Introduction to bonds

April 12, 2021 by Rodolphe CHOLLAT-NAMY

Introduction to bonds

In this article, Rodolphe CHOLLAT-NAMY (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2023) introduces you to bonds.

While the bond market is growing fast and is worth about $115,000 billion as of 2021, in the following series of articles we will try to understand what it is all about. It is therefore appropriate here, firstly, to try to define what a bond is.

What is a bond?

A bond is a debt security, i.e. a tradable financial asset, that represents a loan made by an investor to a borrower. It allows the issuer to finance its investment projects and the creditor to receive interest payments at regular intervals until maturity when it is repaid the nominal amount. Creditors of the issuer are also known as debt holders.
Bonds are fixed-income securities because you know from the debt contract the exact amount of cash you can expect in the future, provided you hold the security until maturity.

What are the main characteristics of a bond?

A bond has several characteristics:

The face value, also known as the par value or principal, equal to the original capital borrowed by the bond issuer divided by the number of securities issued.
The maturity, which expresses the number of years to wait for the principal to be repaid. This is the life of the bond. The average maturity of a bond is ten years.
The coupon, that refers to the payment of interest to the creditor at regular intervals. The interest rate paid may be fixed or variable. It is the creditor’s remuneration for the risk taken as a bondholder. The higher the risk, the higher the return, the coupon, will be.

Example

Let us take the example of a company needs to borrow ten million euros in the bond market.

It decides to issue fixed-rate bonds. It divides this issuance into 1,000 shares of €10,000. The face value of each bond is therefore €10,000. The nominal interest rate is set at 5%. Interest payments are made on an annual basis. The annual coupon is then equal to €500 (=0.05*10,000). The maturity of the bond is set at 10 years.

In terms of cash flows, you will receive €500 per year for ten years. At the end of the tenth year, the issuer will pay you a final installment of €10,000 in addition to the interest payment of €500.

What are the different types of bonds?

The bonds issued can be diverse. Their maturity, interest rate and repayment terms vary. In order to better understand them, we must first distinguish their issuer and then the terms of payment of interest.

Types of issuers

There are three main types of issuers: governments, local authorities, and companies.

Government bonds

A government bond represents a debt that is issued by a government and sold to investors to support government spending. They are considered low-risk investments since the government backs them. So, because of their relative low risk, they are typically pay low interest rates. Country that issues bonds use different terms for them. UK government bonds, for example, are referred to as gilts. In the US, they are referred to as treasuries: T-bills (expire in less than one year), T-notes (expire in one to ten years) and T-bonds (expire in more than ten years).

Municipal bonds (“munis”)

A municipal bond represents a debt that is issued by a local authority (a state, a municipality, or a county) to finance public projects like roads, schools and other infrastructure. Interest paid on municipal bonds is often tax-free, making them an attractive investment option. Because of this tax advantage and of the backing by their issuer, they are also pay low interest rates.

Corporate bonds

A corporate bond represents a debt that is issued by a company in order for it to raise financing for a variety of reasons such as ongoing operations (organic growth) or to expand business (mergers and acquisitions). They have a maturity of at least one year, otherwise they are referred to as commercial paper. They offer higher yields than government or local authority bonds because they carry a higher risk. The more fragile the company is, the higher the return offered to the investor is. They are divided into two main categories High Grade (also called Investment Grade) and High Yield (also called Non-Investment Grade, Speculative Grade, or Junk Bonds) according to their credit rating reflecting the firm financial situation.

Technical characteristics

In addition, the way in which interest is paid may vary from one bond to another. For this purpose, there are several types of bonds:

Fixed-rate bonds

A fixed-rate bond is a bond with a fixed interest rate that entitles the holder to receive interest payments at a predetermined frequency. The interest rate is set when the bond is issued and remains the same throughout the life of the bond. This is the most common type of bond.

Floating-rate notes

A floating-rate note is a bond with an interest rate that changes according to market conditions. The contract of issuance fixes a specific reference serving as a basis for the calculation of the remuneration. For example, the most common references for European bonds are Eonia and Euribor.

Zero-coupon bonds

A zero-coupon bond is a bond that does not pay regular interest. They are therefore sold at a lower price than the value redeemed at maturity by the issuer. This difference represents the investor’s return.

Convertible bonds

A convertible bond is a bond with a conversion right that allows the holder to exchange the bond for shares in the issuing company, the two parties having previously fixed a conversion ratio which defines the number of shares to which the bond gives right.

Useful resources

Rating agencies

S&P

Moody’s

Fitch Rating

▶ Rodolphe CHOLLAT-NAMY Bond valuation

▶ Rodolphe CHOLLAT-NAMY Bond risks

▶ Rodolphe CHOLLAT-NAMY Bond markets

▶ Bijal GANDHI Credit Rating

▶ Jayati WALIA Credit risk

About the author

Article written in April 2021 by Rodolphe CHOLLAT-NAMY (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2023).

Economist – Job description

April 3, 2021 by Akshit GUPTA

Economist – Job Description

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

Introduction

Economists are finance professionals who study and examine market activities in different geographical zones, economic sectors, and industries. They are primarily hired by commercial and investment banks, asset management firms, rating agencies, consultancy firms, central banks and other state agencies. In such institutions, economists are responsible for analyzing market and socioeconomic trends, devising statistical models to predict future trends (economic forecasting) and preparing economic reports.

