Unemployment Rate

April 28, 2021 by Bijal GANDHI

Unemployment Rate

In this article, Bijal Gandhi (ESSEC Business School, Master in Management, 2019-2022) explains in detail about Unemployment Rate.
This read will help you understand the types of unemployment, the categories of unemployed individuals and the measures to calculate the unemployment rate.

What is the unemployment rate?

The unemployment rate is simply the percentage of the total labor force that is currently unemployed. These are individuals who are available to work and have taken measures to find work. The labor force is the total number of employed and unemployed people. This economic indicator is measured in percentage and is seasonally adjusted. The unemployment rate is considered a lagging indicator.
The unemployment rate is a very useful tool used to measure the underutilized labor force. It reflects the economy’s ability to generate employment. It basically helps in analyzing the effectiveness of the economy and its future performance.

Types of unemployment

Unemployment has been one of the most tenacious and unmanageable economic problems for several decades. Almost every country in the world has been affected by the same and therefore it is quite important to understand the types of unemployment and the reasons behind the same. There is a long list of unemployment types, but we will focus on the following important ones.

Structural unemployment

Structural unemployment is a result of technological shifts in the economy. It occurs when the existing skills of the workers are redundant due to mismatch of the skills that they possess versus the skills required. A common example would be automation of manufacturing processes, usage of robots, etc., which would cause unemployment as the workers might no longer be needed. The training of these workers may prove costly or time consuming, resulting in the workers often being displaced and unemployed for extended periods of time.

Frictional unemployment

Frictional unemployment refers to the period of unemployment after an individual leaves a particular job and till he/she finds a new one. It occurs when people voluntarily leave their jobs. It is generally short-lived. This short period of unemployment is caused naturally because it takes time for the individual to find the right job and for the companies to find the right employees. From an economic perspective, it is the least troublesome.

Cyclical unemployment

Cyclical unemployment is a result of economic downturns. It is caused during or before recessionary periods when the demand for goods and services drops drastically. The businesses to cut costs or save their companies would lay off workers resulting in unemployment.
These workers would now spend less, resulting in an even lesser demand for goods and services. Therefore, more workers would be laid-off. Cyclical unemployment creates more cyclical unemployment and therefore it becomes necessary for the government to intervene. The government may either use the monetary policy or the fiscal policy to stop this downward spiral.

How to calculate the unemployment rate?

The standard method for calculating unemployment would simply be:
Unemployment rate = Unemployed/Civilian Labor Force  100
The above formula is used to calculate the most cited unemployment rate called the U-3. For U-3 calculation, categories of individuals who work temporarily or part-time are considered employed and so are the individuals who perform at least 15 hours of unpaid family work like homemakers.

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Alternative measures of calculation

However, there are several other factors that need to be considered for calculation of the unemployment rate. Therefore, The Bureau of Labor Statistics (BLS) releases several variations of unemployment rates such as the U-1, U-2, U-4, U-5, and U-6. This is because the U-3 singularly does not convey the true picture of the unemployed labor force.

For example, the U-6 is considered as the “real unemployment rate” as it includes marginally attached workers and part-time workers unlike U-3. Marginally attached workers are the ones who have stopped looking for work in the past 4 weeks but have been looking for work for the entire year before. Those part-time workers are included who would like a full-time job if given the opportunity.

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Source: Federal Reserve Bank of St. Louis

Useful resources

About the author

Article written in April 2021 by Bijal Gandhi (ESSEC Business School, Master in Management, 2019-2022). Bijal has two years of experience in the financial markets and is currently working as a financial analyst at Mega Biopharma.

Inflation Rate

April 27, 2021 by Bijal GANDHI

Inflation Rate

In this article, Bijal GANDHI (ESSEC Business School, Master in Management, 2019-2022) explains in detail about the inflation Rate.

This read will help you understand the causes for inflation, the pros and cons of inflation and finally how to control inflation.

What is inflation?

Inflation in simple terms means an increase in the cost of living. It is basically an economic term which means that an individual must spend more money now than before to buy the same goods or services. The percentage increase in the prices over a specified period can be termed as the inflation rate. As the prices increase, the purchasing power of each unit of the currency decreases. The change in the price level of a well-diversified basket of goods and services can help estimate the decline in the purchasing power. This basket should include commodities, services, utilities, and everything else that humans need to lead a comfortable life. Therefore, the calculation of inflation is a complex process. It is measured in several ways depending upon the goods and services included in the calculation.

Deflation is the opposite of inflation and it indicates a general decrease in the prices of goods and services. It occurs when the inflation rate is lesser than 0%.

Types of inflation

Inflation rates can be divided into the following categories depending upon their characteristics,

Creeping inflation means that the prices have increased by 3% or less during a year.
Walking inflation refers to an increase in prices between 3-10% a year. It is destructive in nature and is harmful for the economy.
Galloping inflation causes an absolute havoc in the economy as the prices rise by 10% or more.
Hyperinflation is a rare phenomenon which occurs when the prices rise by 50% or more.

What are the three causes of inflation?

The rise in prices is most associated with the rise in demand. But there are several other mechanisms that result in an increase in the money supply of an economy. These mechanisms can be classified into the following three types,

Demand-pull effect

The demand-pull effect refers to the situation in which the demand exceeds the supply for goods and services. This may occur due to an increase in the money supply and credit, stimulating the overall demand. The consumers are willing and able to pay higher prices for a product thereby leading to a price rise.

Cost-Push Effect

A cost-push effect occurs when the supply is restricted while the demand is not. The supply could be restricted due to several factors like the scarcity of raw materials, the increase in the prices of production inputs, pandemics, etc. These additional costs may result in a higher cost for the finished product or reduce supply. In any case, the prices would rise resulting in inflation.

Built-in Inflation

The built-in inflation is a result of the cause-effect relationship. It is based on the people’s expectations of inflation in the coming years. The laborers and workers will demand a higher wage if they expect that the prices of goods and services will rise. Thereby increasing the cost of production. This will further result in an increase of the prices of goods and services again.

Measure of inflation

The Consumer Price Index (CPI) evaluates the change in the average price of a selected basket of goods and services over time. This predetermined basket mainly includes necessities like food, medical care, and transportation. The change in price of each component is calculated over a period and averaged to its relative weight in the basket. It is a widely used measure for both the inflation and effectiveness of the government’s policy. In the US, the CPI reports are published on a monthly and yearly basis by the U.S. Bureau of Labor Statistics. The value of inflation can be calculated over a period between two dates using the following methodology:

Formula for inflation

If you wish to know the purchasing power of a certain sum of money from one period to another, you can input data in this Inflation Calculator by the U.S. Bureau of Labor Statistics and see the results. This calculator uses the same methodology and CPI data as mentioned above.

Is inflation good or bad?

Inflation can be either good or bad depending upon the situation of individuals. For example, individuals holding cash or bonds would not like inflation as the purchasing power of their holdings would decrease. Individuals with investments in assets like real estate, commodities, etc. would appreciate inflation as the real value of their holdings will increase.

Central banks often struggle in maintaining an optimal level of inflation. Spending is encouraged over saving as increased spending will help boost economic activities. This is because it would be profitable for individuals to spend now instead of later if the purchasing power of money is expected to fall. For example, in the U.S., the Federal Reserve aims for a target rate of inflation of 2% YoY. A very high inflation rate can have catastrophic consequences. For example, Venezuela, which was suffering from hyperinflation (1087%) in 2017, collapsed into a situation of extreme poverty and uncertainty. Individuals who depend upon savings or fixed income are affected the most. This is because the interest rates in their savings accounts in the banks are lesser than the inflation rate, thereby making them poorer. Similarly, lower-income families are highly affected if the rise in their wages does not keep up with the rise in the prices. A high inflation also pressurizes governments to take actions to financially support the citizens as the cost-of-living increases.

Bijal Gandhi

Similarly, a deflation situation is not healthy as well. Consumers may put off spending as they may expect a fall in the prices. The reduced demand for goods and services will result in slow economic growth. This could further result in a recession-like situation with increased unemployment and poverty.

How to control inflation?

As discussed in the Interest rates post, the financial regulators of a country shoulder the responsibility of maintaining a stable and steady inflation rate. In the US, the Federal Reserve communicates inflation targets well in advance to keep a steady long-term inflation rate. This is because price stability helps businesses plan well ahead in future and know what to expect. The central banks through the monetary policy actions controls the money supply. For example, they adopt methods like quantitative easing to either counter deflation or to maintain the targeted inflation rate.

One powerful way for individuals would be to increase their earnings either through demanding a higher pay or promotions to keep up with inflation. Other options include investing in the stock market. Stocks are a good way to hedge against inflation. This is because a rise in the stock price will be inclusive of the effects of inflation. Another alternative would be to invest in instruments indexed to the inflation. Treasury Inflation Protected Securities (TIPS) and Series I Bonds are examples of such instruments.

Useful resources

U.S. Bureau of Labor Statistics

Investopedia Inflation Rate

The Balance How to measure Inflation

About the author

Article written in April 2021 by Bijal GANDHI (ESSEC Business School, Master in Management, 2019-2022). Bijal has two years of experience in the financial markets and is currently working as a financial analyst at Mega Biopharma.

Interest Rates

April 27, 2021 by Bijal GANDHI

Interest rates

In this article, Bijal Gandhi (ESSEC Business School, Master in Management, 2019-2022) explains in detail about Interest Rates.

This read will help you understand the impact of rising and falling interest rates and their relationship with the stock and the bond markets.

Definition of Interest Rates

Interest rate is the cost charged by the lender to the borrower for the amount borrowed. The buzz over interest rate is real as it has a huge impact on not just the stock markets but also the overall economy. It is therefore important to understand how the interest rates are set and influenced by different factors.

Economic policy

The primary goal of any nation would be to attain maximum levels of employment, stability in prices, and economic growth. To achieve these goals, the Central Bank uses the interest rates as a switch to either curb inflation or achieve growth. The federal funds rate is the rate at which banks borrow money from each other overnight. The federal body sets the target for the federal funds rate and any deviations from this target has a ripple effect over the entire economy and thereby on the stock markets. The graph below portrays the trajectory of the effective federal funds rate from 1998 to 2018.

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Impact of rising interest rates

In the US, the Federal Reserve increases the federal funds rate in order to make borrowing money more expensive for banks. The Central Bank manages this through open market operations using government securities like Treasury bills, notes and bonds. It sells the Treasury securities in order to increase the interest rates. The banks therefore would charge a higher rate to their customers. With an increase in interest rates, the consumers will now have less money to spend due a decrease in their disposable income (due to a higher cost to obtain credit). An increase in interest rates may impact the demand for goods and services. The prices may fall and thereby help the federal body curb inflation. A further rise will start impacting businesses directly. This is because businesses borrow money from banks for their operations. Rise in interest rates will discourage business spending which may not just slow down the growth of one company but the entire economy. The negative impact on the revenues and profits of a company will eventually reflect in the stock prices.

Bijal Gandhi Source: Federal Reserve & Balance.com

Impact of falling interest rates

Apart from the interest rate at which the banks borrow from one another, the Central Bank also set the reserve requirements for the banks. The reserve requirement is the percentage of deposits a bank is obliged to keep on hand each night. The Fed can also lower the reserve requirements in case it wants to encourage lending to businesses and households in the economy. Similarly, during a slump in the economy, the federal reserve may also stimulate activity by cutting down the federal funds rate. An increase in the borrowing by businesses would act as a catalyst for growth. This is because businesses would enjoy operations, expansions, and acquisitions at a cheaper rate. A lower interest rate will also result in higher consumer spending. The revenues and profits for businesses will rise thereby impacting the stock prices positively.

Relation between interest rates and stock market prices

A higher interest rate would mean higher debt costs for companies, which may result in a decrease in the projected future cash flows for stockholders. This will lower the stock price of that company and if similar situations occur in other companies in the economy, the whole stock market may decline. Not just the existing debt costs, but an interest rate hike may also discourage borrowing for expansionary measures. However, this may not be the case with all sectors. Some sectors like the financial industry may benefit from an increase in the interest rate as they can now charge more for lending. The impact cannot just be financial but also psychological. A reduction in the stock prices may also set off a bout of panic selling due to fear and uncertainty. The investors and businesses may lose confidence and would now not be willing to make any risky investments.

