short to reduce relative labour costs, rather than devaluing the currency as a mean to regain take nominal wage cuts, something which competitiveness. In the absence of high inflation, this means forcing workers to rarely happens, even during periods of high unemployment, due to the phenomenon known as downward nominal wage rigidity (workers are reluctant to accept wage cuts unless everyone else does, as this would make them relatively worse off. Making everyone agree to take cuts at the same time is difficult). Ireland has made only limited progress in reducing labour costs, and the unemployment rate remains as of

late 2012 above 14 percent.

Regaining Competitiveness Currency Union

within

a

High wage growth in the previous decade, fuelled by capital inflows in the form of lending from German and other northern European banks left countries in the euro zone periphery uncompetitive. For the GIPSI countries (Greece, Italy, Portugal, Spain and Ireland) the quick route to restoring competitiveness through currency devaluation is unavailable, as long as they remain in the euro zone. For Greece, the best option would perhaps have been an orderly exit from the euro at an early point in the crisis. Greece’s debt is unlikely to ever come down to sustainable levels, and the austerity programme demanded by the Troika is wrecking tremendous damage to the Greek economy and destroying people’s faith in the European project.

Labour Cost Index 2000 = 100. Eurostat 2012

Guest Article 7

For Spain, Italy, and other peripheral economies, an exit is not, or at least should not be, necessary. These are all solvent countries that maintained fairly balanced budgets before the 2008 crisis (although Italy has had high debt levels for many years). They are now suffering from acute shortages of demand and are under pressure from financial markets that are uncertain of the countries’ capability to service their debts. Current policy in these countries has centred on budget cuts and tax increases designed to reduce budget deficits, trying to regain confidence in financial markets, with the added hope of regaining competitiveness through internal devaluation. The side effect of these contractive measures has been a further drop in private demand, thus throwing several countries, among them Spain, into recession. The Phillips curve establishes a framework about the process of wage reduction through high unemployment:

Due to nominal wage rigidity, the Phillips curve becomes nearly flat at very high levels of unemployment, which is where Spain is now, with an unemployment rate at well above 20 %. At such levels, even a substantial increase in unemployment, moving from point A to point B leads to only a marginal decrease in wages.

Looking at this in terms of the AD-AS model leads to shifting the AS schedule down from AS to AS’ with an increase in output, the strength of which depending on the slope of the AD-schedule:

rigidity that also has the perverse effect of increasing the real value of the country’s debt.

An alternative strategy would be attempting to shift the AD-schedule, i.e. increasing private demand. While the Spanish government’s hands are tied due to high sovereign debt yields, government spending cannot increase. Thus, this can only happen through aggressively expansive monetary policy from the ECB. Expansive monetary policy affects the AD-schedule through increased nominal demand, shifting it outwards, increasing equilibrium output. Because of ample spare capacity in the Spanish economy, the price level is unaffected by a monetary expansion. (Firms will not increase prices while demand is sparse and workers’ price expectations are subdued due to high unemployment.)

Spain

Philips Curve The figure shows price level change, or wage change as π on the vertical axis, and unemployment, u on the horizontal axis.

8 Guest Article

Due to high unemployment and thus ample spare capacity, we can assume that wages, and thus prices, do not increase when output rises, at least not in the short run (if and when Spain approaches full employment,this assumption obviously will not hold), this means that the AS schedule is flat. What the Spanish government is counting on is a fall in nominal wages, which in the model would translate to lowering the expected price level, thus shifting the AS-schedule down.

Lowering nominal wages is highly difficult, however, due to downward nominal wage

Spain While Spanish price level is unaffected by a monetary expansion, this is not necessarily the case for the rest of Europe. In particular, Germany has fared well in the crisis and has actually seen unemployment fall in the aftermath of 2008. In our model, this

amounts to a rising AS-schedule in output:

Germany Expansive monetary policy in Germany leads to an increase in the price level which increases output. Because the price level in Spain does not change, German wages thus rise relatively to Spanish wages, making Spain relatively more competitive, and reducing demand for German goods in Spain. To follow such a strategy, the ECB will need to accept higher inflation in Germany, while the peripheral economies’ price levels adjust, something which the ECB this far has been unwilling to do.

This relative adjustment through different levels of wage growth in the various euro zone countries could boost the process of internal devaluation, shortening the spell of massive unemployment Spain and other peripheral nations currently are facing. This is important both in terms of ending the suffering of the millions of unemployed, but also in preserving the long run potential of the economy. Long term unemployed see their skills erode, and have their lifetime earnings permanently depressed. Increased mismatch in the labour market could lead to hysteresis; that is increased natural unemployment

caused by long periods of high structural unemployment, which reduces the long run potential of the economy.

Monetary policy in and of itself will hardly be enough to bring the euro zone out of its misery, for that the problems are too deep.

Solving this crisis will require extensive political efforts. However, there are still things that monetary policy can do by conventional or unconventional means to make a difference. Arguably, the risks from doing nothing far outweigh the potential costs: massive long term unemployment, lost income from economies operating below potential and perhaps even the end of the European project, a project for which the European Union won the 2012 Nobel Peace Prize. Critics of monetary authorities both in the EU and in the U.S. have raised concerns over inflation, but such concerns have both failed to take into account the absolute lack of inflationary pressures coming from a tripling of the monetary base in the US or more subtle monetary expansion in Europe. Fearing the ghosts of yesterday should not come in the way of solving today’s issues. Europe has shown itself to master this balancing act before; it needs to do so again.

Writer Kjetil Stiansen, Equilibrium Magazine, University of Oslo Photo Alf Melin Illustration Xinga Li

Guest Article 9

Annika Falkengren Age 50 years Family Husband, 8-year-old daughter and a dog.

Favorite travel destination Maldives Hobby Being outdoors, play tennis Hidden talent Really good at baking cookies

My Journey Towards a Great Career Annika Falkengren on Her Career – From Trainee to CEO Annika Falkengren, currently the CEO of SEB Bank, is well known within European Capital markets. She has been named as the most influential and powerful woman in Swedish business.

Fortune magazine has listed her as the ninth most powerful business woman in the world. In this issue, Capital Magazine is delighted to share with you some insights on Annika’s career through this exclusive interview.

A

nnika Falkengren started her career as a trainee at SEB in 1987. Through her hard work and dedication she has risen through the ranks and is now the CEO of the same bank. However, her path to success has not been an easy one.

Before the trainee program at SEB, Annika studied Business Administration at Stockholm University. As many other students, she had no specific career goals at the time of her studies. When she graduated in the spring of 1987, the labor market conditions were quite favorable, and presented Annika with several trainee opportunities. She chose SEB as she enjoyed the idea of working for a large company that operated internationally. However, the program did not turn out to be what she originally expected.

“I found that the trainee program at SEB was not as developed as the one we have today. During one year the participants worked for a couple of months at different departments. After that they were placed where they made the best fit. To some extent, that felt like a waste of time, since

my capacities were not fully utilized.”

Being dissatisfied with the design of the program, Annika approached her manager to share her feelings and thoughts on the issue.

important to listen to your gut feeling; just take a risk and act without doing that one last check.”