In commercial banks, the work of economists will be used to manage credit risk and to prevent corporate credit default. In investment banks, economists will help traders to anticipate the economic events during the day like the publication of an economic indicator (inflation, GDP, unemployment, etc.). In asset management firms, economists will help portfolio managers to optimize their portfolios based on the current economic conditions and future scenarios. In other contexts, economists work on studying and assessing the economic situation to support investment decisions.

Duties of an economist

More specifically, the important duties of an economist include the following:

Analyze economic and market trends – An economist is responsible for researching, collecting data, and analyzing information pertaining to socio-economic, financial, political and market trends in different geographies and sectors.
Develop economic models – After analyzing the different trends, an economist is responsible for making econometric models to compute the numerical impact of different trends and make future predictions.
Prepare economic reports – The economist is responsible for preparing economic reports based on the statistical analysis to present technical insights about an economic situation. The reports are used to advise banks, investment firms, government agencies to take calculated investment decisions.
Communicate data – The reports prepared by the economists are effectively communicated by them to banks or agencies by ways of presentations, media releases or publication in journals.

Whom does an economist work with?

An economist depending in the sector he/she is employed in, works in tandem with many internal and external stakeholders including:

Retail or institutional clients of the firm – A economist works with the retail or institutional clients of the firm to communicate the different economic or market trends and policies.
Sales and Trading – An economist works with the sales and trading team to advise them on the investment decisions across sectors and geographies based on the economic reports.
Sector specialists – An economist works with the sector specialists to assess and quantify the economic opportunities and risks posed by different sectors and industries
Portfolio managers – An economist works with portfolio managers to advise and help them optimize their portfolios as per the current economic and market trends.
Legal compliance – To maintain a proper check over different rules and regulations and prevent legal challenges
Media – To give insights from technical and non-technical economic reports about different sectors and present future forecasts

How much does an economist earn?

The remuneration of an economist depends on the type of role and organization he/she is working in. As of the writing of this article, an entry level economist working in an investment bank earns a base salary between €40,000–50,000 in the initial years of joining. The economist 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 an economist?

An individual working as a economist is expected to have a strong base in economics and mathematics (statistics, econometrics). He/she should be able to understand micro and macro-economic trends, devise different mathematical models, prepare reports and have strong research skills and interpersonal skills.

In France, a Grand Ecole diploma with a specialization in economics/mathematics is highly recommended to get an entry level economist position in a reputed bank, government agency or investment firm.

A bachelor degree coupled with an master degree in economics provides a candidate with an edge over the other applicants while hunting for a job.

In terms of technical skills, an economist should be efficient in using word processing, spreadsheet, presentation tool, and possess good understanding of database management and programming languages like VBA, R, Python, Mathlab, etc.

Example of an economist’s report – BNP Paribas

BNP Paribas – Economic Research Report

Useful Resources

All About Careers

Relevance to the SimTrade certificate

The concepts about the job of an economist can be understood in the SimTrade Certificate:

About theory

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 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).

Is smart beta really smart?

April 3, 2021 by Youssef LOURAOUI

Is smart beta really smart?

In this article, Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2017-2021) presents the concept of smart beta used in the asset management industry.

Mutual funds and Exchange traded funds (ETF) based on the smart beta approach have increased in size during the recent years. As Burton Malkiel (2014), we also wonder if the smart beta approach is really smart.

The smart beta industry

Smart beta funds have experienced a significant growth with total assets under management approaching market 620 billion dollar in the U.S. as shown in Figure 1 (Morningstar Reseach, 2017).

Figure 1. Smart Beta Exchange Traded Products growth in the US market (2000-2017).

Source: Morningstar Research (2017).

Traditional approach in portfolio management

The traditional approach to build asset portfolio is to define asset weights based on the market capitalization. The framework of this traditional approach is based on the Capital Asset Pricing Model (CAPM) introduced by the work of Henry Markowitz and William Sharpe in 1964. The CAPM is based on a set of hypotheses about the market structure and investors:

No intermediaries
No constraints (possibility of short selling)
Supply and demand equilibrium
Inexistence of transaction cost
Investors seeks to maximise its portfolio value by optimizing the mean associated with expected returns while minimizing variance associated with risk
Investors are considered as “rational” with a risk averse profile
Investors have access to the information simultaneously in order to execute their investment ideas

Under this framework, Markowitz developed a model relating the expected return of a given asset and its risk:

Relation between expected return and risk

where E(r) represents the expected return of the asset, r_f the risk-free rate, β a measure of the risk of the asset and E(r_m) the expected return of the market.

In this model, the beta (β) parameter is a key parameter and is defined as:

Beta

where Cov(r,r_m) represents the covariance of the asset with the overall market, and σ(r_m)² is the variance of market return.

The beta represents the sensibility of the asset to the fluctuations of the market. This risk measure helps investors to predict the movements of their asset according to the movement of the market overall. It measures the asset volatility in comparison with the systematic risk inherent to the market. Statistically, the beta represents the slope of the line through a regression of data points between the stock returns in comparison to the market returns. It helps investors to explain how the asset moves compared to the market.

More specifically, we can consider the following cases for beta values:

β = 1 indicates a fluctuation between the asset and its benchmark, thus the asset tends to move in a similar rate than the market fluctuations. A passive ETF replicating an index will present a beta close to 1 with its associated index.
0 < β < 1 indicates that the asset moves in a slower rate than market fluctuations. Defensive stocks, stocks that deliver consistent returns without regarding the market state like P&G or Coca Cola in the US, tend to have a beta with the market lower than 1.
β > 1 indicates a more aggressive effect of amplification between the asset price movements with the market movements. Call options tend to have higher betas than their underlying asset.
β = 0 indicates that the asset or portfolio is uncorrelated to the market. Govies, or sovereign debt bonds, tend to have a beta-neutral exposure to the market.
β < 0 indicates an inverse effect of market fluctuation impact in the asset volatility. In this sense, the asset would behave inversely in terms of volatility compared to the market movements. Put options and Gold typically tend to have negative betas.