Relation between interest rates and bond market prices

Bond prices and interest rates have an inverse relationship: as interest rates rise, bonds prices fall and vice versa. This is because with an increase in interest rates, the cost of borrowing will also increase resulting in a decrease in demand for existing bonds which yield lower returns. Similarly, with a decrease in interest rates, companies will now issue new bonds at lower interest rates for their projects. The demand for high yielding bonds will increase and so would the prices of these bonds. The longer the maturity of a bond, the more the bond value would be subjected to fluctuations. Short-term bonds are less affected by the interest rate changes. Long-term bonds are more affected by the interest rate changes. Technically, this effect is captured by the duration measure of a bond.

Conclusion

Interest rates not just affect businesses and investors but also all individuals of the nation. They play a major role in deciding the fate of both investments and the economy and therefore it is important to understand its role and impact.

Useful resources

About the author

Article written in April 2021 by Bijal Gandhi (ESSEC Business School, Master in Management, 2019-2022).

GDP

April 27, 2021 by Bijal GANDHI

Gross Domestic Product (GDP)

In this article, Bijal GANDHI (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) explains the concept of GDP.

This read will help you understand in detail the calculation, components, variations, and drawbacks of GDP.

Gross Domestic Product

Gross domestic product refers to the total monetary value of all finished goods and services produced within a geographical region during a specific period. The final value of the product is taken into consideration instead of the product components to avoid double-counting. The GDP is calculated for a country on an annual basis through data gathered from surveys and trade flows. The calculation is generally undertaken by the country itself and occasionally by the UN agencies like the World Bank and IMF. As discussed in Economic Indicators post, the GDP is helpful in estimating both the value of an economy and its growth rate.

Measuring GDP

The GDP is primarily calculated through the following three approaches. All three methods would yield the same results if computed correctly.

The Expenditure Approach

As the name suggests, this approach calculates the total spending by different participants in the economy. Therefore, the following formula is used:

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where C represents consumption, G government spending, I investment, and (X-M) exports net of imports. Consumption is the largest and the most significant component of the GDP calculation. Consumers spend on goods and services and their willingness to spend reflects their level of confidence in the economy. Government spending refers to the sum of government consumption plus the total amount invested/spent to generate benefits for the residents. Investment by businesses is the sum of all the money invested in business activities or capital expenditures made to boost the businesses in an economy. Net exports are the total value of exports less the total value of imports. In the U.S., the Bureau of Economic Analysis (BEA) adopts the expenditure approach to calculate the GDP. The following is a snapshot of the U.S. GDP for Q3, 2020.

Bijal Gandhi
Source: Federal Reserve Bank of St. Louis.

The Income Approach

The income approach is based on the accounting logic that the total expenditures in an economy should be equal to the total income generated by the production of all the goods and services in that economy. Here, the assumption is that all revenues eventually go to either one of the four factors of production such as land, labor, capital, or entrepreneurship. Therefore, all the income generated through these factors like rent, wages, return on capital and corporate profits are summed and adjusted with taxes and depreciation.

The Production Approach

The total value of output generated by all the industries in an economy is summed in order to derive the GDP through the production approach. The cost of intermediate goods used in the production of this output is deducted from this value to avoid double-counting. Therefore, the gross value added is basically the total output less intermediate consumption.

Real GDP vs Nominal GDP

Real GDP refers to the inflation-adjusted GDP. It is important to remove the effects of inflation on GDP to make GDP comparable with the previous years. If not, then the real GDP would seem to be increasing while not the case. A price deflator is used to determine the change in prices since the base year.
Nominal GDP refers to the GDP calculated by considering the current market prices in the economy. It is basically the raw measurement which includes price changes over the years. The nominal GDP is the most used while comparing GDP between countries. The currency market exchange rates are used to convert the local currencies into U.S. dollars. Below, we can see that the U.S., China, Japan, Germany, and India dominate the market share of the world economy when measured by the Nominal GDP.

Bijal Gandhi
Source: World Bank.

Variations of GDP

GDP growth rate

The GDP growth rate is the percentage change in the GDP from one period to another. It compares one year/ quarter to another and helps policymakers take informed decisions. A negative growth rate for consecutive years suggests that the economy is contracting which further signals a recession. A very high growth rate is an indication of inflation. According to economists, a growth rate of approximately 2% is ideal for sustainable economic growth.

GDP per capita

GDP cannot be directly compared from one country to another due to the difference in the population size. One of the methods to make GDP comparable would be to use GDP per capita. In GDP per capita calculation, the total GDP is divided by the number of residents in the country. This helps in direct comparison of the standard of living of the residents of two or more nations. The real GDP per capita would be one of the optimal methods as it eliminates the effects of inflation and exchange rates as well. The following graph is the per capita growth rate of China from 1980 to 2019.

Bijal Gandhi Source: Datacommons.org

GDP and PPP (Purchasing power parity)

To make GDP comparable, it is also necessary to adjust for differences of the local currency and the exchange rate. The purchasing power parity method is used to make cross-country comparisons using the real outputs, living standards and real income.

GDP and Investing

Even though a lagging indicator, the GDP is a very important economic indicator for investors. This is because the GDP data aids investors in making comparisons and adjustments for their asset allocation. Being a direct indicator of the condition of the economy, it helps investors make well informed decisions even for their funds in other developed and developing nations. The GDP report is a good source of information and data related to inventory, corporate profits, and operating cash flows of different sectors of the economy. Also, investors can make rough estimations of the equity market value through the ratio of total market capitalization to GDP. To conclude, GDP provides a good decision-making framework for investors.

Criticisms of GDP

Even though very useful, GDP has its own share of drawbacks. The major drawback is that it does not consider the value generated through informal and illegal trade. The activities in the black market are unaccounted for and therefore this results in underestimating the actual output. Also, unpaid work and services like volunteering are not considered, even though they have a significant impact on the economy.

Another major flaw could be that it ignores the environmental costs of producing the output. The impact on the well-being of society and the costs attached to the same are ignored while calculating the GDP. Similarly, every expense or income by the government or individual is included irrespective of whether they were productive or not. Therefore, even the unproductive output regularly contributes to the GDP growth rate.

Useful resources

Investopedia World Economy

The balance GDP Definition

About the author

Article written by Bijal GANDHI (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Could the COVID-19 debt be wiped out?

April 27, 2021 by Raphaël ROERO DE CORTANZE

Could the COVID-19 debt be wiped out?

In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2018-2022) discusses the current debate surrounding the cancellation of the covid debt.

In March 2020, the French President Emmanuel Macron announced during a televised speech that the French government would “mobilize all necessary means […] to save lives, whatever the cost”. In one year, the “whatever the cost” has resulted in a sharp increase of the French national debt from 100% of GDP in March 2020 to 120% in March 2021. In 2020, debt increases and money creation have taken on unprecedented proportions. The Federal Reserve in the US and the Eurosystem in Europe have injected nearly $3 trillion and $2 trillion respectively in the economy.

For many months now, economists in Europe have been calling for a cancellation of the “Covid-debt”. What are their arguments? Why do some refuse to consider this option? What could be the consequences of such a cancellation?

How does public debt work in Europe?

The Article 123 of the Treaty on the Functioning of the European Union forbids the European Central Bank (ECB) to finance and refinance directly the members of the Eurozone. The ECB can only acquire national debt securities such as treasury bills through the secondary market: it has to repurchase the securitizes from other investors which purchased them on the primary market in the first place (where the national debt securities were first emitted).

The European national debts are mainly held (75%) by other States and institutional investors such as banks and insurance companies. The remaining 25% are held by the ECB. The debate around the covid-debt cancellation is solely focused on the 25% held by the ECB. In effect, the very idea of cancelling some of the remaining 75% of debt hold by other States and investors is inconceivable (it would immediately undermine the European union credibility, which would increase the risk linked to national European state securities, thus increasing the cost of debt financing for European countries).

Why should the Covid debt be wiped out — and why it shouldn’t

In February, 150 economists from 13 European countries (such as Thomas Piketty or Gaël Giraud) explained in an opinion page published in Le Monde, that accumulated public debt had reached a level too high to be entirely paid out without a drastic austerity that would damage European economies. They highlighted the fact that raising taxes and/or reduce public spending would have devastating social consequences.

Furthermore, according to Thomas Piketty, as 25% of the European debt is hold by the Eurosystem, which group the ECB and national central banks (such as “Banque de France”), this is equivalent to consider that European countries hold 25% of their own debt. Hence the fact that these 25% of debt are a zero-sum game. He also argues that as “it is unlikely that the ECB […] will ever decide to put these securities back on the markets or to demand their repayment, the decision to no longer count them in the total public debt could be taken now”.

From this perspective, several right and left wing public figures (such as former minister Arnaud Montebourg or economist Alain Minc) advocate for a cancellation of these 25% of debt or a conversion into a perpetual debt with a zero-percent interest rate.

On the other side of the arena, according to those who are against the cancellation, it is forbidden to cancel the debt. Christine Lagarde herself (President of the ECB) has declared such a cancellation is “unthinkable” as it would be a “violation of [the article 123 of] the European treaty” which forbids the ECB to finance and refinance directly Eurozone states.

Furthermore, in the strictest sense, the debt of Eurozone countries is held by the Eurosystem. This implies that European national debt securities generate interests, which are paid back members of the EU. This cash-flow would be cut-off if the debt were to be cancelled or converted into a zero-interest long-term debt.

Finally, some economists like Jean Pisany-Ferry (who backed of the French President Emmanuel Macron during the last 2017 presidential campaign) and Henri Sterdyniak compare this cancellation solution to a “mystification” and a “fake theory”. Cancelling the debt would make the Eurozone States “neither richer nor poorer”. According to them, the 25% of debt held by the Eurosystem is a real debt. Thus, the Covid-debt issue should be addressed with “real economic arguments” like reducing public spending to avoid future macroeconomic imbalances, rather than using a “magic trick to hide public debts”.

What could be the consequences of such a cancellation?

The opponents to this option explain that a debt cancellation goes against the long-term goal of the Eurosystem of a having a controlled inflation rate. Indeed, when a country increases its debt, it receives the amount of money lent through money creation. Money creation is supposed to increase the inflation rate in the long run. Nonetheless, the reimbursement of a debt translates into money destruction. In a perfect world without inflation, the reimbursement of a debt destroys the exact amount of money created to issue the debt, resulting in no inflation effect. Cancelling the debt would thus remove the destruction phase of money creation, which could result in the long run in an increased inflation way above the targeted inflation.

Furthermore, cancelling the debt would undermine the ECB reputation. In another opinion page published in Le Monde newspaper, 80 economists explain that “the supposed alleviation from a cancellation would be quickly cancelled out by the risk premium that the markets would inevitably charge on the signatures of the euro zone member states”. In other words, the loss in credibility of the ECB implied by the cancellation of the debt would increase the interest rate of national Eurozone national securities, thus making the financing of public debt more expensive for Eurozone states and riskier for investors.

The advocates of debt cancellation reply that the risk of creating an uncontrollable inflation is minimal, as the amount of money released by the debt cancellation would be invested in the real economy and support investments, job creation etc. To the argument of loss of credibility, Thomas Piketty replies that an unprecedented situation (the Covid crisis) requires unprecedented means of action.

Amidst this debate, what appears to be certain is that the sharp increase in public debt doesn’t threat public finances in the short run. Nevertheless, this debate introduces relevant questions for the long term, especially in the Eurozone where it could question its model. Finally, if efforts have already been made in favor of developing countries notably by the International Monetary Fund (IMF), associations such as OXFAM call for the pure and simple cancellation of the debts of these countries in order to allow them to survive the Covid crisis.

Key concepts

Eurozone

The Eurozone is a monetary union of 19 member states of the European Union that have adopted the euro as their primary currency. The monetary authority of the eurozone is the Eurosystem. The eurozone is comprised of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Eurosystem

The Eurosystem is comprised of the ECB and the national central banks of the 19 member states that are part of the Eurozone. The national central banks apply the monetary policy of the ECB. The primary objective of the Eurosystem is price stability, followed by systemic stability and financial integration.