Annika comments on how contemporary educational standards have made it extremely important to look for an employee that is highly driven and can make decisions based on scarce information.

“The manager actually listened to what I had to say. He asked me if I could design a trainee program as I saw fit, and so I did!

Interestingly enough, the program that I designed in 1988 is basically the same as the “The one we have today.”

“Today almost everyone has a great education and can theorize, which makes it possible to create problems comprehension from everything and question these of different problems problems from comes with age and different angles. experience. After a while There are few people you develop a feeling for who can say: ‘that’s enough planning, the kind of problems let’s do this!’

Annika pointed out that she always spoke her mind freely and preferred to provide constructive criticism instead of keeping her thoughts and beliefs to herself especially when you face” things could be done in a ”The comprehension of better and more efficient way. different problems comes This mindset is something that she with age and experience. After a has carried with her throughout her career. while you develop a feeling for the kind of problems you face, and with this intuition it Which personal traits contributed the gets easier to make these decisions quickly.” most to your successful career? And what other personal characteristics would you According to Annika, another key identify as particularly important in characteristic for successful career building career building? is an ability to stay focused on your current tasks. She points out that many of the “I have been quite good at searching for university graduates are in a great hurry to opportunities where I can expand my show their skills and to get somewhere fast. skills and responsibilities, and also do However, it is essential to have “a few years something more for the organization, of struggle to create a base, upon which you both horizontally and vertically. I am also can build your career”. good at making decisions. Sometimes it is

Interview Annika Falkengren 11

While on the subject of personalities and attributes, Annika argues that there is also a need for diversity within groups.

When asked what she looks for in team members, she emphasized the importance of having team members with different personalities that complement each other.

females are often subjected to more scrutiny. She also mentionsthat the differences between men and women become clearer as you climb higher up in the hierarchy of the company. However, in the end “it all comes down to delivering results”.

What type of people would you choose to work with?

As the CEO of SEB, do you have any further goals for your career or do you feel that you have reached the top?

“First of all I would choose a few longterm thinkers with vast experience from the finance sector. I would also look for people who are persistent and have the strength and energy to oppose me and fight for their causes. Finally, I would try to find people that see the world in a slightly different way than I do. Since I often tend to see things in black and white, people who have more of a grey-scale vision is of importance to me.”

“First of all, I think it is important to say that you never reach the top. Once you get there you have to deliver top results and you also have to stay on top, and maybe that is even more challenging than reaching it. The truly challenging work begins when you are asked to be the CEO”

“The truly challenging work begins when you are asked to be the CEO”

You are a female in a traditionally male dominated industry. Has that affected your career?

“Personally I have been very fortunate and blessed with amazing managers.

During the 1990s, when I was undergoing the biggest progress in my career, my manager was extremely focused on performance and results. This lead to a very meritocratic environment; it was very difficult to overlook good results, regardless of whether they were generated by a man or a woman”.

Annika is a strong supporter of female leadership within the organization.

She is actively involved in the women’s network and constantly looks for new opportunities for women in the bank.

“I know a lot of women within the company and I am active within their networks. As a result I can often challenge promotions, since I have greater knowledge about the women in the company and their competences. As a female leader it also becomes natural to find female applicants for all positions, and if there is none we have to ask ourselves why.”

Annika also points out the fact that

12 Interview Annika Falkengren

According to Annika, the world of finance moves fast with new regulations, changes in customer demands and other external events, which constantly encourages her to learn new things.

“It is a real challenge to make decisions for several years ahead and still be able to deliver quarterly reports that satisfy stakeholders.”

How do you look at career planning and goal setting?

“It might be a good idea not to take it too seriously. Sometimes it might cause more damage than good, as it creates a disappointment if you do not reach your goals in the time span that you hoped for.”

Annika herself became a CEO at the modest age of 40, but the most important thing according to her is to stay focused on your current tasks and to work hard.

Annika also states that choosing the right employer is also something that can really boost your career. By staying in the same company for a long time, Annika got a chance to work at different departments and learn about different parts of the bank, which contributed greatly to her personal and professional development. However, she claims that “if you’re more of the entrepreneurial kind, you might want to choose a different path.”

Leading a big company is also a big commitment. How do you make time for your personal life?

“If I feel that I have been away a lot and several weekends have been spent on traveling in the job, I have to take time to stay at home with my family.”

“I often feel like I know what to do every hour of every day for the whole year Something that Annika was very honest to come, and this can sometimes feel about during the interview was that you stressful. In order to be able to cope with cannot have everything you want at the this, it is important to find moments where same time. She pointed out that both work you can recover, and this recovery life and family life go in waves, and that phase differs a lot in time and you have to be prepared for that. importance depending on She gave an example from the “It is a real who you ask. I feel that financial crisis in 2008 when challenge to I can recover quickly she spent most of her days and often I just need talking to the Swedish make decisions for half an hour to get Financial Supervisory several years ahead back on track, but Authority and the it is important to Swedish Central Bank. and still be able to remember that some During that period she deliver quarterly days are worse and worked around the clock reports that satisfy and there was no time for some are better, and you just have to make anything other than work. stakeholders.” time for recovery.”

Even though the position of the Annika also follows a tight schedule, CEO can often be stressful and absorb a lot which often requires a lot of traveling. of time and energy, Annika finds her work During these stressful times of long very rewarding and exciting. absences and heavy workloads, her family becomes a new powerful source of energy “The most exciting part of being the and recovery for her.

CEO, is having a strong influence on the organization. However, setting the future

course for the company comes with a huge responsibility.”

Nevertheless, the job brings a lot of joy and satisfaction. Meeting with employees and customers is very rewarding, and the elation I feel in representing this company and its employees is actually a very satisfying feeling.”

What would you say is the most important thing to focus on for students who are looking for a career within finance?

“Attitude and endurance. Education is extremely important, but the right mindset is equally important. When we look at our talents, internally at SEB, we try to decide whether a person has the right mindset or if he or she is only extremely competent.

In order to be successful, you need a combination of both, an education and competence that you maintain, and a drive and an ability to get your hands dirty.”

Interview Ali Sangari Writer Johannes Hultling Jacobsen Photo Xinga Li

Interview Annika Falkengren 13

A solid business law relationship is essential.

All law firms are not the same. This becomes immediately noticeable when you will start working with a team from Hamilton.

With us you will get a partners active attention, and you can always place your trust in lawyers who have the appropriate expertise and experience. Our driving force is to provide you with legal advice that fulfills your goals. Our target, you, the client, are our first and foremost priority.

www.hamilton.se

London Banking Week 2012 – A Report Between 22-28 of October, a group of 25 KTH students visited London on a trip arranged by KTH Finance Society.

During one week, the students got to meet the most attractive firms in the financial services industry including leading investment banks, the world’s largest asset management firm, a huge private equity firm and a management consulting firm specialising in the finance sector. This article will describe the experiences from this trip as well as providing valuable insights on how to enter the finance industry.

