Manipulating Earnings

To cover recent losses associated with CDS trading (see earlier post), JP Morgan sold securities in which they had an unrecognized gain. While this move will make their earnings look less negative, the trades will actually hurt firm value as they will trigger taxable gains and reduce future earning power. Thus, for long-term investors, metrics such as cash flow may be better measures then earnings, which tend to be more short-term in nature, as well as more easy to manipulate. (See article here, Reuters.)

Expect Low Interest Rates to Continue

As the "flight to quality" continues, interest rates will likely remain low for the nations considered to be the most stable (such as the U.S. and Germany). This is a simple supply and demand relationship, as interest rates represent the price of money. (See the article here, the Wall Street Journal.)

CDS Trades Continue

JP Morgan recently announced a $2 billion loss, which renewed criticisms that originally surfaced during the credit crisis. While final details are still to come, initial reports suggest that much of the loss is attributable to the sale of Credit Default Swap (CDS) contracts. Similar exposures helped lead to the downfall of Lehman Bros., Bear Sterns, and AIG following the Crash of 2008. (See the article here, Fox Business.)

Popularity of Alternative Investments Rises

Alternative investments were once thought to be the domain of sophisticated, wealthy investors. However, they are gaining popularity among financial advisors (and their clients) as they realize the potential diversification benefits they provide. In particular, hedge funds and private equity funds are becoming increasingly common additions to even mid-market investors. (See article here, Reuters.)

Germany Sells 0% YTM Bond

With the problems in Greece (and other Euro countries), investors are seeking out safe havens. Similar to Treasuries during the Crash of 2008, investors are willing to accept no return, simply for the assurance that funds will be kept safe. (See article here, Reuters)

Refinancing and MBS

With mortgage interest rates at record lows, refinancings continue to rise. This creates prepayment risk for holders of mortgage backed securities. (See article here, at CNBC.)

HP Cuts Jobs, Stock Price Rises

HP announced on May 23 that it will cut 27,000 jobs (see article). In class I asked students what they thought happened to the stock price. Most thought the price would drop since this is a negative indicator. However, the stock price actually rose 2.2% from its prior day close, while the market was flat. The issue is efficiency (and margin). If HP can sell the same amount with fewer employees, earnings will be higher--which translates to higher growth (and therefore market value).

Shorting Via Options (Facebook)

Following Facebook's IPO, investors were looking to short the stock. However, there was little (to no) available supply of shares to borrow. So, are we unable to create this position? Well, investors can resort to options.

Recall the Put-call parity equation:
S + P = C + K/(1+r)^t

If we rearrange the formula, we can create a synthetic (or replicated) position. So, if we wanted the equivalent of a short position in a stock:

-S = -C - K/(1+r)^t + P

Thus, to create a synthetic short, we would sell a call, short a t-bill (or borrow present value of exercise price) and buy a put.

For more on this, see the article here (Seeking Alpha).

Facebook Trips Circuit Breaker

The fallout of the Facebook IPO keeps getting worse. On the second day of trading, Facebook shares tripped their circuit breaker as prices dropped more than 10% in the opening minutes of trading. This is very unusual for an IPO, particularly one as highly anticipated as Facebook. Recall, these individual stock circuit breakers were implemented following the flash crash (which occurred on May 6, 2010). See the article here (Wall Street Journal).

Facebook IPO

Facebook went public on Friday, May 18. Although the trading was flawed (as Nasdaq admitted), the initial price action was quite typical of an IPO. Shares were offered at $38, but spiked to almost $42 shortly after hitting the secondary market. Shares closed just above the offering price. For about the last 15 years, the average level of underpricing (or first day return) has been 15%. So, in these terms, the Facebook IPO was not that successful.