Useful resources

Sources: Le Monde, Les Echos, Oxfam, European Union Law

https://www.lemonde.fr/idees/article/2021/02/05/la-bce-peut-offrir-aux-etats-europeens-les-moyens-de-leur-reconstruction-ecologique-sociale-economique-et-culturelle_6068861_3232.html

https://www.lemonde.fr/idees/article/2020/06/12/la-bce-devrait-des-maintenant-annuler-une-partie-des-dettes-publiques-qu-elle-detient_6042636_3232.html

What to do with Covid debt?

https://eur-lex.europa.eu/legal-content/FR/TXT/HTML/?uri=CELEX:12008E123&from=FR

https://www.lemonde.fr/idees/article/2020/05/16/jean-pisani-ferry-annuler-la-dette-c-est-toujours-en-transferer-le-fardeau-a-d-autres_6039837_3232.html

Annuler la dette des pays pauvres : une mesure d’urgence face au coronavirus

https://en.wikipedia.org/wiki/Eurozone

https://www.ecb.europa.eu/ecb/orga/escb/eurosystem-mission/html/index.en.html

About the author

Article written in April 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2019-2022).

How has the 21st century revolutionized financing methods?

April 27, 2021 by Raphaël ROERO DE CORTANZE

How has the 21st century revolutionized financing methods?

In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2018-2022) explains how the 21st century revolutionized financing methods.

In The Crisis in Keynesian Economics (1974), the British economist John HICKS described how the world economy shifted during the 20th century from the autoeconomy model to the overdrafteconomy model. An autoeconomy is an “equity” economy, dominated by self-financing and capital market financing. An overdrafteconomy is a “debt” economy, where financing is provided through debt by an intermediary (a bank or credit institution).

What were the reasons which led to this shift from autoeconomy to overdrafteconomy? Why do the evolution of markets and investment regulations during the second half of the 20th century question the typology described by John Hicks in 1974?

From the Industrial Revolution to the 1920s: the development of the autoeconomy model

In the beginning of the 19th century as the first wave of industrialization gained momentum across Europe and North America, the relative peace following the end of Napoleonic wars helped cut public spending. This period brought unparalleled increases in revenue, profit and cash flows, allowing both firms and governments to benefit from tremendous surplus and self-investing capacities. For instance, during the 19th century, the UK was able to reduce dramatically its public debt thanks to unprecedented budget surplus.

Meanwhile, financial markets were gradually asserting themselves as key players in financing the economy. Stock exchanges, which were until then mainly open government bonds, started to allow companies to seek additional financing. Companies started to combine more and more self-financing and capital market financing. The passion for the financial markets also affected the general public. In France in 1911, 45% of the inheritance in the bourgeoisie involved securities. In 1914 there were 2.4 million individual security holders (for a population of 42 million).

Until the end of the Roaring Twenties, the stock market was still very attractive. European governments financed the increase of public debt induced by the First World War through capital market financing. Even though the banking system was also developing in parallel, the financing of the economy remained dominated by financial markets and self-financing.

From the Wall Street Crash of 1929 to the 1970s: the shift towards the overdrafteconomy model

On Monday 28 October 1929 (Black Monday), the greatest sell-off of shares in US history was recorded. The Great Crash quickly spread to Europe, and with it a feeling of mistrust towards financial markets settled in. Following the 1929 crash, the first steps of banking regulation contributed to transitioning from the autoeconomy model to the overdrafteconomy model. Indeed, a separation was introduced between retail and investment banks, in order to reduce the impact of a future financial crisis on real economy (the Glass Steagall Act in 1933 in the US). In France, a deposit insurance scheme was introduced in 1934.

On the one hand, the loss of credibility of financial markets, and on the other hand the revival of banking regulation translated into a shift in financing methods. Numerous countries, such as France and Japan, used bank financing to finance the post World War II reconstruction. In most Western countries (except for the US and UK), companies and governments began preferring bank financing to capital markets financing and went into bank debt (hence the “overdraft” economy – where the economy spends more than it produces) to finance their activities.

Since the 1970s: the development of new financing methods

From the 1970s, two phenomena made financial markets appealing again, by making them more liquid and more accessible:

Financial deregulation: end of the stockbrokers’ monopoly, introduction of derivatives, abolition of regulations that hindered the free international movement of capital, etc.
Departitioning between national and international markets and between debt and stock markets.

Furthermore, the separation between retail and investment banks was abolished (in 1979 in the UK), allowing the emergence of banking behemoths (Citi Group in 1998, BNP Paribas in 2000). Banks did not lose out on these developments: they gradually established themselves as the central players in this new globalized finance.

Technical and regulatory innovations in the markets and the banking sector created financial globalization. This evolution was accompanied by a boom in the collective management of savings with the emergence of huge institutional investors. For instance, between 1980 and 2009 the amount of assets managed by pension funds was multiplied by 33.

Finally, the second part of the 20th century saw the development of new forms of financing. In 1958, in the US, new laws allowing the creation of investment firms, paved the way to private equity and venture capital, which financed the development of start-ups in Silicon Valley. The 1980s witnessed the emergence of the first Leverage Buy Out.

At beginning of the 21st century, crowdfunding through crowd equity (funding in exchange of a stake in the company) of crowd lending (funding in exchange of interests) added another new form of financing.

Thus, the 20th century witnessed the development of the forms of financing that we know today. The typology devised by John Hicks in 1974 appears now to be obsolete, as the means of financing abound, without one imposing itself as in the overdraft and autoeconomy models. Nevertheless, it allows us to understand how the events of the last century have built the globalized finance we know today.

Key concepts

Overdraft

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation, the account is said to be “overdrawn”. If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft limit, then interest is normally charged at the agreed rate. If the negative balance exceeds the agreed terms, then additional fees may be charged and higher interest rates may apply.

Deposit insurance scheme

Deposit insurance or deposit protection is a measure implemented in many countries to protect bank depositors, in full or in part, from losses caused by a bank’s inability to pay its debts when due. Because banking institution failures have the potential to trigger a broad spectrum of harmful events, including economic recessions, policy makers maintain deposit insurance schemes to protect depositors and to give them comfort that their funds are not at risk. In the European Union, the current coverage limit is €100,000.

Useful resources

John Hicks (1974) The Crisis in Keynesian Economics.

Adeline Daumard (1973) Les fortunes françaises au XIXème siècle.

Pierre-Cyrille Hautcoeur, Paul Lagneau-Ymonet, Angelo Riva (2011) Les marchés financiers français : une perspective historique.

André Strauss (1988) Evolution comparée des systèmes de financement : RFA, Royaume-Uni et Japon.

Henri Bourguinat (1992) Finance internationale.

About the author

Article written in April 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2019-2022).

Portfolio manager – Job description

April 25, 2021 by Akshit GUPTA

Portfolio manager – Job description

This article written by Akshit Gupta (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the job description of a Portfolio manager.

Introduction

A portfolio manager is an employee responsible for developing, implementing, analyzing, and managing the asset portfolios of the clients (institutional or retail investors) of the asset management firm he/she is working with. The aim of a portfolio manager is to understand the investment objective of his/her clients and provide good performance for his/her clients’ portfolios. The portfolio managed by the asset manager consists of different securities including equities, bonds, commodities, currencies, etc.

Types of portfolio managers

In general, a portfolio manager is responsible for advising or managing a client’s portfolio using various strategies which include top-down approach or bottom-up approach.

The top-down approach refers to studying the economic trends, sector analysis and looking for suitable asset classes (sectors and countries) to invest in.

Whereas, in bottom-up approach the manager majorly focuses on studying the financial information about different asset and then moves to sector and economic analysis.

The professional working as portfolio managers can be divided into two categories namely, buy side managers and sell side managers.

Buy-side portfolio managers

Buy-side managers generally work in asset management firms, investment funds, and trading firms. The managers receive financial and non-financial data of different asset classes from financial analysts.
They portfolio managers are responsible for designing and managing the portfolios of clients based on the financial analyst’s reports, client’s investment objectives and return expectations.
Buy-side managers are commonly more prestigious than sell-side managers. The competition is stiffer and entry into this job requires a knowledge of finance and a strong experience in the sector followed.

Sell-side portfolio managers

Sell-side managers are generally employed by the research division of investment banks, investment firms, brokerage houses and hedge funds. The managers are responsible for providing insights about the latest trends, developments, and financial projections about target companies. They generate reports on the basis of their analysis and provides recommendations for investment decisions to the firm’s clients.
The sell-side managers usually specialize in a particular sector or a geographical region and produce reports within that area.

Duties of a portfolio manager

Portfolio managers study the economic conditions, financial information pertaining to companies and investment strategies to manage the asset portfolio of their clients. More specifically, the important duties of a portfolio manager include the following:

Understanding client’s investment objectives – Different clients have different investment criteria based on their capital availability, duration of investments and financial position. A portfolio manager is responsible for understanding the clients’ needs, risk appetite and return expectations to design a suitable portfolio.

Studying market trends – Several economic, sector or asset-based factors affects the performance of a portfolio managed by a professional. A portfolio manager is responsible for studying and understanding the economic, sector and asset-based trends in a market.

Optimizing client’s portfolio – By studying and understanding the trends in the market, a portfolio manager should optimize the investments made for different clients. He should be able to understand different asset classes including fixed income, equities, commodities, and foreign currencies. The knowledge helps the manager to strategically allocate investments to different assets and maximize the returns for their clients.

Generating investment reports – A portfolio manager must generate and share investment reports with the clients at different time intervals. An investment report generally includes the portfolio’s value, asset performance and latest trends in the market based on the manager’s analysis.

With whom does a portfolio manager work?

A portfolio manager depending on the buy or sell side he/she is employed in, works in tandem with many internal and external stakeholders:

Retail or institutional clients of the firm- A portfolio manager works with the retail or institutional clients of the firm to design and manage their portfolios.
Sales and Trading – A portfolio manager works with the sales and trading team to execute trades based on the reports and information given by the financial analysts
Quants – to develop financial models to take decisions in terms of valuation and investment in different asset classes
Risk Managers – To manage and control the risk of the designed portfolios
Economists and Sector specialists – to gather information about specific sectors and economies
Legal Compliance – To maintain a proper check over different rules and regulations and prevent legal challenges
Equity researchers – To gather insights about financial and non-financial data about different companies

How much does a portfolio manager earn?

The remuneration of a portfolio manager depends on the type of role and organization he/she is working in. As of the writing of this article, an entry level portfolio manager working in a bank earns a base salary between €40,000–50,000 in the initial years of joining. The manager also avails bonuses and other monetary/non- monetary benefits depending on the firm he/she works at.
(Source: Glassdoor)

What training do you need to become a portfolio manager?

An individual working as a portfolio manager is expected to have a strong base in market and corporate finance. He/she should be able to understand the different financial statements, financial instruments, economic trends, and have strong research skills and interpersonal skills.

In France, a Grand Ecole diploma with a specialization in corporate or market finance is highly recommended to get an entry level portfolio manager position in a reputed bank or firm.

The Chartered Financial Analyst (CFA) certification provides a candidate with an edge over the other applicants while hunting for a job.

In terms of technical skills, a portfolio manager should be efficient in using MS Excel, Powerpoint and possess basic knowledge of programming languages like VBA.

Useful resources

Investopedia: Portfolio analyst job description

Corporate Finance Institute: What does a Portfolio manager do?

Relevance to the SimTrade course

The concepts about portfolio management can be learnt in the SimTrade Certificate:

About theory

By taking the Exchange orders course, you will know more about the different type of orders that you can use to buy and sell assets in financial markets.

By taking the Market information course, you will understand how information is incorporated into market prices and the associated concept of market efficiency.

About practice

By launching the Sending an Order simulation, you will practice how financial markets really work and how to act in the market by sending orders.

By launching the Efficient market simulation, you will practice how information is incorporated into market prices through the trading of market participants and grasp the concept of market efficiency.

About the author

Article written in April 2021 by Akshit Gupta (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Sales analyst – Job description

April 25, 2021 by Akshit GUPTA

Sales – Job description

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2019-2022) presents the job description of a Sales analyst.

Introduction

Sales analysts are sell-side analysts that develop and pitch ideas to sell financial securities to the firm’s clients and build relationships with them. They are responsible for analyzing and monitoring market activities to develop trade ideas to suit the client’s needs. The job of a sales analyst involves looking for potential assets to invest in and making PowerPoint presentations to pitch ideas to already existing and new clients. These finance professionals are employed by financial institutions like investment banks, asset management firms, hedge funds and stock brokerage firms.

The sales and trading team forms the backbone of any investment bank or asset management firm. The job of a sales analyst and a trader goes alongside, as the sales analyst conveys ideas and opportunities to the firm’s clients and the trader executes trades as per the client’s demands.