A

fter an intense week with exams, it was finally the week everyone had been looking forward to: London banking week!

We departed from Arlanda on Sunday and arrived at our centrally located hotel at Russel Square later that same evening.

In order to prepare ourselves for this trip, I suppose all of us found it extremely useful to read Vault’s Career Guide to Investment Banking as well as browsing Mergers & Inquisitions, a website about working in the finance industry. This material explains what an investment bank is, its different business operations, job specific information and other valuable key insights.

Busy days Every day at 07:00 a.m. the alarm went off, and after an ultra-fast shower, a 10 minutes subsequent dress-up and a 15 minutes breakfast, we were ready to go. The first company visit was Morgan Stanley, a leading and global financial services firm.

They are located in Canary Wharf, one of London’s two financial districts. Canary

Wharf has some of the tallest buildings in the UK and the view from these buildings is impressive. In Canary Wharf we also visited Citi Group and Credit Suisse. The other main financial district is the City. In the City we visited BlackRock, Blackstone, Nomura, Goldman Sachs, Bank of America Merrill Lynch and Oliver Wyman.

assessment day. The assessment day is quite intense and may include several interviews, technical questions and a case. However, if you manage to get a summer internship and perform well on this internship, you have a great opportunity to receive a full time offer since the main recruiting pool for full time positions is from former summer interns.

We had two company visits per day; one in the morning and one in the afternoon.

Almost all of them started out similarly: presentations about their operations, followed by questions & answers. During these sessions we were able to ask questions about things we were curious to learn about. It could be responsibilities as a junior analyst, what differentiates a particular firm from its competitors, and practical tips on how to break into investment banking. This gave us a more thorough understanding of this business with real examples on certain deals and trades they had done.

Experiences from within

Further, a person from human resources (HR) went through the internship process.

Generally speaking, you apply on the firm’s website through their application system.

After submitting your application, you will be invited to do a numerical and sometimes a verbal test. HR really encourages practising these tests as much as possible before doing them (in the fact box you can find more information on where to practise these tests). If you are successful with your application you will have your first round interview. This interview will normally be a phone interview or held at the firm’s local Stockholm office. The interview may contain both personal questions to determine fit as well as market related questions. If this interview goes well you will typically be invited to London for an

One of the most fascinating experiences was seeing the trading floor at J.P. Morgan.

On a size similar to the area of one football pitch, there was more than 1000 employees doing sales and trading in a variety of securities and markets.

As I understood it, this is by far the biggest trading floor in London. The trading floor is typically divided into different desks selling and trading certain securities such as equities, municipal bonds and high yield bonds. On a big trading floor, i.e. that of J.P. Morgan, there can be more than 50 different desks.

Another epic experience was to sit in the conference room of BlackRock, the world’s largest asset management firm. Sitting there and knowing that the firm manages over $3.35 trillion on behalf of its clients, which is more than seven times the GDP of Sweden was just insane. On top of this, they have also advised the Federal Reserve (FED) on the rescue loan to American International Group (AIG) during the global financial crisis. This year, the Fed completed the sale of their mortgagebacked securities they received from AIG in return of the loan. This yielded a $2.8 billion net gain going back to taxpayers – a win-win for BlackRock as well as the Obama administration.

London Banking Week 15

Some firms offered us networking opportunities with both junior and senior employees. This was more informal and a perfect opportunity to demonstrate your interest, ask clever questions and impress them. When it comes to networking, always try to ask for business cards from those you have spoken with. A good tip is to write down a few words what you talked about on the back of the business card immediately afterwards.

This makes it a lot easier to write your cover letter in terms of referrals: When HR reads your cover letter he or she might ask the person you have named for their opinions.

If you have the necessary skillsets and this recommendation, you have differentiated yourself amongst the rest. Most likely the first interview waits around the corner.

In addition to this, there were some interactive sessions where we were divided into groups and solved different business problems. At one firm we were separated into two groups depending on our interest in either investment banking or markets.

Those who had an interest in investment banking did a fictitious, Mergers and

16 London Banking Week

Acquisitions d e a l.

Half of the group represented the buyer and the other half represented the seller.. Naturally the buyer wanted the business as cheap as possible whereas the seller wanted to sell for as much as possible. To agree upon a price, the deal was followed by intense negotiations. On the other hand, those who joined the market side listened to a seminar on the basics of trading volatility.

This gave the group real insight into what a trader does and how he or she can make profit by looking at volatility. The bottomline was that one could hedge movement in the stock price and take a bet on volatility.

Effectively, volatility can be seen as a price where one buys if he or she considers volatility to be too low and sells if it is too high respectively.

On our final company visit at Oliver Wyman, a management consulting firm, we did a typical interview case. However, the difference from a real one-on-one interview is that you then actually have a discussion with the interviewer. This means you will actually motivate why you

will look into this area and describe how you are thinking in general. It is not about coming up with the correct answer; rather motivate the assumptions behind the answer and how you are thinking.

Apply as soon as possible The deadlines for the summer internships are due soon. Moreover, most firms recruit on a rolling basis. Hence, if you have a great passion for finance and want to work in a challenging environment where you learn a great deal – start by applying today. Further, most firms are also looking for full-time analysts off-cycle interns and spring interns, go to their websites to find out more. Finally, stay tuned for next year’s London banking week. Take the chance to apply and meet with all the firms and experience a vivid London!

Writer Rasmus Wiman Photo Astrid Gustafsson Illustration Xinga Li

Deadline for applications

London Banking Week 17

Tiantian Kullander Age 20 years Family Younger brother Recidence Stockholm and Durham Favorite travel destination US West Coast, especially San Francisco Hobby Basketball Hidden talent Used to be a card shark

Interview:

How to Break Into Finance The financial sector has undoubtedly taken reputational hit in the recent years, as the competition is tough. Therefore, we have tried collecting insight track on how to reach your first internship in finance. This interview is dedicated to address the application process- CVs, interviews and assessments. For this purpose we would like to share Tiantians Kullander’s experience. In an era of ever-increasing competition in the internship and graduate job market, you will hopefully find it useful.

18 Interview Tiantian Kullander

Background

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am currently a third-year undergraduate at Durham University in the UK. I have been very fortunate to have had some great experiences in both investment banking and trading throughout my time here. In my first year, I completed the investment banking spring programme at Goldman Sachs, which served as a real eye-opener into the world of corporate finance. I spent 10 weeks last summer working at Jefferies & Company, a middle-market investment bank. Subsequently, I returned to Goldman Sachs this summer where I interned on a proprietary/principal trading desk, gaining invaluable exposure to various funding and credit products such as CDOs/CLOs, CDS, CLNs and other financial instruments with ‘cool’ abbreviations.

As a finance geek, I am heavily involved in the finance society at my university; I currently co-run our society’s investment fund, trading a variety of strategies including long-short equity and global macro with a focus on relative value.

Investment banking and trading are two of the most difficult fields to get into.

Based on your interviews with Jefferies and Goldman Sachs can you give some advices to our readers?