In order to better monitor the performance of an actively managed fund, active fund managers seek to improve the performance of their fund compared to the market. This additional performance is measured by the “alpha” (Jensen, 1968) defined by:

Alpha Jensen

where E(r) is the average return of the fund over the period studied, r_f the risk-free rate, E(r_m) the expected return of the market, and β×(E(r_m)-r_f) represents the systematic risk of the fund.

Jensen’s alpha (α) represents the abnormal returns of the fund.

The Smart beta approach

The smart beta approach is based on the construction of a portfolio of assets using several different yield enhancement “factors”. BlackRock Investment Solutions (2021) lists the following factors mainly used in the smart beta approach:

Quality, which aims to study the financial environment of the underlying asset.
Volatility which aims to filter assets according to their risk.
Momentum, which aims to identify trends in the selection of assets to be retained by focusing on stocks that have performed strongly in the short term.
Growth is the approach that aims to select securities that have strong return expectations in the medium to long term.
Size which aims to classify according to the size of the assets.
Value that seeks to denote undervalued assets that are close to their fundamental values.

The smart beta approach is opposed to the traditional portfolio approach where a portfolio is constructed using the weights defined by the market capitalization of its assets. The smart beta approach aims to position the portfolio sensitivity or “beta” according to the market environment expectation of the asset manager. For a bull market, the fund manager will select a set of factors to achieve a pronounced exposure of his portfolio. Symmetrically, for a bear market, the fund manager will select another set of factors opting for a beta neutral approach to protect the sensitivity of his portfolio against bear market fluctuations.

Performance and impact factor

S&P Group (2016) studied the performance of different factors (volatility, momentum, quality, value, dividend yield, growth and size) on the S&P500 index for 1994-2014 broken down into sub-sectors (see Table 1). This study finds that each sector is impacted differently by choosing one factor over another. For example, in the energy sector, the strategies of value and growth has led to a positive performance with respectively 1.22% and 2.56%, while in the industrial sector, the strategies of size were the only factor with a positive performance of 1.66%. In practice, there are two approaches: focusing on a single factor or finding a combination of factors that offers the most interesting risk-adjusted return to the investor in view of his/her investment strategy.

Table 1. Sector exposures to smart beta factors (1994-2014).

Source: S&P Research (2014).

S&P Group (2016) also studies the performance of the factors according to the market cycles (bull, bear or recovery markets), business cycles (expansion or contraction) and investor sentiment (neutral, bullish and bearish). The study shows how each factor has been mostly effective for every market condition.

Table 2. Performance of factors according to different market cycles, business cycles and investor sentiment.

Source: S&P Research (2014).

In summary, the following characteristics of the different approaches discussed in this article can be identified:

The CAPM approach aims to give a practical configuration of the relationship between the return of an asset with the market return as well as the return considered as risk-free.
Alpha is an essential metric in the calculation of the portfolio manager’s return in an actively managed fund. In this sense, alpha and CAPM are linked in the fund given the nature of the formulas used.
Smart beta or factor investing follows an approach that straddles the line between active and passive management where the manager of this type of fund will use factors to filter its source of return generation which differs from the common approach based on CAPM reasoning (Fidelity, 2021).
The conductive link of these three reasoning is closely related to the fact that historically the CAPM model has been a pillar in financial theory, the smart beta being a more recent approach that tries to disrupt the codes of the so-called market capitalization based investment by integrating factors to increase the sources of return. Alpha is related to smart beta in the sense that the manager of this type of fund will want to outperform a benchmark and therefore, alpha allows to know the nature of this out-performance of the manager compared to a benchmark.

Is smart beta really smart?

Nevertheless, the vision of this smart beta approach has raised criticisms regarding the relevance of the financial results that this strategy brings to a portfolio’s return. Malkiel (2014) questioned the smartness of smart beta and found that the performance of this new strategy is only the result of chance in the sense that the persistence of performance is dependent in large part on the market configuration.

In his analysis of the performance of the smart ETF fund called FTSE RAFI over the period 2009-2014, he attributed the out-performance to luck. The portfolio allocation was highly exposed to two financial stocks, Citigroup and Bank of America, which accounted for 15% of the portfolio allocation. Note that Citigroup and Bank of America were prosecuted by the American courts for post-crisis financial events and interest rate manipulation operations related to the LIBOR scandal. This smart beta fund outperformed the passive managed US large cap ETF (SPY). Malkiel associated the asset selection of the FTSE RAFI fund with a bet on Bank of America that with another market configuration it could have ended in a sadder way.

Figure 2. FTSE RAFI ETF (orange) compared with its benchmark (FTSE RAFI US 1000) and with SPY ETF (green).

Source: Thomson Reuters Datastream.

We can conclude that the smart beta strategy can allow, as outlined in Blackrock’s research (BlackRock Investment Solutions, 2021), an opportunity to improve portfolio performance while seeking to manage variables such as portfolio out-performance, minimizing its volatility compared to the market or seeking diversification to reduce the risk of the investor’s portfolio. It is an instrument that must be taken judiciously in order to be able to affirm in fine if it is smart in the end, as Malkiel would say.