Types of Sales Analyst

A financial institution like an investment bank asset management firm or a stock brokerage firm has different departments which can be product specific or client specific. As an institution deals in different types of financial securities, with different types of clients across different geographies, a sales analyst can be divided into different categories:

Product-specific sales analyst

As a financial institution deals in many financial product categories, a sales analyst cannot keep a track of all the securities. So, the analysts are divided amongst different types of financial securities which include,

Equities
The role of a sales analyst working in the equities division is to develop and pitch ideas about equity investments to the firm’s clients. The type of investments in equities can take several forms like investments in options, futures, structured products, emerging market equities or value/ growth investment equities.
Fixed Income
The role of a sales analyst working in the fixed income division is to develop and pitch ideas about fixed income investments to the firm’s clients. The type of fixed income investment includes investment in government or municipal bonds, investments in treasury bonds or mortgage-backed securities.
Foreign exchange
The role of a sales analyst working in the foreign exchange division is to develop and pitch ideas about investments in foreign exchanges to the firm’s clients.
Commodities
The role of a sales analyst working in the commodities division is to develop and pitch ideas about investments in different commodities (like gold, silver, or crude) and their futures to the firm’s clients.

Client-specific sales analyst

As a financial institution deals with different types of clients, a sales analyst can be categorized as per the clients they serve, which includes,

Institutional clients like sovereign funds, government agencies, pension, or insurance companies
Retail investors
High net worth individuals (Private banking)
Corporates

Duties of a Sales Analyst

As the sales and trading analysts is the lifeblood of an investment bank or an asset management firm, the sales analyst working must undertake a wide range of duties which includes,

Monitoring and analyzing the financial markets to develop trading ideas
Understanding the clients’ needs and developing solutions as per their expectations
Effectively communicate with the traders, portfolio managers, equity researchers and sector specialists to stay updated with the current market information
Build strong relationship with the clients
Researching and analyzing fundamental and technical information about different financial securities

Whom does a Sales Analyst work with?

Traders – A sales analyst primarily works with the traders on the floor to execute trades as per the client’s demand and suggest entry/exit positions
Retail or institutional clients of the firm- A sales analyst works with the retail or institutional clients of the firm to understand their needs and develop trade ideas.
Portfolio managers – The sales analyst works with the portfolio managers to stay updated with the current market information
Economists and Sector specialists – A sales analyst works with the economists and sector specialists to get insights about different sectors and formulate investment strategies
Legal Compliance – A sales analyst also works with the legal compliance team of the firm to maintain a proper check over different rules and regulations and prevent legal challenges
Equity researchers – A sales analyst also works with the equity researchers to obtain insights about financial and non-financial data about different companies

How much does a Sales Analyst earn?

The remuneration of a sales analyst depends on the type of role and organization he/she is working in. As of the writing of this article, an entry level sales analyst working in a financial institution earns a salary between €45,000-€55,000/year (Source: Glassdoor). The analyst also avails bonuses based on his/her performance and other monetary/non-monetary benefits depending on the firm he/she works at.

What training do you need to become a Sales Analyst?

An individual working as a sales analyst is expected to have a strong base in market finance. He/she must possess strong knowledge of different types of financial instruments and their dynamics and should also be able to understand the market and economic trends. Besides having a strong academic knowledge, a sales analyst is also expected to have strong research and interpersonal skills to effectively communicate with the clients and build relationships.

In France, a Grand Ecole diploma from a Business School with a specialization in market finance is highly recommended to get an entry level sales analyst position in a reputed investment bank or investment firm.

The Chartered Financial Analyst (CFA) certification provides a candidate with an edge over the other applicants while hunting for a job as a sales analyst.

Also, to gain industry experience as a sales analyst, students are advised to work as interns and apprentices before stepping into this domain as full-time employees.

Useful Resources

Corporate finance institute What does a Sales analyst do?

Wallstreetprep Ultimate guide to sales and trading

Relevance to the SimTrade course

The concepts about the work of a sales analyst can be learnt in the SimTrade Certificate:

About theory

By taking the Exchange orders course, you will know more about the different type of orders that you can use to buy and sell assets in financial markets.

By taking the Market information course, you will understand how information is incorporated into market prices and the associated concept of market efficiency.

About practice

By launching the Sending an Order simulation, you will practice how financial markets really work and how to act in the market by sending orders.

By launching the Efficient market simulation, you will practice how information is incorporated into market prices through the trading of market participants and grasp the concept of market efficiency.

About the author

Article written by Akshit Gupta (ESSEC Business School, Master in Management, 2019-2022).

Short selling

April 25, 2021 by Akshit GUPTA

Short selling

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the trading strategy of Short Selling.

Introduction

Short selling refers to the act of selling a stock without actually owning it. By definition, an investor makes a short sell when he/she borrows a stock, then sells it and buys it later to return it to the lender.

The primary reason why investors choose to short sell is because they anticipate a drop in the price. The rationale behind the act is to make money when the investor actually sells the stock at a higher price and then buys the stock at a lower price when the market price of that asset falls.

This can be illustrated through an example:

If an investor shorts 10 shares of Apple currently priced at $100, then the investor will borrow 10 shares of Apple from his/her broker. Let’s say after 2 days, the stock price falls to $80, the investor will buy it back and make a profit of 10*(100-80) = $200.

In this case, the price of the stock decreased and hence, the investor could make money. Now in a contrasting scenario, the price of the stock can increase, in which case the investor will lose money.

In the above example, imagine that the investor goes short for 10 shares of Apple at $100 each and the price after 2 days increases to $150. In this case, the loss for the investor is 10*(150-100)= $500.

Since the price of the stock can keep increasing or decreasing in theory, short selling position can lead to huge losses or profits. Hence short selling comes with high risk and is usually used by hedge fund managers and institutional investors for speculation with high-risk appetite. Hedge funds are in fact the most active users of short selling positions to mitigate losses in a security or portfolio they already own.

Who short sells the most in the stock market?

Short selling can be practiced by any trader participating in the financial markets but due to the high risk involved and requirement of strong market understanding it is generally practiced by:

Hedgers: An investor who already is long in the market using options or futures contracts, will naturally short the underlying security. This is referred to as Delta Hedge.
Speculators: Speculative investors are involved in short selling to take advantage of market movements. They in fact account for a significant share of short activity.
Day Traders: These short term traders with a lot of risk exposure keep a close eye on the market movements and take short position from time to time for a very short term to hedge against their current positions.
Hedge funds: Active entities who manage funds for high net worth individuals, enterprises, or other market participants short sell on various stocks by betting on sectors, industries or companies where they expect a fall in value of the asset prices.

Mechanism of Short Selling

Since the short sell involves borrowing stock, an initial margin is required by the broker at the time the trade is initiated. For instance, this initial margin is set to 50% of the value of the short sale. This money is essentially the collateral on the short sale to protect the lender in the future against the default of the borrower.

Followed by this, a maintenance margin is required at any point of time after the trade is initiated. The maintenance is taken as 30% of the total value of the position. The short seller has to ensure that any time the position falls below this maintenance margin requirements, he/she will get a margin call and has to increase funds into the margin account.

Here is an example of a typical case of short selling and its margin mechanism:

▶ Akshit GUPTA Trader – Job description

▶ Akshit GUPTA Analysis of the Big Short movie

▶ Akshit GUPTA Analysis of the Margin call movie

▶ Akshit GUPTA Analysis of the Trading places movie

Useful resources

BusinessInsider article: What is short selling?

About the author

Article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Share buy-back

April 25, 2021 by Akshit GUPTA

Share buyback

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2019-2022) presents an introduction of a Share buyback .

Definition

Share buyback or share repurchase refers to a financial transaction where a company buys a part of its outstanding shares that it issued earlier in the market. The repurchase of shares reduces the outstanding share capital of the company and increases the ownership rights of the continuing shareholders. The shareholders who are willing to subscribe to the share buyback program are paid in cash and lose their ownership in the company to the extent of their shares sold back. The shares bought back by the company are either held by it for issuance on a future date or cancelled depending on the company’s decision.

Share buyback programs are either funded using the cash of the company or by taking additional debt to fund the buyback program. Generally, if a company takes a debt to fund the share buyback programs, it sends a mixed signal (positive as well as negative, depending on how the market participant is affected by such a program) to the market participants as the company takes on more debt. The credit rating agencies also tend to downgrade the respective company’s ratings due to the increase in debt.

Share buyback mechanism

When a company executes a stock buyback program, the transaction reduces the company’s number of shares outstanding in the market. The transaction can be carried out using several methods, some of which are:

Buyback from open market
Under such a mechanism, the company informs its brokers to systematically buy the shares from the open market at the currently prevailing market price. The action generally leads to an increase in the market price of the shares due to the increase in demand for the share and positive investor outlook for the buyback. Also, a company buying back shares from open market doesn’t have any legal limitations in terms of the buyback program, which means the company can suspend or cancel the program at any given point.
Tender offer
Another way a company can execute stock buyback program is through issuance of tender offers to the investors. The company can either issue a fixed price tender offer or a Dutch style tender offer (such offers generally have a price range and the investors have the power to decide the ideal buyback price). The company provides a fixed window to complete the buyback program and such offers are generally carried out at a premium on top of the stock’s market price.

Reasons for a share buyback program

A company can execute a share buyback program for several reasons:

Undervalued stock price – If the company’s management think that the company’s share prices in the market are undervalued, they can go for a share buyback program to decrease the number of outstanding shares in the market and increase the share prices. If the share prices increase on a later date, the company can also re-issue the bought back shares at a better market price.
Availability of debt at lower cost – The cost of equity for a company generally exceeds the cost of debt. If a company has availability of debt at lower rates, they can buy back shares from the market by taking additional debt to support the funding.
Control dilution of ownership – Whenever a company wants to control the dilution of their ownership, they resort to share buyback programs which reduces the number of outstanding shares in the market and also increases the shareholder value. The issue of Employee stock options (ESOP) is generally followed by a share buyback program which helps the company to reduce the dilution of ownership and voting rights.
Improve financial statements and ratios – Share buyback programs improves the financial ratios for a company by improving the different financial statements for the company. Share buybacks help in reducing the number of outstanding shares of a company which increases the Earning Per Share (EPS). It leads to a higher Price/Earnings ratio without having an actual increase in the earnings.
Tax benefits – In certain countries, the tax rates on dividends and capital gains differ with a high margin. A company can execute a share buyback program which benefit the investors who will have to pay lower taxes for the capital gains earned through share buybacks.
For example, in most of the countries the share buybacks are taxed at a short/long term capital gain tax rate and dividends are taxed at the income tax rate. If the income tax rate is 35% and long-term capital gain tax rate is 25% in a country, the shareholders benefit from share buy- back programs by paying less taxes if they own the shares for more than 1 year.
Avoid hostile takeover attempts – The management of a company fearing a hostile takeover can also execute a share buyback program to reduce the number of outstanding shares in the market and protect themselves from takeover attempts in the marketplace. The shares are either held by the company in their treasuries for issuance in the future or cancelled by them.

Benefits of Stock buyback

The companies benefit from the share buy back in several ways which includes,

Reduction in dilution of ownership by cancelling the shares bought-back.
Share buy backs help the companies to improve their market price of shares by reducing the number of shares available in the open market.
The companies can utilize the excess cash during period of slow growth to buy back the shares from the market.
The companies can also benefit by selling the bought back shares at higher market prices (purchased at undervalued prices).

The shareholders entering share buyback programs can benefit in following ways,

The shareholders benefits from the tax benefits on the income generated by selling the shares back to the company.
The companies generally buy back shares at a premium over the prevailing market price. The shareholders also benefit from capital gains earned in the share buyback programs.

The shareholders who don’t prefer to enter the share buy-back programs also benefits from,

Increase in market price of shares post share buybacks.
Increase in shareholder value due to decrease in the dilution of ownership.
Increase in ownership and voting rights.

Example of share buyback programs

Microsoft (2019)

In September 2019, Microsoft announced a share buyback program worth $40 billion, giving a boost to the market prices of company’s shares and the investors also saw an increase in the dividends given by the company. The company has been using its cash resources to fund this share repurchase program.

Alphabet (2019)

Alphabet (the parent company of Google) allocated more than $18 billion to fund the share repurchase program over 2019. The company has been using its cash resources to fund the buyback program. Although the company has been continuously buying back shares from the market, its number of shares outstanding in the market remains the same due to an increase in share-based compensation to its employees.