As I am sure many students will know, firstround interviews are typically competencybased. Know yourself, and know the firm you are applying for. Be prepared to give examples of times you have led or worked in a team, demonstrated communication skills, exceeded expectations, a time you failed etcetera. I know these may look easy to answer on paper, but when you are interviewing face-to-face you want to make sure that you come across as articulate and well-spoken as possible, so preparation is crucial.

Second and final-round interviews tend get more technical. Needless to say, you cannot walk into a Sales & Trading interview and not know where the S&P 500, FTSE 100, gold, Brent, WTI or EUR/USD exchange rates are trading. For Sales & Trading, expect lots of markets-related questions.

Have an opinion, and be ready to defend it.

For IBD, make sure to be up to date with recent M&A deals and IPOs. If you are applying for Debt Capital Markets and can talk about a recent bond offering or high-yield refinancing you read about on Bloomberg, that is even better.

Commercial awareness is key. From time to time, the interviewer will let you steer the conversation, so you never want to end up in a situation where you run out of things to talk about.

Internship interviews can be very rigorous – I had to go through 11 rounds at Goldman before getting my offer. Try to stay energetic and enthusiastic throughout. Don’t drink coffee or coke before your interviews.

Caffeine gets you nervous. Have a snickers or something instead.

What is your career advice for KTH students?

TIANTIAN KULLANDER Past Experience Summer Analyst, FICC Trading at Goldman Sachs 2012 Summer Analyst, M&A at Jefferies & Company 2011 Spring Week, Investment Banking at Goldman Sachs 2011

A lot of companies on the banking day emphasized that they are looking for well-rounded individuals with relevant work experience coupled with academic excellence. In order to be seen as wellrounded, how important is extra curriculum activities?

If you manage a small amount of money trading on your own account, or follow the markets, these are always great things to talk about in your interview. I personally find trading enjoyable as it ensures I am up to date with markets and looking for new investment ideas, putting me in good stead to come across as keen in interviews.

I believe that any experiences, whether it is team sports, student society involvement, or trading on your own account, that help you develop reasoning, teamwork, and communication skills are valuable.

What kind of literature and reading-materials do you recommend for preparation?

“Understand how to network in order to get ahead The Vault Guide – going to a bank to Investment B an k i ng , presentation is useless Sales & unless you speak with Trading, Asset Man age me nt , the various business and Finance representatives and Interviews are all very useful. The build some sort of FT and Bloomberg connection.” are absolutely essential.

Studying hard and getting good grades will not land you an internship.

Everyone has good grades. If you are fortunate to go to a great school like KTH, you are already one step ahead. I know KTH has an amazing Finance Society that organizes some fantastic sponsor-led events and various networking sessions. Make an effort to attend these, and make the best out of them. Apply for the London Banking Week. Understand how to network in order to get ahead – going to a bank presentation is useless unless you speak with the various business representatives and build some sort of connection. Stay in touch via email; set up a coffee meeting next time you are in London. Don’t be scared to reach out - use LinkedIn, connect with people you have not met yet and introduce yourself.

I got the chance to interview with Mark McGoldrick’s hedge fund in London through cold emailing. I have friends that interviewed with some of the world’s best hedge funds just through LinkedIn networking. The world is small enough for you to get your name out there.

If you want to get more technical – check out Rosenbaum & Pearl (this is the investment banking bible). For S&T:ers, check out Hull’s ‘Options, Futures and Other Derivatives’, as well as Fabozzi’s ‘Handbook of Fixed Income Securities’. Jack Schwager and Steven Drobny also have some trading classics. However with all said, I think staying up to date with current affairs is more important than knowing how to build an LBO or value a credit default swap.

Writer & Interview Annika Eving / Alexander Gustafsson Photo Xinga Li

Interview Tiantian Kullander 19

Has PetroChina

Seized

ExxonMobil’s Throne?

In its 2011 annual report, PetroChina, a 13-year-old Chinese state-owned oil company, declared an average daily crude oil production of 2.4 million barrels. This means that PetroChina now has the highest production capacity among the publicly traded oil companies, surpassing the former top firm ExxonMobil by 0.1 million barrels a day.

strong support from its government-owned parent company CNPC (China National Petroleum Corporation) and has grown to become the most profitable company in Asia.

N

Firstly, considering the combined oil and natural gas production, PetroChina reports 3.5 million bpd (barrels per day) of oil equivalent. While due to its tremendous advantage in natural gas, ExxonMobil reports an overwhelming 4.5 million bpd of oil equivalent.

ewspapers and websites in the Unites States get nervous. MarketWatch comments that “it might be the first time Exxon, a direct descendent of John Rockefeller’s Standard Oil, hasn’t led production stats among the world’s biggest publicly-traded oil companies.”

Indeed, born as the largest company on the planet in 1999 by the merger of two centuries-old oil companies, ExxonMobil has managed to maintain the dominance in both productivity and profitability ever since. No wonder people get shocked that a legendary giant is outstripped by an unknown firm.

However, although publicly not as famous as ExxonMobil, PetroChina is definitely not a small player. Established within the same month as the merger of Exxon and Mobil in November 1999, PetroChina enjoys

20 Energy & Commodities

“Be careful, rising China is threatening the United States!” seems to be the drum that American media beats once again. But is that the full story?

production of the US almost tripled that of China, with 299.8 against 107.7 (in trillion cubic feet).

Consequently, though it is remarkable that Chinese government has raised a fast growing oil giant, it is way too far to infer that China has been powerful enough to compete with the US on the oil field.

Moreover, in view of the biggest oil company (not publicly traded) Saudi Aramco and Russian natural gas giant Gazprom, both ExxonMobil and PetroChina would have a long way to go in order to narrow their gap with those real rulers.

Secondly, these two companies diverge on their business targets. ExxonMobil advocates a profit-oriented business model, which brought ExxonMobil a 35% profits surge to US$41.1 billion in 2011. At the same time, mainly as a government tool to secure more oil for the nation’s booming economy, PetroChina saw profits slide 5 percent to US$21 billion despite its growing production capacity.

Last but not least, do not forget that there are numerous other oil giants such as ConocoPhillips and Chevron Corporation in the United States. According to BP 2011 Energy Report, the US produced 7.8 million bpd of crude oil in 2011, while China produced merely 4.1 million bpd. Besides, on the natural gas battlefield, the total amount of

Source: Croation Center of Renewable Energy Sources (CCRES) Writer Rice Mi Illustration Henrik Xu

Peak Oil – The Fear of Running Out of Oil Predictions of peak oil have been made for many decades. Some experts predicted the maximum extraction rate to be reached as early as 1995.

This proved to be wrong. However, the recent historically high and volatile oil prices have refueled the peak oil discussion. What is peak oil and what will the consequences be when peak oil is reached?

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he definition of peak oil is the point in time where the maximum extraction rate of crude oil is reached as a result of the finite oil resources. After this point a steady decline will be expected.

It is a fact that consumption of oil increases in an ever-faster rate worldwide. An alarming example is the amount of new cars shipped to China each year, a total of 14.5 million.