Useful resources

Academic articles

Malkiel, B. (2014). Is Smart Beta smart? The Journal of Portfolio Management 40, 5: 127-134

El Lamti N. (2017) Are smart beta strategies really smart? HEC Paris.

Business resources

BlackRock Investment Solutions (2021) What is Factor Investing

Fidelity (2021) Smart beta

S&P Global Research (2016) What Is in Your Smart Beta Portfolio? A Fundamental and Macroeconomic Analysis

Morningstar Research (2017) A Global Guide to Strategic-Beta Exchange-Traded Products

Fidelity (2021) Smart beta

About the author

The article in April 2021 was written by Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2017-2021).

Financial leverage

December 25, 2023March 16, 2021 by Shruti CHAND

Financial leverage

In this article, Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022) elaborates on the concept of financial leverage.

This read will help you get started with understanding financial leverage and understand its impact of the business, advantages and disadvantages.

Definition of financial leverage

Financial leverage in simple words is the use of debt to acquire additional assets. Imagine this, if you are borrowing money and using it to expand your business’ assets, you are using financial leverage. Financial leverage is also known as gearing as it deals with profit magnification. Debt is important for a company because it’s an integral way to grow business. The most important question to ask here is why would someone borrow money to acquire assets? The answer is that financial leverage is based on the expectation that the income or capital gain from assets will exceed the cost of borrowing.

How does financial leverage work in real life?

Let’s say a company wants to acquire an asset, the financing options available to the company are: equity and debt.

Equity: shares issued to the public by giving out ownership.
Debt: funds borrowed through bonds, commercial papers and debentures to be paid back to lenders along with interest.

Here, in case of equity, no fixed costs are incurred, hence the profit/capital gain from the asset remains totally as profits, while in case of debt and leases, there are fixed costs associated in terms of interest that the company expects to be lower than the profit/capital gain expected.

How is financial leverage measured?

Since financial leverage is considered to be a measure of the company’s exposure to risk, company’s stakeholders look at the Debt / Equity ratio, which is a measure of the extent of financial leverage.

Total Debt = Current liabilities + Long-term liabilities
Total Equity = Shareholders’ equity + Retained Earnings

Analysis: The higher the debt-equity ratio, the weaker the financial position of the enterprise. Hence, lesser the ratio, lesser the chances of bankruptcy and insolvency.

Other ratios that can be used to measure financial leverage: Debt to Capital Ratio, Interest Coverage Ratio, and Debt to Ebitda Ratio.

Example of financial leverage in action

A company with $1 million shareholder equity, borrows $4 million and has $5 million to invest in assets and operations. This will allow this company to set up new factories, take up growth opportunities and expand.

Let’s assume the cost of debt is $0.5 million for a year and at the end of the first year, the company makes $1 million in profits (20% for the return on assets), the realised profit for the business becomes $1 million (profits) – $0.5 million (debt cost) = $0.5 million (50% for the return on equity for shareholders).

Now on the other hand, if the company makes $1 million in losses (-20% for the return on assets), then the realised loss for the business is $1 million + $0.5 million= $1.5 million. (-150% for the return on equity for shareholders).

You can see how in adverse situation that the effect of leverage can be really detrimental.

Now let’s consider a scenario with no leverage, the business utilizes only the $ 1 million that it already has. Considering the profit and loss percentage in the previous scenario, the business will end up making or losing $200,000 in profitable and loss making scenario respectively (20% for the return on equity for shareholders for the positive scenario and -20% for the negative scenario).

Any business needs to support its activity with borrowed money to acquire assets and hence it can be seen that manufacturing companies such as automakers have a higher debt equity ratio than service industry companies.

Advantages of financial leverage

Among the main benefits of financial leverage is the opportunities to invest in larger projects. There are also tax advantages (linked to the deductibility of interests in the income statement).

Disadvantages of financial leverage

As attractive as financial leverage might sound for a business to grow, leverage can sometimes in fact be really complex. As much as it magnifies gains, it can also magnify losses. With interest expenses and credit risk exposure, a company can often destroy shareholder value to a greater extent if it would have grown its business without Leverage.

All in all, leverage can increase burden on the company, high risk of losses, may lead to bankruptcy and other reputational losses.

Conclusion

It is really important for a company to be wise with its financial leverage position. While giving out too much ownership is not good for the shareholders, in the same way taking too much debt can also be hazardous for the company. Hence, even though the debt equity ratio differs for different industries, it is of a consensus that ideally it shouldn’t be more than 2.

Relevance to the SimTrade certificate

This post deals with financial leverage for firms. Similarly, financial leverage can be used investors in financial markets. This can be learnt in the SimTrade Certificate:

About theory

By taking the Financial leverage course (Period 3 of the certificate), you will know more about how investors can use financial leverage to buy and sell assets in financial markets.

About practice

By launching the series of Market maker simulations, you will practice how investors can use financial leverage to buy and sell assets in financial markets.

Useful resources

SimTrade course Financial leverage

About the author

Article written in March 2021 by Shruti CHAND (ESSEC Business School, Grande Ecole Program – Master in Management, 2020-2022).

Palantir: a potential and controversial rising decacorn

March 13, 2021 by Quentin BONNEFOND

Palantir: a potential and controversial rising decacorn

This article written by Quentin Bonnefond (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2021) discusses the case of Palantir.

Introduction

Founded in 2003 by entrepreneur Peter Thiel, Palantir provides software and data analysis services to help government agencies (CIA, NSA, etc.) and large corporations (among which Merck, Fiat-Chrysler, Ferrari, Crédit Suisse, Airbus, etc.) process large amounts of information. This discreet activity has led Palantir to be regularly accused of mass surveillance and criticized for its close links with law enforcement agencies.