Market reaction after the announcement of a stock buyback program

The market reaction of share buyback programs is different for different market participant. But in general, the program sends a positive signal to the market as the share buyback programs show companies strong financial health and the top management’s belief in their strengths. A company undertaking share buyback generally believes their share prices are undervalued by the market. So, such a program sends a positive signal to the market regarding company’s optimism and trust in their market value.
But, if the share buyback programs are funded by taking additional debt, it can also be perceived negatively by certain market participants. Credit rating agencies and some investors have a negative outlook for companies that have higher debts. So, such a program can lead to negative sentiments about the company for some participants.

Useful resources

Investopedia article: Introduction to share buyback
Harvard business review article: “Is a Share Buyback Right for Your Company?” by Justin Pettit
The Balance article: Benefits of the stock buy-back programs

About the author

Article written by Akshit Gupta (ESSEC Business School, Master in Management, 2019-2022).

Asset management firms

April 25, 2021 by Akshit GUPTA

Asset management firms

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the role and functioning of an Asset management firm.

Introduction

Asset Management is one of the lucrative fields of the financial industry over the world. As the name suggests, it is essentially handling and management of assets and investments of a portfolio, on behalf of clients. These clients are generally corporate, institutional or government investors, third-party brokers, high net-worth individuals, or mutual funds among many others. Financial institutions that cater these services are referred to as Asset Management Firms.

For entities with large portfolios comprising of multiple and diverse tangible and intangible assets, maintenance is a genuine concern. Business requires a robust asset management framework to not only grow the valuation of clients’ portfolios, but also keep track of the operations, compliance and risks related to the assets. This is where Asset Management firms come into picture.

Benefits of an asset management firm

The asset management firms provide the clients with tools and mechanisms that enable them to handle their assets in an easy and efficient manner and optimize their businesses with maximum returns and minimum risk.
They are also responsible for managing their client’s portfolios and provide risk-adjusted returns. Thus, Asset Management firms are often acknowledged as the ‘money managers’ in the industry.

Types of products offered by asset management firms

Asset management firms offer many different products to their clients:

Mutual funds – These are a form of asset management firms that invest in less risky financial products and provide stabilized risk adjusted returns.
Index funds – Index funds are an investment funds that comprise of a portfolio of stocks (present in a market index) and tries to mimic the performance of the index.
Exchange-traded funds – ETFs are investment funds that can comprise of different stocks, bonds or indices and are traded on exchanges.
Hedge funds – Also called speculative funds, hedge funds are asset management firms that pool in money from several retail or high net worth individuals to invest in different financial products which generally provide high returns. They practice high risk investment strategies that can generate high returns.
Private equity funds – these funds pool in money from different investors and invest in private companies by taking share ownerships
Structured products – These are investment products that generally comprise of a mix of assets with interest payouts and derivatives.

Types of roles provided by asset management firms

Financial Analysts – A financial analyst is a finance professional who is responsible for making financial and investment decisions for a company. The work involves a broad area of expertise and a financial analyst generally works in corporate and investment roles.
Quants – Quants are finance professionals that work on designing, implementing, and analyzing algorithms based on mathematical or statistical models to help firms in taking financial decisions.
Economists – Economists are finance professionals who study and examine market activities in different geographical zones, economic sectors, and industries.
Sales Analyst – Sales analysts are sell-side analysts that develop and pitch ideas to sell financial securities to the firm’s clients and build relationship with them.
Portfolio Managers – A portfolio manager is a finance professional responsible for developing, implementing, analyzing, and managing the asset portfolios of the clients (institutional or retail investors) of the asset management firm he/she is working with.
Risk managers – A risk manager is a finance professional responsible to control and manage the risks arising from different financial activities that a financial institution undertakes.

Services provided by asset management firms

Some of the major services provided by asset management firms are as follows:

Financial Investing: One of the major goals of the companies is to earn returns on the assets owned by the client. They do so by the conventional trading and investment strategies approach. Firms may also introduce their own financial products such as ETFs, mutual funds, index funds, retirement pension plans etc. to cater to a wider array of clients and serve their needs.
Tracking of Assets: Another service provided by the asset management firms is to keep a track of the tangible fixed investments (like real estate or commodities) made by their clients. These services include, maintaining records of the market value, amortization and tracking of returns on these assets.
Risk Management: The asset management firms also provide risk management services to their clients on the portfolios managed by the firm. The risk managers working in the firm continuously looks for solutions to optimize the client’s portfolio and provide good returns.
Transaction Support: The asset management firms provide transaction support to their clients for executing positions in the capital markets which forms an integral part of implementing important financial decisions.

Fee structure

The business model of asset management firms is largely based on pooling in money from several investors and investing in a wide class of assets ranging from real estate to equities. The revenues generated by the firms are in form of advisory services, investment management fees, maintenance fees, commissions on transactions and incentive charges on the portfolios managed by them. The compensations can differ among different firms, products, and services. Some may even charge other commissions and transaction fees.

Generally, an asset management firm charges a management fees which is varying for different firms but generally range between 15 bps to 200 bps. Also, the firms charge incentive charges which is a percentage of the profits generated on a portfolio. These incentive charges are normally charged on the excess returns of the portfolio over the set hurdle rate.

The hurdle rate is generally the minimum returns that an investor expects on his investments. The minimum return is set by the asset management firms while making investment decisions.

Major asset managers in the world

Asset management firms are usually ranked according to their asset under management (AUM). Well-known asset management firms are:

BlackRock: BlackRock is the global leading Asset Management Firm with 6,704,235 million USD AUM (Assets under Management) as of 2020. In FY2020, they earned a total revenue of 16.2 billion USD of which nearly 80% of came from investment management services they offer their clients. The world largest provider of ETFs(Exchange Traded Funds) ‘iShares’ listed on exchanged like NYSE, LSE, SEHK, BATS etc, is a creation of BlackRock.
Vanguard Group: With 6.7 trillion USD worth AUM, Vanguard is BlackRock’s biggest competition and dominates the mutual funds market while holding a solid position in ETFs too. Vanguard funds are popular among investors not just because of their performance, but also comparatively lower fees which they manage because the group is not owned by external shareholders.
Amundi: If you are French or even European, Amundi is a familiar name. Resulting from a merger between the asset management subsidiaries of Credit Agricole Group and Société Générale in 2010, Amundi is one of the fastest growing firms with almost 1.7 trillion USD AUM leading the European Asset Management Market and among top 10 globally. They majorly deal in UCITS (Undertakings for the Collective Investment in Transferable Securities), ETFs and funds in real estate and structured products.

▶ Akshit GUPTA Trader – Job description

▶ Akshit GUPTA Financial Analyst – Job description

▶ Akshit GUPTA Economist – Job Description

▶ Akshit GUPTA Sales analyst – Job description

▶ Akshit GUPTA Portfolio Manager – Job Description

Useful resources

The balance: what is asset management?
The balance: Top 10 asset management firms in 2020

About the author

Article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Growth investment strategy

April 25, 2021 by Akshit GUPTA

Growth Investment strategy

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the strategy of Growth Investing.

Introduction

Growth investment strategy is an investment style where investors look for companies, industries, sectors, or markets that are rapidly growing and have the future potential to grow at a higher-than-average rate compared to its market or industry average. It is a part of a fundamental investment style where investors look for stocks that can provide short/long term capital appreciation on their investments rather than mere dividend earnings.

The growth investment style is the opposite of value investment style and is considered to be an offensive strategy. Value investment strategy is an investment style where investors look for shares that are undervalued by the market. It is rather a defensive strategy where the investors are conservative in approach ad have low risk appetite. An offensive strategy refers to an investment style where investors are actively looking to build up their portfolios by capital appreciations and earn higher than average returns.

A growth investor is not affected by the company’s current or historical earnings but strictly takes into consideration the company’s future growth potential before investing his/her money.

In general, growth investing is less concerned about dividend payments or stable cash inflows and is not preferred by investors who have a low-risk appetite. The income generated by companies having more-than-average growth rates are reinvested in the business to expand their growth potential and are not distributed as dividends to the shareholders. So, the growth investors look for capital appreciations over the period rather than having stable cash inflows.

For example, a growth investor Mr. X maintains a portfolio A of high growth stocks. The companies that Mr. X target are generally young companies with small market capitalization (between $300 million to $2 billion) and which have the potential to grow exponentially over the coming years. The minimum return expectation of Mr. X hovers around 15%-20% p.a.

However, the portfolio generated an annual return of 22% while the benchmark index saw an annual return of 14%. When the rate is compounded annually, a growth investor expects to double his/her money in a period of 5-6 years.

Indicators to practice Growth investment strategy

Although there is no certain set of indicators that can help an investor judge a company’s future growth potential, an investor practicing growth investment style looks for certain fundamental factors of a company before investing his money. Some of the most commonly used growth investment indicators are:

Projected future earnings – A growth investor pay close attention to the projected future earning potential of a company rather than focusing on the current or historical earnings. The aim of a growth investor is to buy stocks of a company which presents strong future growth which is generally higher than the average market growth rate.
Return on Equity – Return on equity is a good fundamental analysis tool that helps growth investors to determine how efficiently a company is using the shareholder’s equity to generate profits. The ROE multiple is calculated by dividing the company’s net profits after tax by the total shareholders equity. A growth investor prefers a company with a ROE multiple which is at least stable or increasing and generally higher than the industry or market average.
Earnings per share – The earnings per share (EPS) is an important fundamental analysis tool that is calculated by dividing the company’s earnings by the total number of shareholders. A growth investor prefers a company which has seen a steady increase in the EPS growth over the years.
Price/Earnings ratio – Price to earnings ratio is a fundamental analysis tool that helps an investor to determine how much the current market price of a company is compared to its current earnings per share. A growth investor compares the price – to – earnings multiple of a company to the average industry P/E multiple to understand the growth potential of a company compared to its industry’s growth.
Price/Earnings to Growth ratio – Price/earnings to growth (PEG) ratio is calculated by dividing the price/earnings ratio of a company by its expected future growth rate. This multiple provides more comprehensive information about the company’s future potential.

In the current era, startups are considered to be a very hot space for investors practicing growth investment strategy on their portfolios. Although, the current earnings of the startups might be zero or negative, they hold true growth potential and can provide exponential returns on the investments made by growth investors.

Some of the typical industries that growth investors prefer to invest in include technology and healthcare services. Both the sectors have the power to provide revolutionary and cutting-edge products to the market. The prices for stocks of such companies can sharply rise in a short period of time, making them a trending place for growth investors.

Useful Resources

Corporate finance institute A guide to growth investing

About the author

Article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Risk Manager – Job description

April 25, 2021 by Akshit GUPTA

Risk Manager – Job Description

This article written by Akshit Gupta (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the job description of a Risk Manager.

Introduction

Ever since the financial crisis of 2008, new rules and regulations have been put into place by different regulatory authorities across the world. These rules and regulations demand strict monitoring of a financial institution’s risk exposure and compliance with them. They have emphasized the practice of risk management in almost all the financial institutions and companies across the world.

Risk management practices involve setting up policies and procedures in place to assess, analyze, control, and manage different risks that an institution is exposed to.

Within the scope of finance, a risk manager is responsible to control and manage the risks arising from different financial activities that a financial institution undertakes. The risk manager does his/her job by setting up policies and procedures to analyze and mitigate the risk inherent in these day-to-day activities. Different banks and institutions have specifics models in place to monitor and quantify their risk exposure.

Types of risk managers

To analyze and mitigate the risk present across the organization, risk managers are appointed across different departments and their field of expertise includes the following categories:

Credit risk manager

The job of a credit risk manager involves analyzing and mitigating the risk arising from,

default on different loans a bank has given to its clients (total credit exposure)
Or, counterparty risk which may arise if the other party to the investment or trading transaction (futures, options, or swaps) may not fulfil their obligation

The most important factor when working as a credit risk manager involves evaluating, controlling, and managing the risk of default by the clients to whom loans have been extended to or counterparties. A credit risk manager uses quantitative models to assess credit risk. For retail customers, credit risk is often assessed with scoring methods. For the securities issued by firms (commercial paper and bonds for example), credit rating agencies also play a major role in assigning ratings based on the counterparty’s financial conditions.