The most important factor, however, is that we are very dependent on oil to have a functional economy. Everything from food production to shipping will require oil either directly or indirectly. Another example is that 95% of all types of trading are oil dependent. Therefore there is no doubt that the demand for oil will continue to rise rapidly in the medium-long term.

So what are the expected effects of peak oil on the market? The most immediate effect of reaching peak oil will be a surge in the oil prices as supply will stagnate before starting to decrease while demand continues to grow. This surge in oil prices would result

in an oil shock that would impact trade negatively and result in a slowdown of the world economy as a whole. The oil shock may even have more dramatic impact on the economy, as seen in the 1970s where many developed countries were pushed down into recession following a surge in oil prices. Countries highly dependent on export and import are likely to be impacted first and hardest as well as countries with high government debt, as they will not have the opportunity to grow out of their problems. These effects may be eased momentarily by coal or liquefied natural gas but in the long run there will be a need for a shift towards renewable energy sources. Considering the world’s current dependence on oil, that shift will not be easy to manage.

if we are able to shift our oil dependence to more renewable energy sources such as wind and sun energy. This, however, still seems to be a few decades away so all we can hope for is that peak oil will not happen in the near future. In the meantime, we need to continue developing more oil independent energy sources, both for the sake of the economy and the environment.

Sources: Timesunion.com, The Guardian and BBC Writer Lennart Wang Illustration Henrik Xu

Some countries, Mexico for example, have already seen a sharp decrease in the level of oil production. Many have sounded alarms that we are close to reaching peak oil but most experts believe that peak oil is a decade or more away in the future. The sheer fear of peak oil combined with new extraction technologies and fuel-efficient energy plants can push peak oil even further into the future, which is good news for the world economy and bad news for the environment. Also, it buys us time for the inevitable shift from finite sources of energy to renewable energy sources.

Peak oil will eventually be reached, but the effects on the market will also be less severe

Energy & Commodities 21

The Price of Oil Oil and its many different applications play an important role in today’s overall market conditions. This makes it crucial to look for events that can affect the oil prices.

Oil prices and the stock market

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hen looking back at the oil prices before the period of the great financial crisis, it shows a peak just before plunging along with world markets. Some accuse the high oil prices for being part of the cause, partially because prices of oil directly affect industries, as increased prices result in higher transport and production costs. To say that high oil prices in itself caused the crisis is most likely not correct.

Although it is widely known that a lot of other factors also played an important part, it is wrong to completely neglect it.

To demonstrate, the correlation between the overall market and the prices of oil are often very high. High oil prices or sharp declines can be identified as a warning of what is to come for the stock market.

Looking back and more closely on the United States, a peak in oil prices can be seen just before most recessions as far back as 1970. Further, this linkage is reinforced in two occasions over the past two years

22 Energy & Commodities

when comparing the WTI Crude oil price, the Dow jones industrial average and the Nasdaq 100 index. The first occasion was during February 2011 when the prices of oil were driven down due to political unrest in Libya and the second was in early may 2012 due to increased economic uncertainty within the euro zone and lower growth figures from Asia.

Emerging markets Why are emerging countries important when explaining the drivers of oil prices?

China being an emerging country and currently one of the largest importers of oil is often mentioned as the reason for the earlier steady climb in oil prices. Their continuous growth has created a climate where news about the Chinese economy often tends to cause quite notable jumps in prices. This is related to the fact that countries experiencing increased growth often need to consume more oil. Prices reacting in such a high degree show how emerging markets in a way is steering the oil price. Just recently China reported a decrease in oil imports and this was seen as a sign of a possible lower future growth, which would decrease demand for oil.

Due to this report the price of Brent crude dropped by 3.1 percent giving an example

on how the price of oil differs from the regular stock markets as commodity markets in a way are something to consider more as global markets where macroeconomics play a bigger role.

Supply and demand With the example regarding China, let us instead look at the broader picture. All commodities and their prices are mainly controlled by current/future supply and demand. Thus events that have a direct impact on these factors will affect the price. Political disturbances, new deposit discoveries and overall economic conditions are often amongst the most commonly heard news following a more noticeably change in price levels. Also, an increased amount of uncertainty is seen in the market today due to the situation in and around the OPEC area resulting in concerns regarding the future supply.

In addition, with recent reports regarding the future growth in Asia and speculative investors, the market is kept volatile. For the last five years the price of Brent crude has differed as much as $56 per barrel with current price at $110.16 per barrel with oil being the most actively traded commodity on the market.

Production costs and the American dollar As with all products the price of which you can sell something is largely connected to production costs, oil prices are not an exception. Recent increase in global concern of the environmental effects from fossil fuels has led to stricter regulations and higher taxes resulting in higher production costs thus pushing up the price of oil. The taxation aspect can for example be seen when comparing taxes on the sector in the United States. It is not uncommon to hear news regarding something happening in the United States together with a report about the current direction of the oil price.

They do produce a large amount of oil, however, not nearly as much as for example the combined countries in OPEC. Then why is the United States so important?

This is because the influence of the US dollar, the most widely used currency in commodity trading today, makes the economic climate of the United States crucial to take into account when trying to determine future prices. Often, investing in commodities is used as a hedging method against depreciation in the American dollar.

A simplified explanation is that when the value of the American dollar declines, the actual value of the product you are looking at does not.

This results in a higher

dollar cost for the same product.

Conclusion Given the rather uncertain outlook of the global economy, it is very difficult to determine the future direction of oil prices. If the Eurozone situation would stabilize and China’s growth continues it is very likely that oil prices will increase. On

the other hand, in the future it is possible that more advanced technology will make production more efficient thus lowering the production costs. However, with oil being a finite resource, a future lack of supply might inadvertently push the prices higher.

Writer Johan Källmark Illustration Xinga Li

Source: DI

Energy & Commodities 23

The BRICs - Saviors of the World Economy?

G

lobalization can no longer be described in a future context; it is here now and here to stay. Information and communication technology has been one of the main driving forces behind this growing trend of international trade and transaction. People and services no longer have to move physically. Time and space have become more closely bound allowing more output and efficiency.

This has been the main driving force for emerging markets, among which the BRICs are prominent players.

Emerging markets, as they have come to be known, are thriving in these times

24 Emerging Markets

of economic uncertainty. Prominent among these emerging markets are the BRICs (Brazil, Russia, India and China).

They are enjoying an increasing role in the world economy and politics because of their enormous human and natural resource potential.

The BRICs are taking advantage of the global nature of the word economy, by attracting investors and taking advantage of free trade. Over time these countries have shown promising economic growth and returns on investment. It is projected by many scholars that if things continue to develop in a similar pace, these economies will soon grow from middle income status to become leading word economies that will shape the global economy.

According to UN world population figures the BRICs make up a little over 40 percent of the world’s population. Economic growth and development among the BRICs currently has greatly exceeded that of the world’s leading industrialized nations after the economic crises started in 2007.

In 2009, the BRICs where responsible for almost 60% of the world’s economic growth1.

Economic outlook Goldman Sachs estimates that China might surpass the US in equity market capitalization by 2030 to become the single largest equity market in the world. Their report also showed that the BRICs may account for a little over 40 percent of the world capital market by 2013.