Palantir introduced in the NSYE Banque Internationale à Luxembourg (BIL)

Source : https://finance.yahoo.com/

Still no profits

Palantir is a real cash consumer. In 2019, its operations consumed $165 million in cash, or 22% of its revenues. And its cash consumption increased from the previous year. In 2018, Palantir’s negative cash flow from operations was $39 million, its cash consumption in 2019 soared by 323% while its revenues increased by only 25%.

The company has very high overhead costs, which accounted for 105% of sales last year. This is due to high R&D costs and low selling prices compare to traditional consulting due to the lengths of its project (several years). To be competitive and acquire new clients, the firm needs to propose reasonable prices.

In 2019, for example, Palantir’s sales and marketing expenses of $450 million accounted for 61% of sales, while general and administrative expenses of $321 million accounted for 44%.

After 17 years of existence, Palantir still hasn’t figured out how to make a profit.

The financial and health crisis: an opportunity not to be missed

The coronavirus crisis has created “enormous opportunities”. This phrase has prompted many funds to invest in the company. Moreover, at the end of January 2021, in a morose context of economic and health crisis, the Californian firm announced a partnership with IBM, which skyrocketed the share price to $39, which was 4 times its value at the time of its initial public offering (IPO), 4 months earlier.

Source: https://fr.finance.yahoo.com/quote/PLTR/

A price correction

Uncertainty linked to the global health crisis smiles on Palantir, but the end of the crisis could be (slightly) more unfavorable for the firm. The US company says that revenue growth is expected to slow to about 30% in 2021, compared to 47% in 2020. This announcement is reflected in the share price: $26.75 at the market closing of 23/02, a 31.41% drop in one month.

The company reported better-than-expected sales in the fourth quarter and recorded more than $1.1 billion in annual revenues by winning 21 contracts worth $5 million or more.

Insights:

$1.1 billion in revenue for full-year 2020, up 47% year-over-year
$322 million in revenue for Q4 2020, up 40% year-over-year
New contracts in Q4 2020 include Rio Tinto, PG&E, BP, U.S. Army, U.S. Air Force, FDA, and NHS
Expects Q1 2021 revenue growth of 45% year-over-year

A bright future for data and Palantir

In a conference call with analysts, Palantir’s Chief Operating Officer, Shyam Sankar, indicated that the company’s approach to automated data management and software will increase the total addressable market. “Look at our investments in archetypes. This means that in a few clicks you can deploy powerful end-to-end use cases that would have cost millions of dollars and taken many months to develop and can now be deployed in minutes,” he boasted.

“These are examples of why we’re confident in our long-term growth, which is expected to exceed $4 billion by 2025,” he said. Indeed, the company has a lot of leads for acquiring corporate customers. Palantir had eight Fortune 100 clients and twelve Global 100 clients.

The recent launch of the company’s platform, called Foundry 21, is expected to make it more modular with better data integration, code-free applications and a mobile offering. Historically, Palantir has always needed more implementations and high-level consultants. Recently, a demo day has generated more requests from potential customers.

Conclusion

In spite of huge cash consumption preventing Palantir from being profitable, the crisis has had a boost effect on the American firm’s activity. Growth is expected for 2020 and is expected to be, admittedly less, but at least significant for 2021. Excluding the accusations surrounding data protection and privacy, Palantir is promised to make great strides. A stock to watch.

Capital structure

Top 3 shareholders:

Thiel Peter (co-founder): 16.60%
Sompo Holdings, Inc: 7.30%
Alexander C. Karp (co-founder and CEO): 5.50%

Full structure and top 10 funds shareholders: money.cnn.com

Key concepts

Unicorn, decacorn and hectocorn

In business, a unicorn is a privately held startup company valued at over $1 billion. The term was coined in 2013 by venture capitalist Aileen Lee, choosing the mythical animal to represent the statistical rarity of such successful ventures. Decacorn is a word used for those companies over $10 billion, while hectocorn is used for such a company valued at over $100 billion.

Start-up valuation

Startups, pretty much like babies, need money to expand themselves, test ideas and develop a team. To raise money, a startup needs to be valued and therefore, understanding how the startup valuation process works is very important for any serious and committed entrepreneur.
Various valuation methods are used such as the Venture Capital, the Berkus, the Cost-to-ducat, the DCF or the Comparables methods.

Link: https://pro-business-plans.medium.com/startup-valuation-the-ultimate-guide-to-value-startups-2019-a31cbdaebd51

Initial Public Offering (IPO)

An initial public offering (IPO) or stock market launch is a public offering in which shares of a company are sold to individual and institutional investors. After the IPO, shares are traded freely in the market (secondary market).

Secondary market

The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The existence of a secondary market provides liquidity for investors.

Useful resources

Capital.fr : https://www.capital.fr/entreprises-marches/palantir-le-big-brother-de-lanalyse-de-donnees-debarque-en-fanfare-en-bourse-1381955
https://www.capital.fr/entreprises-marches/palantir-devisse-la-croissance-de-lactivite-va-nettement-ralentir-en-2021-1394242
Forbes.fr: https://www.forbes.fr/finance/entree-en-bourse-de-palantir-pourquoi-il-ne-faut-pas-investir/
Palantir.com: https://www.palantir.com/
fr.finance.yahoo.com: https://fr.finance.yahoo.com/quote/PLTR/
marketwatch.com: https://www.marketwatch.com/investing/stock/pltr

Relevance to the SimTrade Certificate

The case of Palantir is relevant to the SimTrade Certificate as the stocks issued by the company are now traded on the stock market which brings liquidity for investors. It relates to the SimTrade Certificate in the following ways:

About theory

By taking the Discover SimTrade course (Period 1), you will discover the SimTrade platform that simulates a secondary market with a limit order book.
By taking the Market information course (Period 2), you will know more about how information is incorporated in the stock market price.