Market risk manager

The job of a market risk manager involves analyzing and mitigating the risks of loss of an institution’s capital arising from its operations in financial markets. Banks, investment and trading firms have several portfolios comprising of financial instruments including stocks, bonds, derivatives, commodities, currencies, or interest rates. The performance of these instruments is monitored of a continuous basis. A market risk manager is responsible for monitoring the financial markets on a real time basis and implement appropriate measures to protect the institution’s capital. Different quantitative models like VaR and stress tests are used to analyze and control an institution’s exposure to market risk. (For example, in a trading firm, an market risk can arise from fluctuations in international commodity prices, interest rates, foreign exchange rates, or in equity shares that a firm trades in.)

Operational risk manager

The job of an operational risk manager involves analyzing and controlling the internal risk of an institutions arising from lack of rules and regulations or human errors. The risk can be due to human errors which can include corruption, internal frauds or malpractices followed by employees. (For example, a trader at an investment firm can take a trading position with leverage in excess to the approved amount. Such a position can put the firm in a difficult position if the market moves in an un-favorable direction leading to heavy losses to the firm.) An operational risk manager is responsible for setting up internal checks and controls to monitor an institution’s risk exposure related to its internal operations. He should ensure implementation and monitoring of procedures and methods by employees to ensure proper compliance to internal and external regulations.

(For example, a trader at an investment firm can take a trading position with leverage in excess to the approved amount. Such a position can put the firm in a difficult position if the market moves in an un-favorable direction leading to heavy losses to the firm.)

With whom does a risk manager work?

In a financial institution, the risk management departments are generally present in the middle office, overlooking the functioning of the back, middle and front office. The risk managers take inputs from the front office, which has the most significant trading activities and client interactions, to manage credit or market risks.

Since the job of a risk manager covers a wide area of activities, he/she works in coordination with different teams to ensure smooth functioning of an institution. (For example, the sales and trading team provides the risk managers with financial and transactional inputs which helps the risk managers to make statistical models and mitigate the counterparty or market risk arising from any transaction.) Some of the other most common teams a risk manager works with are:

Sales and trading team
Quants
Legal compliance
External regulatory bodies
Sector specialists and economists
Portfolio managers

How much does a risk manager earn?

The openings for the job of a risk manager have been increasing ever since the financial crisis of 2008. The remuneration of a risk manager depends on the type of role and organization he/she is working in. As of the writing of this article, an entry level risk manager working in a bank earns between €40,000–50,000 in the initial years of joining (source: Emolument).

As the analyst grows in experience, he/she earns an average salary of €70,000–80,000 including bonuses and extra benefits.

What training do you need to become a risk manager?

An individual working as a risk manager is expected to have a strong base in market finance and mathematics. He/she should be able to understand financial statements issued by firms (for credit risk) and statistical models (for market risk). As the risk manager talks to different employees, he/she should show strong interpersonal skills.

In France, a Grand Ecole diploma with a specialization in market finance is highly recommended to get an entry level risk manager position in a reputed bank or firm. The
Financial Risk Management (FRM) certification also provides a candidate with an edge over the other applicants while hunting for a job.

Useful resources

Efinancemanagement article: Introduction to financial risk

Relevance to the SimTrade course

The concepts about risk management can be learnt in the SimTrade Certificate:

About theory

By taking the Exchange orders course, you will know more about the different type of orders that you can use to buy and sell assets in financial markets.

By taking the Market information course, you will understand how information is incorporated into market prices and the associated concept of market efficiency.

About practice

By launching the Sending an Order simulation, you will practice how financial markets really work and how to act in the market by sending orders.

By launching the Efficient market simulation, you will practice how information is incorporated into market prices through the trading of market participants, and grasp the concept of market efficiency.

About the author

Article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

The GameStop saga

April 24, 2021 by Alexandre VERLET

The GameStop saga

In this article, Alexandre VERLET (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) explains the GameStop saga. Why does the app “Robinhood” bears its name so well? Did hedge funds actually kneeled down before a bunch of Reddit users? What is a short squeeze? Let’s find out!

Speculation on GameStop

For some, it is a massive collusion that dangerously overvalued a firm, for others, forum users beat the greedy Wall Street hedge funds at their own game and allowed millions of ordinary millennials to make money. GameStop, which is now being referred to as the MOASS (the Mother of All Short Squeezes), is a financial drama that challenged Wall Street players and public regulators and a premise of the major shifts that amateur investing will impose upon financial markets. It all started on the Reddit forum called “WallStreetBets” in early January 2021, where amateur investors were merely sharing hinches and posting memes about their latest profits or losses. It became much more than that the day some users started to take personally the short selling of GameStop, a video games firm that had been a part of their teenage years and that they considered seriously undervalued. That was the spark that triggered a massive buy trend on the GameStop stock, to both support GameStop and to make money out of the big funds that seemed to always win on the markets. Then, a speculation bubble grew as the media started to report what was happening, amateur investors betting that millions of others would join the party, making money out of it and beating the hedge funds at their own game. The GameStop share rose from around $20 in early January to $480 in late January, a 2,300% increase that caused the short-selling hedge funds in what is known as a short squeeze position.

Figure 1. GameStop share price.

Source: Source: Google Finance.

Short selling

In order to understand what a short squeeze is, you must first get familiar with the concept of shorting. The simplest definition of shorting a stock would be to bet against that stock, meaning that one anticipates the stock price will drop at some point and wishes to make a profit out of that fall. Usually, an investor can either buy or sell a stock to respectively bet it will go up or down, but selling a stock implies the investor owns that stock. Although that sounds rather obvious, selling without owning a stock at all is actually possible – it is known as a “naked short”-, but it is theoretically illegal to do so in the USA. What investors do when they want to bet against a stock but do not own it, which is by far the most common case, is to place a “covered short”, meaning they borrow the stock from a broker in exchange for a commission, sell it for its current market price at time t, and buy it later once the price has fallen, say, at t+1. The current market price at time t minus the market price at time t+1 minus the broker’s commission is the investor’s profit. That is what happens when the investor is right. When he or she is wrong, things get trickier. Investing on financial markets is by definition risky, but buying shares only exposes the investor to lose the money invested. On the other hand, short-selling exposes to a loss that is theoretically limitless: a share price is bounded by 0 for a caller, but could rise to levels that could send the short seller to bankruptcy. That is what the short squeeze is all about: if the share price at time t+1 is much higher than at time t, buying the shares would mean a massive loss for the investor.

Now, the obvious question would be: why on earth would an investor sell at time t+1 and expose himself to massive losses, and not just wait for the share price to go down later? The first reason is that the investor pays fees to the broker that work like an adjustable interest rate, meaning the price rise will also drive the brokers fees up to the point that the investor might lose big, especially if he or she has to wait long enough for the price to go back to its selling price (and even lower than that to compensate the broker’s fees paid in-between). Second, the regulator, in our case the clearing house, ensures the solvability of investors by demanding they either refund their margin account or liquidate assets to make sure they are able to face their financial obligations towards the broker – this process is known as a “margin call”. The short squeeze happens when the investor is forced to buy back the shares he borrowed and sold initially, at a price that is much higher, which further drives the share price up in the case of a big investor.

In the case of GameStop, the short sellers were indeed big investors, with at least the two hedge funds Melvin Capital and Citron Capital short squeezed only a couple of weeks after the frenzy began. Since those investors short sold the stocks for around 20$, you can easily imagine that being forced to sell around 350$ costed huge amounts of money to those firms- up to $5 billion. What is brand new about GameStop, is the fact that the short squeeze was orchestrated by a group of amateur investors with no connections in Wall Street and using a public internet forum. The fact that it happened in 2021 is not so random. In recent years, social networks laid the ground for collusion at large scale, “free” trading apps such as Robinhood made investing as easy as a game, and the lockdowns imposed in 2020 boosted amateur investing activity. Considering the dreadful reputation of hedge funds, particularly since the 2008 crisis, such news was welcomed with much enthusiasm on the internet and beyond.

Political issues and future challenge for regulators

Consequently, when GameStop trading was frozen on the investing apps, the issue became political: “People on Wall Street only care about the rules when they’re the ones getting hurt. It’s time for SEC and Congress to make the economy work for everyone” said US Senator Sherrod Brown (Chairman of the Senate Banking Committee). Investor populism gained support on both sides of the political scene, as exemplified by the similar positions held by the Democrat AOC and the Republican Ted Cruz in favor of the amateur investors. Unfortunately, the reality is more complex than just GameStop being a victory for the democratization of finance where the mob overthrows the big players who run Wall Street. The SEC is currently investigating where the profits of the short squeeze went, and ironically a significant part of it might have been generated by innovative hedge funds who anticipated the trends by tracking forums and app data. Therefore, if financial markets keep attracting amateur investors people in the coming years, and they most likely will, a huge challenge awaits financial regulators. Meanwhile, AMC and Blackberry’s shares have been the next targets of the Reddit traders, and there is no doubt that the MOASS will engender many more financial dramas. To be continued…

GameStop – Power to the players GameStop - Power to the players

Source: GameStop

Useful resources

WallStreetBets

Robinhood

GameStop (GME) (Yahoo Finance)

About the author

This article was written in April 2021 by Alexandre VERLET (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Fixed-income products

April 19, 2021 by Jayati WALIA

Fixed-income products

In this article, Jayati WALIA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) presents fixed-income products.

Introduction

Fixed-income products are a type of debt securities that provides predetermined returns to investors in terms of a principle amount at maturity and/or interest payments paid periodically up to and including the maturity date (also known as coupon payments). For investors, fixed-income securities pay out a fixed set of cashflows that are known in advance and are hence preferred by conservative investors with low-risk appetite or those looking to diversify their portfolio and limit risk exposure. For companies and governments issuing these securities, it is a mechanism to raise capital to fund operations and projects.

The most elementary type of fixed-income instrument is the coupon-bearing bond. The values of different bonds depend on the coupon size, maturity date and market view of future interest rate behaviours (or essentially bond market yields). For eg., prices of bonds with longer maturity fluctuate more by interest rate changes. Bonds are generally traded OTC unlike equity stocks that are traded via exchanges. The risk exposure of a bond can be gauged by their Credit Rating issued by rating agencies (S&P, Moody’s, Fitch). The least risky bonds have a rating of AAA which indicates a high measure of credit worthiness and minimum degree of default.

Fixed-income products can come in many forms as well which include single securities like treasury bills, government bonds, certificate of deposits, commercial papers and corporate bonds, and also mutual funds and structured products such as asset back securities.

Types of fixed-income products

Fixed-income products come in several structures catering to the needs of investors and issuers. The most common types are explored below in detail:

Treasury bills

Treasury bills (also called “T-bills”) are money market instruments that are issued by governments with a short maturity ranging from one month to one year. These bills are used to fund short-term financing needs of governments and are backed by the Treasury Department. They are issued at discounted value and redeemed at par value. The difference between the issuance and redemption price is the net gain or income for the investor. The T-Bills are generally issued in denomination of $1,000 per bill. For example, if you buy a T-bill issued by the US Department of Treasury with a maturity of 52 weeks at $990, you will redeem your T-bill at a price of $1,000 upon maturity.

Treasury notes and bonds

Treasury notes and bonds are a type of fixed-income security issued by governments with a medium or long maturity beyond one year. These bonds are used to fund permanent financial needs of governments and are backed by the Treasury Department. They come with predetermined interest payments. They are considered to be the safest investment since they are backed by the government. As a consequence, government bonds come with low returns. Government bonds are usually traded over the counter (OTC) markets. Technically, government bonds come in various forms: zero-coupon bonds, fixed payment and inflation protected securities.

Corporate bonds

Corporate bonds, as the name suggests, are issued by corporations to finance their investments. They generally come with higher yields as compared to the government bonds as they are perceived as more risky investments. The expected return for such bonds generally depends on the company’s financial situation reflected in its credit rating. Corporations can issue different types of bonds which includes zero-coupon bonds, floating-rate bonds, convertible bonds, perpetual bonds, and subordinated bonds.

Asset-backed securities

Asset-backed securities (ABS) is a kind of fixed-income product that comprises of multiple debt pools packaged together as a single security (also known as ‘securitization’) and sold to investors. The assets that can be securitized include home loans (mortgages), auto loans, student loans, credit card receivables among others. Thus the interest and principal payments made by consumers of the individual debts are passed on to the investors as the yield earned on the ABS.

Benefits of fixed-income products

For issuers

Generally, fixed-income products are issued by governments and corporations to raise capital for their operation.