The BRIC countries depend on their geographic advantage and abundant natural resources for economic development.

Large amounts of foreign direct investment in these countries have provided them with the necessary financing for economic development.

Currently China and India are taking advantage of their large human resource

capacities by dominating both the manufacturing and service industries, while Brazil and Russia are utilizing their potential of possessing large quantities of raw materials.

Investment in infrastructure has increased tremendously among the BRICs. Exports from China have also been increasing yearly, branding it as the “World Factory”.

China has placed emphasis on developing technology and has committed a lot of resources to research and development.

The Future

With China being referred to as the world factory, India can be regarded as the world leading service industry. It offers services to many international corporations in the information and communication technology sector. Its service industry contributes approximately 50 percent to its GDP. India’s capital market is growing very fast, with the stock market rising significantly over the past few years. Focus on R&D has also gone a long way to propel growth in the economy. Indian companies have moved into new markets, with Tata Motor’s acquisition of the British premium car maker Jaguar Land Rover in 2008 from Ford Motors as an excellent example.

Nevertheless, the traditional sectors of the economy like farming and handcraft have not been neglected.

Multinational companies within the BRIC countries should be encouraged to develop strategies that will allow them to be more competitive in the global market place.

Growth projections from researchers show that growth among the BRICs and other emerging market countries will be up and above the average growth of the word and developed economies. This will go a long way to serve as a cushion against slower growth in the global economy.

Russia’s fast paced growth can be attributed to its massive natural resource reserves in natural gas and crude oil. This in addition to timber and precious metals account for a little over 80 percent of the country’s exports.

The BRICs have immense potential of becoming a global economic power with large consumer bases, abundant natural resources and innovative and technical skills to propel growth in the right direction to affect the global economic landscape.

Sustainable development of the BRICs depends on the effective development and utilization of their potential resources through innovation and technology.

Should the BRICs decide to come together as an economic body and cooperate more closely, they will become a force to reckon with in the global market. However this is far from being a reality presently due to differences in politics and geographical location, but it is not an option that can be totally ruled out. If achieved, this could permanently alter world trade in a way that has never been seen before.

Writer Edward Ofori Boamah Illustration Xinga Li

Brazil has the smallest economy among the BRICs. However, it is ranked among the highest in terms of investment potential. Emphasis has been placed on R&D, especially in developing bio-diesels, improving agriculture productivity and the aerospace industry. There have been a total of 7012 mergers and acquisitions from 1993 to 2010 worth a total value of US$707 billion.

Emerging Markets 25

Understanding Sub-Saharan Africa A report on the current economic situation, and identification of key opportunities going forward

W

hat is the current situation in SubSaharan Africa? For a long time, media has reported about starvation, disease, draughts, corruption and poverty.

Is the correct picture of the region really being painted or do most of us have an outdated view? Unfortunately, these images reflect the dire reality in some Sub-Saharan countries but certainly not all. This article tries to outline the possibilities that exist in Sub-Sahara today and discuss the projections for the near future. By examining a number of recent macroeconomic reports by some of the biggest authorities, this article seeks to supply a snap shot of the region with a focus on disentangling specific growth regions, industries and sectors that may be of special interest to potential investors.

A diverse set of economies and outlooks One of the largest misconceptions about Africa is a generalization that it is a single country. Although Sub-Sahara is a large market with a population of 840 million people and a GDP excess of 2 trillion dollars in 2011, making it efficiently a larger economy than any individual BRIC country,

26 Emerging Markets

each country presents unique business opportunities and challenges. Furthermore, the continent is also fairly vibrant. Over the last twenty some years, economies have reformed, markets deregulated, national debts decreased, governments have stabilized and institutions reformed.

Even conflicts, one of the major concerns when investing in Africa, have become less frequent. In matter of facts, according to a survey for the year of 2011 made by the IMF, the International Monetary Fund, six of the ten fastest growing economies in the world were located in Sub-Sahara. In the preceding year, that figure was eight and Ghana was the fastest growing economy in the world. This is further supported by looking at investment grades, the risk of default set by international credit rating firms such as Moody’s and Standard & Poor. South Africa has a sovereign credit rating of BBB+ by S&P whilst Botswana has an A-, which can be compared to India’s BBB+ and Brazil’s BBB. But where is Sub-Sahara heading?

Projections tell us that the region will continue to grow despite the global macroeconomic turmoil. This is mostly

due to the fact that Sub-Saharan countries are starting off from a very small base.

During the financial crisis of 2008, and the following years of uncertainty, SubSahara continued growing at a rate of 5 percent annually. As mentioned earlier, Africa is not a single country; thereby the opportunities at a granular level may prove to be even significantly higher.

The two largest economies of Sub-Saharan Africa’s (SSA) 57 countries will for example develop quite differently. In South Africa, GDP growth is estimated to slow down in 2013 and end up at around 3 percent.

This is mostly due to the country’s export dependence on the euro zone, and in particular trade with southern European countries. The second largest economy, Nigeria, is projected to continue to show GDP growth in the region of 6.6 percent.

The oil-producing countries will most likely have the highest GDP growth in the region in 2013 and at the top of the list is Chad and Angola. The group of countries that are named Middle-Income Countries will have the slowest developments, again due to stronger trade connections to the

rest of the world economy. The group Low-Income Countries is estimated to outperform SSA as a whole. This is mostly due to developments in commodities industries and generally high world prices on the commodities that these low-income countries export. Especially Nigeria and Sierra Leone have invested vast sums in their commodities industries and this is expected to pay off in the form of GDP growth in the years to come, which increases their exposure to the global demand of commodities.

Difficulties ahead But, all is not good. SSA is today more integrated with the world economy and international trade than ever before, which is of course very positive. However, being increasingly interlinked with the international community makes any country more dependent on foreign demand for its goods. Other threats are increased prices of oil and other commodities as this triggers inflation. In order to combat this risk, a strict monetary policy is traditionally described, which naturally impedes investments. For a region where investment spending is already too low, this is very troublesome.

In the group commonly referred to as the Big Five (South Africa, Nigeria, Kenya, Angola, and Ethiopia) there are some common policy measures that are carried out by the respective governments. The states are generally attempting to make the taxation system more effective in order to increase tax revenue that is used to fund government policies aimed at expanding the economy and lifting people out of poverty. There is a focus on decreasing

the dependence on commodities as the country’s whole export market. Angola is a country highly dependent on its oil sector. This sector is very capital intensive and has very weak linkage to the rest of the economy. Less than one percent of Angola’s working population is employed in this industry. As a consequence, even with huge growth in this sector, the unemployment rate of 25 percent is unlikely to decline. The Angolan government is hence investing in infrastructure in order to support the private sector, where jobs are anticipated to be created. Fiscal policy in this group is generally rather expansionary in order to counterbalance the slow global economic development in recent years.