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 Market order simulation and the Limit order simulation, you will practice market orders and limit orders that are the two main orders used by investors to build and liquidate positions in financial markets.

More about SimTrade

About the author

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

SimTrade: an inspiration for a career in finance

March 13, 2021 by Qiuyi XU

SimTrade: an inspiration for a career in finance

In this article, Qiuyi Xu (ESSEC Business School, Global Bachelor of Business Administration, 2019-2021) shares her experience as an intern in a securities company in China.

Interested in finance, I took the SimTrade course during my study at ESSEC Business School. This course helped me gain knowledge about financial markets as well as served to motivate me to continue my exploration in the sector of finance. Now I have started an internship at the investment banking department of a top 10 securities company in China.

The concept of “investment banking services” is slightly different in China. While in the US and Europe, it refers to all kinds of services (investment banking division, asset management, sales & trading and research departments), in China, it mainly includes securities (stocks and bonds) issuance and underwriting, merger & acquisition and restructuring.

My mission

My mission is to support the team responsible for an initial public offering (IPO) project. An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. Public share issuance allows a company to raise capital from public investors.

A main part of our work is to conduct pre-IPO due diligence. Due diligence is regularly carried out to assess the market maturity of the IPO candidate. We deal executers, together with the accompanying issuing houses and the advisers, typically commissions due diligence covering the financial, tax, legal, commercial, IT, operational, environmental and human resource areas. The objective of the pre-IPO due diligence is to analyze the sustainability of the business model, the plausibility of planning and the disbursement capacity of the company.

I am responsible for financial due diligence and shareholders’ due diligence. A pre-IPO due diligence delivers insights into the sustainability of the company’s business model, assesses the competitive landscape, delves into the opportunities available in the candidate’s industry and fully assesses the potential risks that could impact the company.

For financial due diligence, I check the bank card records of transactions of senior executives to identify whether their receipts and payments are normal transactions or there are possibilities of property transfer or commercial bribery. In addition, I check a large number of loan contracts, including the debt amount, starting and ending date, guarantors and guarantee amount to confirm whether the company’s liabilities are within a reasonable range and whether it has potential debt crisis. I am also responsible for writing the relevant part of financial analysis in the prospectus. For shareholders’ due diligence, I have collected the information of the company’s shareholders which should be disclosed in the prospectus through questionnaires under my mentor’s guide. In the case of an IPO, the shareholders of a company are usually directors, supervisors, and senior managers. Since they are the persons who are actually responsible for the operation of the company, we need to disclose in the prospectus their educational and professional backgrounds in detail so that investors can judge whether the company’s top management team can manage the company well to ensure its long-term growth. It is also important to know their investments in other companies or their holdings of shares of other companies, and to recognize the benefit relationship between shareholders and related companies.

Although I did not have the opportunity to participate in the whole process of an IPO project as it usually takes about two years to carry out a project from the beginning of due diligence to the final listing on an exchange, I still feel it is a rewarding experience because so far, I have helped my mentor completed a lot of basic information processing and through this process I have learned how the data and information in the prospectus are obtained, and I have gained an extensive series of knowledge of auditing, commercial laws, and corporate management.

Through the communication with the associates in my group, I learned about what the working environment and lifestyles are like for bankers. The work in an investment bank may begin with dealing with trivial things for several years, but the fact that many elites gather there and their pursuit of perfection in work allow people to develop working capacities and qualities that ordinary people need ten years to cultivate in three years. For example, the customers you are facing are senior executives of large companies, so you can touch the ideas of leaders in the industry; your skills to make and present slides will be greatly improved by doing numerous presentations to customers; and by analyzing the company’s business, you will have a deep understanding of the industry that it is in after each deal.

Relevance to the SimTrade certificate

Primary market and secondary market are interdependent upon each other. Primary market brings new tradeable stocks and bonds to secondary market. A company is considered private prior to an IPO. It grows with a relatively small number of shareholders including early investors like the founders, family and relatives along with professional investors such as angel investors. To expand at a higher speed, the company needs to raise more capital. That’s what an IPO can provide. Via an IPO, securities are created in the primary market. Those securities are then traded by public investors in the secondary market. The secondary market provides liquidity to company founders and early investors, and they can take advantage of a higher valuation to generate dividends for themselves.

From the course SimTrade, I learned many factors that may affect a company’s stock price. For example, when the company appoints a new director who has many years’ experience in the company’s business sector, this favorable news will attract more investors to invest because they believe that under the guidance of this new director, the company’s performance will improve. As a result, the valuation will increase, and the stock price will rise. If the news comes like the company’s new product development has failed, it will lower the expectations of investors, causing some of them to sell stocks and invest in other stocks, accompanied by a decline in stock price. This knowledge about the secondary market also helps me find out more factors that should be considered in pre-IPO due diligence. We should identify the company’s potential competitive advantages, which will become an attraction to public investors and ensure its vitality in the securities market; we also need to recognize its risk factors because if the company does not operate well, it will face the risk of delisting, and more importantly, we are responsible for ensuring the sustainable trade order in the secondary market.