For firms, the issuance of bonds in financial markets along with bank credit (two types of debt) allows firms to use leverage. Interests can also be deduced from income such that the firm will pay less taxes.

For investors

The investment in fixed-income products is considered to be a conservative strategy as it presents low returns (compared to stocks) but also provides a relatively low-risk exposure. Other benefits include:

Capital protection: Fixed income products carry less risk as compared to other asset classes such as stocks. These investments ensure capital preservation till the maturity of the investment and are preferred by investors who are risk averse and look for stable returns.
Generation of predetermined income: The income from fixed-income products is generated by means of interest or coupon payments. The income level for such products is predetermined at the time of investment and is paid on a regular basis (usually semi-annually or annually). Also, investors benefit from income tax exemption on investment in many fixed-income products.
Seniority rights: The holders of corporate bonds get seniority rights in terms of repayment of their capital if the company goes into bankruptcy.
Diversification: The fixed-income markets are less sensitive to market risk compared to the equity markets. So, the fixed-income products are considered to be less risky than the equity market investments and generally provides a fixed or stable stream of income. To manage the risk exposure for any portfolio, investors prefer investing in fixed income products to diversify their investments and offset any losses which may result from the equity markets.

Risks associated with fixed-income products

While fixed-income securities are considered to provide relatively low risk exposure, volatility in the bond market may still prove tricky. Bond value and interest rates have an inverse relationship and increase in interest rates thus affects the bond value negatively. Due to the fixed coupon rate and interest payments, fixed-income securities are highly sensitive to inflation rates as cashflows may lose value. There is also credit risk including potential default by the issuer. If an investor buys international bonds, she/he is always exposed to exchange risk due to the ever-fluctuating FX rates.

Thus it is essential for investors to take into account these factors and purchase fixed-income securities according to their individual requirements and risk appetite.

Useful resources

Amodeo K. (10/05/20201) Fixed Income Explanation, Types, and Impact on Economy The Balance.

Blackrock Education: What is fixed income investing?

Corporate Fiannce Institute: Fixed-income securities

About the author

The article was written by Jayati WALIA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022).

What is an Institutional Investor?

April 17, 2021 by Raphaël ROERO DE CORTANZE

What is an Institutional Investor?

In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Grande Ecole Program – Master in Management, 2018-2022) explains what is an institutional investor.

What do an investment management firm like BlackRock, a Pension Fund like the Caisse de Dépôt et Placement du Québec and an insurance company like AXA Investment Managers have in common? They are all institutional investors, a wide group of investors that is behind the largest supply and demand movements in securities markets.

What is an Institutional Investor?

An institutional investor is an organization that pools money to purchase securities such as bonds or stocks, real-estate, and other assets on behalf of its clients. The characteristics of an Institutional Investor can be summarized in three points. An institutional investor:
Is a legal entity that manages a number of funds (not the fund itself)
Manages professionally numerous assets according to the interest and the goals of its clients
Manages a significant number of funds

Institutional investors include:

Banks (Goldman Sachs, BNP Paribas, etc.)
Credit unions (Navy Federal Credit Union etc.)
Insurance companies (Insurers like AXA or Reinsurers like SCOR)
Pension funds (Caisse de dépôt et placement du Québec etc.)
Hedge funds (Archegos, etc.)
Others: REITs (Real-Estate), investment advisors, endowments, and mutual funds.
Compared to other investors, Institutional Investors as professional investment managers face fewer regulations as they are believed to be more capable of protecting themselves from risk.

Institutional investor VS Retail Investor

A Retail Investor, or individual investor is a non-professional investor who purchases securities for its own personal accounts and often trade in dramatically smaller amounts as compared to Institutional Investors. Like Institutional Investors, Retail Investors are active in a variety of markets (bonds, options, commodities, forex, futures contracts, and stocks). Nonetheless, some markets are primarily for Institutional Investors, such as swaps and forward markets.

As an estimation, retail investors typically buy and sell stocks in round lots of 100 shares or more while institutional investors are known to buy and sell in block trades of 10,000 shares or more. Thus, institutional investors’ buying and selling decisions can have tremendous impact on shares prices. This is why Institutional Investors avoid buying or selling large blocks of small companies, as it could create sudden supply and demand imbalances which could be detrimental to the market equilibrium. Nonetheless, Institutional investors also typically avoid owning large stake in big companies because doing so can violate securities law: some Institutional Investors are limited as to the magnitude of their voting stake in a company.

As Institutional Investors’ investment strategy are expected to be formulated by market professionals, Retail Investors sometimes try to mimic buying and selling decisions of Institutional Investors. This behavior known as “smart money” also comes from the fact that Institutional Investors’ investment decisions are formulated according to extensive and well documented researches. As Institutional Investors have a lot more resources at their disposal (both cash and information) in order to invest, they bring in their wake numerous Retail Investors, eager to benefit from the Institutional Investors’ expertise.

The impact of Institutional Investors

As explained above, Institutional Investors can significantly impact financial markets through their buying and selling decisions. In 2015, the three biggest US asset managers (BlackRock, The Vanguard Group and Fidelity Investments) together owned an average of 18% in the S&P 500 Index and constituted the largest shareholder in 88% of the firms included in the S&P 500 index. Thus, it is no coincidence that Institutional Investors are often called “market makers” as they exert a large influence on the price dynamics of different financial instruments.

The majority of Institutional Investors focus on long-term profitability rather than short-term profit. Nonetheless, this statement strongly varies according to the investor which is considered. An Insurance Company for instance focuses on investment capable of creating long-term returns, as the money insurance companies invest comes directly from their client. As Insurance companies need to be capable of facing claim settlements, they cannot allow themselves to gamble with their clients’ money. That is why the Institutional Investors’ activism as shareholders is thought to improve corporate governance — exception being made for investors such as Hedge Funds which, through very aggressive investment management, can have long-term negative located impacts.
As a conclusion, the presence of Institutional Investors in a market creates a positive effect on overall economic conditions.

Key concepts

Bond

A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental)

Credit Union

A type of financial institution similar to a commercial bank, is a member-owned financial cooperative, controlled by its members and operated on a not-for-profit basis.

Mutual Funds

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund.

Options

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset.

Commodities

A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. Commodities are most often used as inputs in the production of other goods or services.

Forex

The foreign exchange market is where currencies are traded. Forex markets exist as spot (cash) markets as well as derivatives markets offering forwards, futures, options, and currency swaps.

Futures contracts

Futures are derivative financial contracts that obligate the parties to transact an asset at a predetermined future date and price. The buyer must purchase or the seller must sell the underlying asset at the set price, regardless of the current market price at the expiration date.

Sources: OECD, Corporate Finance Institute, MarketWatch, Wallstreet Prep

About the author

Article written in June 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

What is an Activist Investor?

April 17, 2021 by Raphaël ROERO DE CORTANZE

What is an Activist Investor?

In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2018-2022) explains what is an activist investor.

What is an Activist Investor?

Activist Investors regularly make the headlines. In March 2021, Emmanuel Faber stepped down as CEO of Danone as a result of an aggressive campaign led by Bluebell Capital Partners and Artisan Partners, two investment funds.
Who are these activist investors? What is their modus operandi? And, above all, what are the consequences of their actions on the companies they target?

Activist investors are mostly Private Equity firms, hedge funds and wealthy individuals that acquire a significant stake in a public company in order to influence how the company is managed, with a view to extracting short-term profits. As shareholders activists, they attempt to use their rights as a shareholder of a publicly-traded corporation to bring about change within the corporation.

Activist investors seek companies they think are mismanaged, have excessive costs or could be run in a more profitable way. Their goal is to boost the short-term profitability of a company, in order to make a quick capital gain by reselling the shares at a higher price than the activist investor acquired them before the company’s upheaval.

Owning a small proportion of the shares of a publicly-traded company is sufficient for an activist investor to wield enough shareholder power to implement short-term profit maximizing changes. Indeed, 5% or even 3% can already carry a lot of control power: above a certain percentage of ownership, it is possible to request the inclusion of a draft resolution on the agenda of a general assembly.

Modus operandi

The typical modus operandi of activist investors is the following:

acquire some shares of a company
heavily criticize the company’s current management
demand changes: cost reductions, board seats, departure of the current CEO, etc.
convince other shareholders of the validity of their criticism and demands in order to gather around them sufficient shareholder voting rights and ownership to propose and implement their decision during a general assembly
see these changes being implemented and bring short-term profitability
resell the shares

The Danone case

Mid-January, the activist fund Bluebell Capital Partners (with an ownership believed to range between 2% to 3%) began attacking Emmanuel Faber’s governance. It was joined a few days later by Artisan Partners (0,6% of ownership). Together they deplored what they considered to be the poor performance of the company compared to its competitors Unilever or Nestlé.

Initially, a separation of functions between chairman and CEO was made in response to the investment funds’ attacks: Emmanuel Faber would have remained chairman while his former CEO position would have been filled by Gilles Schnepp, former CEO of the Legrand group. However, the two funds quickly objected to this move and Emmanuel Faber was eventually forced to leave the group while Gilles Schnepp succeeding him as chairman (with two co-CEOs running the Executive Committee). In less than two months, therefore, the CEO was removed, replaced by a profile a little less focused on corporate social responsibility and a little more on financial results.

Activist investors: good or bad for shareholders?

On the one hand, one might think that the intervention of an activist fund is a good thing for the shareholders. Shareholder activism might bring about change in the corporation, or even in the company’s objectives and vision, and will lead to a growth in profits, which will inevitably result in a rise in the share price rather quickly.

However, it is important to keep in mind that activist funds have a short-term investment horizon and want to increase the share price quickly in order to pocket a capital gain as soon as possible. It’s far from being synonymous with long-term value creation. Furthermore, the public image of a company can be severely damaged by industrial actions and cost-cutting plans.

It is therefore difficult to say whether activist funds are beneficial or not. The arrival of an activist fund in a very badly managed company can be very good news. But it all boils down to what is considered to be a “bad” management. Could Emmanuel Faber’s focus on corporate social responsibility be really considered as bad management?

The role of activist investor cab be seen in two famous financial movies: Other people’s money and Wall Street.

Watch Garfield (in the Other people’s money movie) making his point about wealth maximization at the shareholders’ Annual Meeting of their company.

This could be compared to Gordon Gekko explaining “Greed, for the lack of a better word, is good” to the shareholders during the General Meeting of their company (in the Wall Street movie).

Useful resources

Sources: Les Echos, Boursorama, Investopedia, LegalAction, Wikipedia

Film analysis – Other People’s Money

Film analysis – Wall Street: Money Never Sleeps

About the author

Article written in June 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2019-2022).

In the shoes of a Corporate M&A Analyst

April 17, 2021 by Raphaël ROERO DE CORTANZE

In the shoes of a Corporate M&A Analyst

In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2018-2022) shares his experience as a Corporate M&A Intern.

My internship at Scor

In 2020 as an intern, I had the opportunity to join the M&A Team of the French Reinsurer “SCOR” for 6 months.

As this internship allowed me to develop both hard and soft skills as well as helping me devising my future career path, I think it would be interesting to share this experience with you, hoping it could help you or give you some ideas.

SCOR is the world’s fourth-largest reinsurer with 16.4€bn of revenue in 2020. As a reinsurer, SCOR provides insurance companies with a range of solutions and services to control and manage the risks they face through its three divisions: Property & Casualty Reinsurance, Life & Health Reinsurance, and Investment Partners (the institutional investor division of SCOR).

What is a Corporate M&A Analyst?

A Corporate M&A Analyst is a Financial Analyst who works within and for a company, in comparison of a M&A Investment Banking Analyst who works in an Investment Bank or a Boutique.

The Corporate M&A Team is responsible for overseeing and carrying out all the transactions (acquisition, divesture, etc.) of a company. The team is in direct contact with investment banks, which it mandates in the case of an M&A operations. The team is also in direct contact with the Executive Committee and/or the Board of Directors of firms. Corporate M&A Analyst also work with other divisions within the company.

On average, a Corporate M&A Analyst and the rest of the M&A teamwork fewer hours than in an investment bank. Nonetheless, workhours strongly depend on the number of transactions the team makes in a year, and a M&A process can still be very intense and demanding even in a company.

What does a Corporate M&A Analyst do?