The Doing Business Project, initiated by the International Finance Corporation, a sub organization to the World Bank, provides objective measures of business regulations and their enforcement across 185 economies. It covers eleven indicators ranging from the ease of starting a business to electricity supply, access to credit and contract enforcement. The Big Five countries have an average of 118, meaning they rank at place number 118 out of 185 countries. Only South Africa and Kenya make it to the top-ten of the Sub-Saharan countries. South Africa ranks as number 39 in the world and Kenya as number 121.

Hence, work is needed in order to improve the business climate in the group.

Foreign investments are important Foreign direct investments, FDIs, and foreign aid are still the main sources of external capital and financial inflow to the SSA. Nonetheless, the increase in investments in the region over the last ten

years has not created enough jobs. Africa in general has to attract more FDI so that the economies can diversify and take advantage of technology transfers and so-called spill over effects. For instance, a direct investment of $1 billion in a new mine will create more jobs in the rural areas leading to more jobs, due to the multiplier effect, and thus leading to expansion of economic output According to the OECD, the Organization for Economic Cooperation and Development, an FDI is defined as a foreign investor managing more than 10 percent of the total assets in another country. SSA experienced a 25 percent increase in FDI in 2011, which means that the region has recovered from the global financial crisis.

This increase also signals that the changes in the investment climate that occurred before the crisis still attract international capital. Another important reason as to why FDI levels are up again is that both the price of different metals, oil and agro-related commodities reached very high levels in 2011. SSA’s share of global FDI is still small and both Russia and Brazil received more external capital in 2010. China received twice the amount. OECD still remains as the largest investor in SSA but this is likely to change as other developing countries currently are investing at a faster pace.

Between the years 2003-2010, Brazil, China and India increased their FDI spending by 13 percent compared to OECD’s 7 percent.

The developing countries tend to invest in commodities industries while the developed countries have increased their investment spending in less capitalintensive sectors. Between the years 20032010, 70 percent of total FDI have been

Emerging Markets 27

invested in manufacturing industries and this industry makes up 40 percent of all new jobs. For instance, the automotive industry, which is especially labor intensive, has alone created 100 000 new jobs in SSA. Identifying investment opportunities Which country an investor should consider as a potential investment receiver depends on the company’s specific operations and conditions. However, three factors are generally worth considering; the size of the market, market growth potential and the business climate. Particularly, based on those factors, three sectors have been identified: 1 The energy sector: SSA has fantastic energy resources but at present the degree of utilization is very limited. There is a huge demand for electricity but the supply side is very small. Consequently, market makers will make efforts to meet customer needs. In many countries, government policies focus on supplying electricity to the rural areas where less than one third of the population has access to electricity. In South Africa, Industrial Development Corporation, a venture capital firm, has decided to invest US$3.4 billion in green energy during the course of the next five years. Additionally, in Botswana and South Africa, huge solar parks are planned in areas that have the best potential for solar energy in the world.

Even though SSA has proven oil, gas and coal reserves, it should be noticed that some countries are investing in renewable energy as well.

2 The mining sector: The mining sector in SSA is potentially one of the largest in the world and is expected to grow in the near future. 39 out of the 45 SSA countries have large deposits of natural resources in primary commodities and much of the reserves are unexploited. Half of the world’s minerals are found in this region. However, investments in infrastructure are needed to utilize the business opportunities the mining sector presents. Countries such as Angola and the Democratic Republic of Congo are benefitting from the roads, harbors and increased electricity supply that stem from the development of the countries’ mining sector.

3 Infrastructure: SSA is in need for improved infrastructure and the region is far behind the other developing countries.

28 Emerging Markets

SSA in general invests only 21 percent of their GDP on infrastructure compared to developing countries in Asia where that number is 42 percent. However, analysis shows that the investment rate will increase.

In countries such as Angola, Madagascar, Zambia, Mozambique and Ethiopia the infrastructure investments are projected to increase by 60 percent in the next five years.

With growing transparency, investors will hopefully be attracted to Sub-Saharan Africa at a much greater extent than now. It is evident that the issues of poverty, underdevelopment and corruption still exist in the region. As this article have highlighted, there are some positive trends that potential investors should consider.

Writer Louisa Brandt Illustration Xinga Li

Financial Weapons of Mass Destruction - The CDO Explained In the field of structured fixed income there are more ways of constructing a security than there are ice-cream flavors.

One of the most important instruments both from an evolutionary standpoint as well as a historical one is the Collateralized Debt Obligation or CDO for short. Much insight into structured fixed income can be garnered by understanding the workings of a CDO.

T

he CDO is a complicated product that did not develop overnight. It is hard to point at a specific point in time when it all begun but a certain hotel visit at Boca Raton hotel, Florida, in June 1994 was made famous by the author and journalist Gillian Tett. A group of J. P. Morgan swap bankers made history by having the first vision of credit derivatives. It all accelerated from there and the credit derivative market topped out in 2007 at an astonishing US$62 trillion. During this journey many important breakthroughs were made, such as the securitization process, off balance sheet vehicle, and tranching, which enabled the birth of the CDO. So what is a CDO? In short it is a security with multiple tranches which is issued by an SPV and is collateralized by debt obligations. Great, so what does that mean?

Unfortunately, there is no short answer so let us start with the key words.

Slice and dice A tranche or tranching is the process of slicing a security into different levels. This is done to offer investors different risks and returns depending on their appetite, all from the same asset. The process essentially works out by dividing an income stream into different tranches, usually at least three which are commonly referred to as senior, mezzanine, and equity tranches. Risk is

30 Financial Instruments

redistributed by having any losses first paid by the equity tranche. If the losses are too large we move on to the mezzanine tranche and finally if the losses are so extreme the senior tranche will need to pay up. To compensate the mezzanine tranche for the added risk, the mezzanine tranche receives higher returns than the senior tranche.

The same is true for the equity tranche compared to the mezzanine tranche. In this genius way, risky hedge funds can buy into the equity tranche and risk-averse pension funds can buy into the usually AAA rated senior tranche. By this brilliant stroke of financial engineering we are for example able to offer an AAA rated investment to a pension fund and a BBB rated investment to a hedge fund, all from the same A rated asset.

A Special Purpose Vehicle or SPV is nothing more than an off balance sheet legal entity used for parking assets such as a limited company. SPVs can be used for many reasons, for example to reduce tax burden by moving assets to an SPV registered in a tax haven. In our case it is used to ring fence assets, i.e. the SPV is

the entity which buys assets and issues the securities. It is the CDO. Collateralization or securitization is the process of pooling a number of different debts thus allowing investors to access a much wider pool of assets. This offers an effective way for the investor to diversify but also to invest in assets which otherwise is illiquid or is in any other way difficult to trade. The debt can be of one or different kind, i.e. mortgages, auto loans, credit card debt, corporate debt, student loans and more. It all depends on the security the assets are pooled for.

Constructing the CDO To construct a CDO, an SPV is first created.