In short, the SimTrade course has equipped me with necessary knowledge needed in internship as well as future work and paved the way for me to secure an ideal position. This will be an asset that I will cherish for the rest of life.

About the author

Article written in May 2021 by Qiuyi Xu (ESSEC Business School, Global Bachelor of Business Administration, 2019-2021).

Private banking: evolving in a challenging environment

March 12, 2021 by Hélène VAGUET-AUBERT

Private banking: evolving in a challenging environment

This article written by Hélène Vaguet-Aubert (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2021) discusses the challenging environment in private banking based on her experience at the Banque Internationale à Luxembourg (BIL).

Banque Internationale à Luxembourg (BIL)

Banque Internationale à Luxembourg (BIL) was founded in 1856 and is now steered by Marcel Leyers, appointed as director and chairman of BIL’s executive committee in 2019 (BIL, 2021). Being a top bank for over 160 years and being owned to a 10% extent by the Luxembourgish government, BIL supports Luxembourg’s economy at all levels. BIL has also established itself as top international player thanks to its international subsidiaries. BIL’s international scope, 2,000 top-skilled employees worldwide, strong financial results and growth confirms its systemic importance.

Headquarters of Banque Internationale à Luxembourg (BIL)

Source: BIL

BIL brings together all its banking business lines under a common umbrella in order to propose top-of-the-range solutions tailored to the requirements of a very diverse client base. Indeed, the bank has all the financial products and expertise necessary to fulfill all of its clients’ needs: private banking, retail banking, corporate banking and financial markets. As of H1 2019, the bank had a €45 million profit and €41.9 million of assets under management.

As BIL’s “create, collaborate, care” mission statement clearly indicates, BIL’s marketing strategy is client oriented. BIL’s objectives are to focus on core competencies to boost its revenues. To do so, BIL’s short term strategy is to strengthen its activities in mature markets such as Luxembourg and Switzerland. On the long term, BIL’s objective is to leverage the potential of Legend Holdings and the Chinese private banking market.

My internship at BIL

Passionate by strategy and sales, and willing to acquire international experience in the financial sector, I carried out a six-month internship in the Sales Management Department of Banque Internationale à Luxembourg (BIL). In this department, I worked with a team of five international people whose role was to design strategy, sales and marketing solutions to be the direct support of BIL front office and the private banking clients’ indirect support. During this internship, the responsibilities that I had where divided in two parts: on the one hand, sales and marketing, and on the other hand, strategy.

First, regarding the sales and marketing part, my role was to analyze the performance of the bonds and equity financial markets and mutual funds as well to develop weekly sell/buy/hold recommendations regarding BIL products. Once these sales recommendations were made, my role was to analyze the performance of wealth managers from BIL Europe, Asia and Middle East. Finally, once BIL products and wealth managers’ performances were analyzed, I had the opportunity to design relevant marketing content (pitch book containing the details of the financial products) for BIL 20,000 private banking clients.

Second, regarding the more strategic parts, I contributed to the management of two projects at the group level: digitalization of the commercial process on a selection of 2,500 products and repositioning of the private banking service offering targeting 2,000 customers.

Private banking

The financial concept that was the most linked to my experience at BIL is the concept of private banking. Private banking is the main subset of wealth management, it offers investment, banking and other financial services to high-net-worth individuals (HNWI) on different markets. The adjective “private” emphasizes a more consumer-centered approach than what is offered by retail banks since each client is usually assigned to dedicated relationship managers and benefits from tailor-made products. Historically, HNWI from different markets or private banks’ target, were individuals with liquidity over $2 million. However, now, it is possible to open a private banking account with cash and/or financial assets of $250,000. Hence, HNWIs segments that wealth management institutions such as private banks target can be divided into four categories based on their income:

Affluent: between $250,000 and $1 million
Lower HNWI: between $1 million and $20 million
Upper HNWI: between $ 20 million and $100 million
Ultra-High Net Worth individuals or UHNWI: over $100 million

Under one roof, private banks’ offering encompasses wealth management, tax and insurance services.

Pricing model

For these services, private banks can use three types of pricing models (Goyal et al., 2019):

“Standard” model: the client pays custody fees, transaction fees and management fees
“All-in fee” model: the client only pays management fees
“Performance fee” model: the client pays performance fees and custody fees

Challenges

Today, the private banking industry is facing many threats such as: digitalization, enhanced regulations, rising clients expectations but I would say one of the most important one I noticed in the wake of my internship is: negative interest rates, which is the second financial concept I will introduce here. Indeed, in the wake of the 2008 financial crisis, central banks such as the European Central Bank (ECB) in 2014 had to charge negative interest rates to fight the deflationary spiral. These negative interest rates (-0.5% since September 2019) are a big trouble for European banks such as the ones in Luxembourg: banks must now pay interests on their reserves to the ECB. The excess in bank reserves has exploded since the “Quantitative Easing” program of the ECB in 2015. Therefore, banks have paid €25 billion of negative deposit rate to the ECB since 2014 which had a had a considerable impact on banks’ profitability, equating to a 4% decline in profits for European banks in 2018 for instance (Honoré-Rougé, 2019).

To compensate these profits cuts, some European banks have started charging their clients on their cash deposits or take the risk to grant more risky loans to maintain a decent level of profitability (Arnold, Morris & Storbeck, 2019). However, despite these negative economic trends, Luxembourg is still the leading asset management center in the Eurozone. In Luxembourg, AUM increased to $4.9 trillion in 2020 (+5.4% from 2019).