The tasks of a Corporate M&A Analyst are usually divided into two parts, the first being M&A-linked tasks and the other linked to the other activities the Corporate M&A team is related. For instance, at SCOR, the M&A team was also responsible for overseeing Corporate Finance at group level. Thus, I also worked on internal projects such as a cross-border restructuring project. In other corporates, M&A teams can be merged with Investor Relations, Strategy or for instance being only responsible for M&A related issues.

M&A tasks consist of:

Performing financial modelling and valuation: with conventional valuation tools (discounted cash flows, trading comparables and precedent transactions, etc.) and industry-specific tools (dividend discount model, appraisal value – for the Insurance/Reinsurance industry for instance)
Carrying out competitive and market intelligence of the industry: at SCOR I monitored 20+ competitors and targets, while devising regular updates and case studies on insurance/reinsurance transactions (merger, divesture, IPO, etc.)
Assisting in the execution on deals: in an acquisition or divesture process, the main task will be to perform valuation from bank documents (Info Memos), data rooms and internal data (in the case of a divesture). Compared to an M&A Analyst in an Investment Bank, a Corporate M&A Analyst also works on and follow the integration challenges raised by an acquisition.

The main tools used by a Corporate M&A Analyst are similar to the ones used by an M&A Analyst in a bank: Excel and Powerpoint of course, but also financial data providers such as Bloomberg, Factset, S&P Global, etc.

How can you become a Corporate M&A Analyst?

The majority of Corporate M&A Analysts and their colleagues usually spend some time in an Investment Bank before joining a Corporate M&A Team. This is why the work habits of a Corporate M&A team are similar to those in a bank: high attention to details, same requirements in terms of mastery of Excel and Powerpoint, high expectations in terms of speed and quality.

Between a job at an investment bank a corporate job, a Corporate M&A position can be a good opportunity to get the best of both worlds: high level of technicity and knowledge of a sector, combined with a more manageable workflow. Furthermore, members of a Corporate M&A team have the opportunity to work on transforming deals for the sake of the company they work for. In comparison, Investment Banking Teams continuously switch from a client to another, from a deal to another, without having the corporate strategy dimension of a Corpor
ate M&A Team.

Key concepts

Trading comparable

A comparable company analysis (CCA) is a process used to evaluate the value of a company using the metrics of other businesses of similar size in the same industry. Comparable company analysis operates under the assumption that similar companies will have similar valuation multiples, such as EV/EBITDA. Analysts compile a list of available statistics for the companies being reviewed and calculate the valuation multiples in order to compare them.

Precedent transaction

The cost of a precedent transaction is used to estimate the value of a company that is being considered. The reasoning is the same as that of a prospective home buyer who checks out recent sales in a neighborhood.

Discounted cash flow

The discounted cash flow (DCF) method is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future. A DCF valuation of a company gives the Enterprise Value.

Dividend discount model

The dividend discount model (DDM) is a quantitative method used for predicting the price of a company’s stock based on the theory that its present-day price is worth the sum of all of its future dividend payments when discounted back to their present value. A DDM valuation gives the Equity Value (or stock value).

Divesture

A divestiture is the partial or full disposal of a business unit which most commonly results from a management decision.

Property & Casualty insurance

Property and casualty (P&C) insurance provides coverage on assets (e.g., house, car, etc.) and also liability insurance for accidents, injuries, and damage to other people or their belongings.

Life & Health insurance

Life and health (L&H) insurance provides coverage on the risk of life and medical expenses incurred from illness or injuries.

Reinsurer

A reinsurer is a company that provides financial protection to insurance companies (basically an insurer of an insurer). Reinsurers handle risks that are too large for insurance companies to handle on their own and make it possible for insurers to obtain more business than they would otherwise be able to.

Useful resources

Sources: Investopedia, Wikipedia, Corporate Finance Institute, Scor

About the author

Article written in April 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2018-2022)

Covid-19 and its effect around hospital

April 16, 2021 by Subhasish CHATTERJEE

Covid-19 and its effect around hospital

This article written by Subhasish CHATTERJEE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2021) discusses the financial impact of the Covid-19 crisis on the healthcare sector in India and especially for hospitals.

Impact of the Covid-19 crisis on hospital operations

For any organization, a positive operating margin is essential for long-term Financial stability. Few organizations can maintain themselves for a long period when total operating expenses are greater than total operating revenues. A positive operating margin allows the organisation to develop its business by financing new projects with internal financial resources along with external financial resources such as debt and equity.

For hospitals, a positive operating margin allows them to invest in new treatment services for enhancing patient satisfaction, building of new facilities, and researching on new drugs.

Before Covid-19

Compared with other sectors, healthcare margins typically have been very low. Even before the appearance of Covid-19, a number of Indian hospitals struggled with poor or even negative margins—in other words, they were losing money on their operations. In fact, the median hospital margin was around 4.7 percent. This situation has been perilous to the future viability of many of Indian hospitals.

My experience during my internship

When the Covid-19 pandemic emerged, hospitals had to renounce the non-Covid treatment. The result was a drastic slowdown in volume of patients and in revenue, but the expenses remained high. To date, nobody can assure when and to what degree these non-Covid patients will return in the hospital. The result has been an uncertain future about the ability of hospitals to serve their communities and remain financially viable. My experience was in India but if you follow the statistics, the hospitals are suffering from same consequences anywhere in the world.

As indicated in Figure 1, during the year 2020, because of the Covid-19 crisis, 39.4% of hospitals lost more than 50% of their revenue compared to last year. Hospital Systems are Data from Hospital Centre Compiled Together.

Figure 1. Covid-19’s impact on hospital systems’ finances
Covid- 19 Impact on hospital systems finance

Source: AMGA surveys.

As indicated in Figure 2, during the year 2020, because of the Covid-19 crisis, 47.6% of independent medical groups lost more than 50% revenue as clinics couldn’t treat and provide bed to patients on a larger scale like hospitals. Independent Medical group are the private clinics run by physicians.

Figure 2. Covid-19’s impact on independent medical group finances
Covid- 19 Impact on independent medical group finances

Source: AMGA surveys.

The possible long-term impact of Covid-19 in hospitals

To date, the financial impact of Covid-19 has been significant, even with Government funding, the financial damage is likely to continue. Adding to this is the unpredictable nature of Covid-19. Now more than ever, hospitals will need support from governments, and will need to rethink their strategic–financial plans for what is likely to be a highly challenging environment even as Covid-19 cases diminish.

Key concepts

I present below key concepts to understand the financial situation of a business.

Ebitda

Ebitda = Revenue – Operating expense – Employee expense – Administrative & other expense

Some expenses of hospitals:

Wages and benefits
Professional fees
Food for patients
Medical equipment
Prescription drugs
Professional liability insurance
Utilities
Nursing, general and other professional services.

Some revenue of hospitals:

Patient service revenue
Research revenue
Academic revenue

Profit before and after tax

Profit before tax = Ebitda – Depreciation – Amortization – Interest on debt

Profit after tax = Profit Before Tax – Tax rate ✖ Profit Before Tax

About the author

Article written by Subhasish CHATTERJEE (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2021).

Veolia and Suez: the epitome of a hostile takeover bid

April 16, 2021 by Raphaël ROERO DE CORTANZE

Veolia and Suez: the epitome of a hostile takeover bid

In this article, Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2019-2022) details the Veolia-Suez saga.

Since August 30, 2020, when Engie put its 29,9% stake in Suez for sale, the Veolia-Suez saga continues to make headlines.

Veolia is a French company with activities in three main service and utility areas traditionally managed by public authorities: water management, waste management and energy services. Suez (formerly Suez Environnement) is a French-based utility company which operates largely in the water and waste management sectors. Suez is the largest private water provider worldwide, by number of people served.

Let’s go through the key stages of this saga with a view to understanding what is a hostile takeover, and why Veolia’s takeover bid on Suez can be considered as such.

August 2020: the beginning of hostilities

On August 30, 2020, Engie voiced its will to sell its 29,9% stake in Suez. This divesture aims at refocusing the group’s activities on renewable energies. Following this announcement, Veolia made a €2.9bn offer directly to Engie, for its stake in Suez. In the wake of this first offer, both boards of Engie and Suez rejected the bid: Suez feared that the acquisition would have serious consequences on the group’s employment, while Engie considered the offer price too low and put the increase of the offer price as a sine qua non condition to the completion of the deal.

This first offer is considered as a hostile bid as Veolia was willing to accomplish the acquisition with cash and by going directly to Engie, one of Suez’s shareholders, rather than by going to Suez’s board or executives. In other words, the transaction would have taken place without the approval of the purchased company.

September 2020: Engie accepts Veolia’s offer

Despite Suez’s counterattacks, Veolia continued and came back with a second offer at €3.4bn, higher than the first one, in order to convince Engie to give up its shares.

Engie’s board showed support for this second bid and later accepted the offer, highlighting the effort on the price, the strategic rationale and the social plan. Veolia, whose intention is to acquire the remaining 70% of Suez in the future, has also committed not to launch a full takeover bid without the agreement of Suez’s Board — thus proceeding with a friendly instead of hostile takeover.

Indeed, it is not uncommon for an acquirer willing to acquire 100% of the shares of a company to acquire a smaller block of shares in the first place and proceed later with the acquisition of the remaining block. Furthermore, in France, any shareholder who reaches or exceeds 30% of a listed French company will have to launch a takeover bid for the entire capital. In other words, Veolia, after having acquired 29,9% of Suez, would have had to propose a purchase offer to all shareholders, as a 30% stake triggers an automatic takeover bid.

February: Veolia launches a hostile takeover bid on 100% of Suez

Since Veolia’s second bid, Suez and Veolia haven’t been able to bridge divisions, and Suez continued to strongly reject the unfriendly acquisition. The counterproposition made by Suez to have an Ardian-GIP consortium taking over Suez’s French and international “Water and Technology” activities has been rejected by Veolia. On February 7, 2021, Veolia broke its commitment and filed a third public takeover bid but this time on 100% of Suez shares, at the same price as the second offer made exclusively to Engie. This acquisition would make Veolia the world leader in water and waste treatment. Once again, the offer was made without Suez’s approval, reinforcing the hostile dimension of the deal.

Have the negotiations reached a dead-end?

Bruno Le Maire, French Minister of Economy, denounced Veolia’s “unfriendly” bid and announced that he would refer the matter to the Autorité des Marchés Financiers (AMF) in order to verify the conformity of the group’s announcements with its previous commitments.

The situation seems to have reached a dead-end. On one side, Veolia has been ordered by the Tribunal de Commerce of Nanterre to suspend its takeover bid and to wait for validation of its offer by the Suez board of directors. On the other hand, Suez takeover defense strategy (which consists in the domiciliation of its Eau de France activity (targeted by Veolia) in a Dutch company for 4 years in order to make it inaccessible to a hostile bid) has just been rejected by the AMF on April 2, 2021.
Will Veolia and Suez be able to overcome their disagreements? Time will tell…

Key concepts

I present below key concepts to understand the Veolia-Suez saga.

Defense strategy

In response to hostile takeovers, targets can devise defense strategies in order to prevent the takeover from going across the finish line. Well-known defense strategies are:

Stock repurchase: purchase by the target of its own-issued shares from its shareholders
Poison pill: distribution to the target’s shareholders of the rights to purchase shares of the target or the merging acquirer at a substantially reduced price
White knight: the target seeks a friendlier acquirer
Crown jewels: the target divests one or several of its flagship activities or divisions (“jewel”) in order to reduce the interest of the hostile bidder
Fat man: the target issue new debt and or purchase assets or companies which are too large or known to be disliked by the hostile acquire, in order to “fatten up” and transform the target into a less attractive purchase

Public takeover bid

A public takeover bid can take two forms: the acquisition of the stake of the target company is made with cash (“Offre publique d’achat” or “OPA” in French) and the acquisition of the stake of a listed company is made by exchanging shares of the acquiring company with shares of the acquired company (“Offre publique d’échange” or “OPE” in French).

OPA and OPE refers to acquisition methods, not to acquisition behavior: an OPA or OPE can be friendly or hostile depending on whether the acquirer decides to obtain the acquired company’s approval or goes directly to the shareholders of the acquired company.

Useful resources

Sources: La Tribune, Le Monde, Easy Bourse, La Finance Pour Tous, Wikipedia

About the author

Article written in April 2021 by Raphaël ROERO DE CORTANZE (ESSEC Business School, Master in Management, 2019-2022).

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