It is through this entity all cash flow will be channeled. The SPV is then collateralized by buying hundreds of different debts. This is paid for by the initial investment made by investors coming in from the different tranches. A generic CDO can then look like this:

The assets bought by the SPV generate a cash flow. This cash flow is channeled through the SPV to the investors. The amount is determined by the initial conditions. When the investors invested in the CDO they were guaranteed a rate of return. It could for example be 5 percent for the equity tranche, 3.5 percent for the mezzanine tranche, and 1.5 percent for the senior tranche. Assuming that all the tranches are of the same size, this SPV pays out a 10 percent rate in total. This is offset by the payments made to the SPV by the debtors which are amounts to 10.1 percent in our example. The remaining 0.1 percent is used to pay for the management of the credit portfolio and other administrative expenses.

Develop it further This is the basic generic cash CDO which in turn can be modified in several different ways. At the height of the credit boom these made up a diminishing portion of issued CDOs where the synthetic CDO was far more common. The difference between a synthetic and cash CDO is that for a synthetic CDO, the SPV issues Credit Default Swaps (CDS) on the desired debt instead of buying it in the cash market. The main reason for this was simply that there were not enough available assets to buy for the CDOs. By using CDSs there was theoretically an unlimited supply as long as someone was willing to buy the issued credit protection. Furthermore there are some funding advantages with using CDSs since it is a credit derivative. This means there are no upfront payments made by the SPV when it issues the credit protection (CDS).

return through trading in the debt pool as opposed to a Cash flow CDO where the manager only focus on keeping the credit quality of the pool constant. There are also different kinds of CDOs depending on the collateral used. It can be mortgage or student debt as in our example but there are numerous other alternatives such as corporate debt and auto loans. It can also be other structured instruments, for example other CDOs. A CDO using other CDOs as collateral is called CDO² (CDOsquared) but the engineering did not stop there, CDO3 and higher exists though they are not as common. The reason for this is that some tranches of a CDO might be hard to sell to investors, so it is instead mixed together with other hard sold CDO tranches and out comes a brand new CDO² that can be marketed and sold. The presiding idea was that the risk could be eliminated by diversification. The problem though with diversification is that it has a diminishing effect. This combined with a zealous belief that house prices could not all fall at once throughout the whole country played an important factor in the buildup and inevitable bursting of the house pricing bubble in the USA, which led to the 2008 financial crisis.

Writer Lukas Magnusson Illustration Xinga Li

The majority of CDOs which are issued are so called Market value CDOs where the asset manager attempt to increase

Financial Instruments 31

The Notion of Risk Measuring the Unmeasurable

R

isk seems like a very simple and basic concept. Every human on the planet intuitively knows what risk is. But risk, we shall see, is actually a more elusive concept than one might think. If one is considering climbing a ladder to paint a house, the risk scenario seems obvious: the risk of falling from the ladder. But even this simple scenario is a bit more complicated than it looks. What, for instance, is an acceptable probability of falling? Or an acceptable probability of death or serious injury? How do we even judge that probability? In the case of climbing a ladder the answer is that we cannot accurately judge the involved probabilities, but that we tend to keep a good margin, making such a catastrophic event highly unlikely.

32 Financial Instruments

Risk measures within finance In finance, of course, margins are smaller and the scenarios vastly more complex.

While crises have succeeded each other, governments and investors have put more pressure on institutions to manage their risk, which has led to the increased use of risk measures. The term “risk measure” itself might require an introduction. A risk measure is a way to define how much “buffer capital” a portfolio needs to be acceptable with respect to potential losses.

The oldest and simplest of risk measures is to simply measure the volatility of the portfolio. The volatility, roughly, is how “jumpy” the portfolio is; how much it tends to go up and down from one point of time to the other. It is still common practice for funds to try to keep the volatility of the fund price low – worried investors can be quick to withdraw money from what seems to be a risky investment. However, volatility is a crude measure of risk at best. For instance, it does not differentiate between potential gains and losses, which both contribute to a high volatility. Obviously, more complex risk measures are required. Enter the closely related risk measures Value-at-Risk (VaR) and Expected Shortfall (ES).

Two common ways to measure risk Value at risk is, to put it simply, the amount you at most stand to lose in a certain time with the probability 1-p percent. The probability p percent is referred to as the confidence interval. So if a risk manager tells you that your “5 percent VaR” (with a one day time horizon) is $1000, it means that you will not lose more than $1000 by tomorrow, with 95 percent probability.

VaR is widely used, but its inherent flaw is

obvious: it does not account for what would happen in those ill-fated 5% (which would occur fairly regularly, about once a month).

Hedge fund manager David Einhorn once compared VaR to an “airbag that works all the time, except when you have a car accident”.

That is where Expected Shortfall comes into the picture. Say that we have calculated the VaR of a portfolio with p percent confidence. The Expected Shortfall at the p percent level is then what you would expect to lose given that we have lost more than the VaR number. That is, we look at the worst p percent of possible outcomes.

In many ways, it is the opposite of the VaR, but also a close mathematical relative; you can obtain the Expected Shortfall by integrating over the Value-at-Risk.

Graph illustrating VaR on a return probability distribution Use it sensibly As the more mathematically experienced readers may have figured out by now, all of these risk measures requires the user to make a small concession: to assume probability distributions for the underlying assets. This, as it has turned out, is highly problematic.

The usual procedure to obtain distributions is to fit a model to historic data that accurately describes it. And by accurately, I mean “most of the time”. And that is where it gets problematic: 99 percent of the time our models neatly describe and predict risk, but the remaining 1 percent is unknown territory – the laws of statistics seemingly cease to hold and are replaced by jungle law. This is unfortunate, since it is here, in the extreme cases, that the biggest risks are hiding. This also makes it very difficult to calculate expected shortfall, since when we try to do that we are, so to speak, in the jungle in which our model likely will not be accurate.

For this reason, Value-at-Risk, rather than expected shortfall is the most prominent risk measure when it comes to regulation and risk control, but given what we have just read, would we be better off disregarding it? This author would say no, but we need to take it for what it is: a measure of risk under normal market circumstances. We should not let a low VaR figure make us think we are not at risk, but rather look at it as a way of measuring one aspect of risk. The risk of a portfolio consists of all possible negative scenarios and their respective probabilities, not something that could ever be captured by one number. In order to properly manage risks, qualitative as well as quantitative methods must be applied.

When it comes to extreme events, in this author’s opinion, the best risk measuring tool at hand will always be our own critical thinking and imagination.

Writer Hampus Engsner Illustration Xinga Li

Financial Instruments 33

International Summer Internship 2013

Merchant Banking

Are you a professional, driven and outgoing person with a genuine interest in financial markets and strong analytical skills? Merchant Banking, SEB’s division for large corporate and institutional clients, offers talented students the opportunity to work in the exciting and demanding fields of bank and finance.

The program begins with an introduction week and team building in June and ends with a summing-up session in August.

You will be involved in SEB’s business activities and explore the environment within banking. You will work with some of the top professionals in your specific area. The introduction week includes traditional presentations, case studies with our best specialists, lunch with managers and tutors, and a team building activity.

Internships will be available in various business units and countries within Merchant Banking.

Application Please find more information about our program at sebgroup.com/career.

Positions will be available for application from 1 November.

Last day of application is 2 December.