Useful resources

Arnold, M., Morris, S., & Storbeck, O. (2019). European banks fear no escape from negative rates. The Financial Times, 1-3. Retrieved from https://www.ft.com/content/93015730-d960-11e9-8f9b-77216ebe1f17

BIL. (2021). BIL, a key player in the Luxembourgish financial market. Retrieved 27 December 2021, from https://www.bil.com/en/bil group/the-bank/Pages/discover-BIL.aspx

Goyal, D., Zakrzewski, A., Mende, M., Alm, E., Kowalczyk, L., & Wachters, I. (2019). Solving the Pricing Puzzle in Wealth Management. Retrieved 28 December 2019, from https://www.bcg.com/publications/2019/solving-the-pricing-puzzle-in-wealth-management.aspx

Honoré-Rougé, C. (2019). Les taux négatifs et leurs conséquences sur les banques de la zone euro. Retrieved 25 February 2021, from http://www.bsi-economics.org/1039-taux-negatifs-consequences-banques-zone-euro-chr

Relevance to the SimTrade Certificate

It relates to the SimTrade Certificate in the following ways:

About theory

By taking the Discover SimTrade course (Period 1), you will discover the SimTrade platform that allows investors (or their financial advisors or private bankers) to invest in the financial markets.
By taking the Market information course (Period 2), you will know more about how information is incorporated in the stock market price.

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 Market order simulation and the Limit order simulation, you will practice market orders and limit orders that are the two main orders used by investors to build and liquidate positions in financial markets.

More about SimTrade

About the author

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

Asset valuation in the real estate sector

March 11, 2021 by Ghali EL KOUHENE

Asset valuation in the Real Estate sector

This article written by Ghali El Kouhene (ESSEC Business School, Global BBA, 2019-2022) discusses the valuation methods in the real estate sector.

Definition of a real estate

Real estate is a property, land, buildings, air rights above the land (with certain limitations) and underground rights below the land. The term “real estate” means real, or physical, property. It is the land and its attached constructions that represent a capital good that produces a flow of services over time. Therefore, land includes earth’s surface, lateral support and subjacent support. But it also includes materials under the surface such as substances, minerals oil and gas.

There are four types of real estate assets. First, we find residential real estate. It is a type of leased property, containing either a single family or multifamily structure that is available for occupation for non-business purposes. This includes both new construction and resale homes. Secondly, there is commercial real estate. They are property used exclusively for business purposes or to provide a workspace rather than a living space. All of them are owned to produce income. Thirdly, we can mention industrial real estate. There are generally two uses for industrial properties: companies make things, or they store things. These includes manufacturing buildings and property, as well as warehouses.

Finally, land is real estate or property, minus buildings and equipment that is designated by fixed spatial boundaries. Land ownership may offer the titleholder the right to natural resources on the land. Traditionally it is defined as a factor of production, along with capital and labor.

Importance of the real estate sector in the economy

According to the European Real Estate Forum, the real estate sector has a higher economic importance than several other sectors. Indeed, it makes a major contribution to GDP in the European Union and provides prosperity and jobs. The real estate sector contributed approximately 7% to the USA economy and 12% to the European economy.
Real estate represents the majority of the existing real capital and is particularly relevant too because of its additional function as provision for old age and protection against inflation.

The value of the world’s real estate reached US$281 trillion, the highest figure we’ve ever recorded. Residential real estate accounted for the largest share ($US220.2 trillion) of that huge figure.

Real estate is by far the most significant store of wealth, representing more than 3.5 times the total global GDP. For comparison, financial instruments like equities represent US$83,3 million, which is three times less than commercial real estate.

Global real estate universe in comparison

Source: Savills World Research

Why does the need for property valuation arise?

The need for property valuation arises in many decisions in real estate project like investing, managing, disinvesting and financing. Thereby, valuation is present throughout the life of real estate investment. It is not a unique need for real estate but common to any investment such as stock investment.

There are fundamental characteristics to be evaluated in the valuation process. Characteristics like the use of the asset (commercial, residential, etc.), the location, the antiquity (1st hand, 2nd hand), construction costs and surfaces.

What are the different types of value for a real estate asset?

According to the Royal Institution Of Chartered Surveyors standards (RICS) which offers qualifications and standards recognized in the real estate sector, a value is an estimated amount for which an asset or an obligation should be exchanged at the valuation date between a buyer willing to buy and a seller willing to sell, in a free transaction, after appropriate marketing, in which the parties have acted with sufficient information, prudence and without coercion. This specific definition is declined in several others values like equitable value, fair value or market value. For each value, different methods of valuation are used.

Which methods are used to appraise an asset?

The great diversity of real estate assets must be approached from different approaches in order to determine their value. The existence of comparable assets in the market, the type of use made of them, the cash flows that they may eventually generate, replacement costs or the state of development of the same opens up a wide range of valuation methodologies. In this way we can identify at least six different types of valuation methodologies applicable to the different types of real estate assets that we will classify into at least 14 large groups. The main axes of the valuation methodologies are: comparison, residual, capitalization and cash flows. It is important to know that each type of real estate asset has its preferred method of valuation. For example, the comparison method is mainly utilized for assets for own use (dwellings and premises mainly) and for rustic land. The concept for this method consists in comparing a property of known price and characteristics with the one we want to value. Regarding the discounted cash flow methodology, it consists in determining the market value of a property by estimating the cash flows generated by the property (mainly rents) during a determined period of time and the resale of the investment.

Reading the real estate market requires the development of an information tool. The study of the traditional approach has shown that the reliability of real estate valuation methods is intimately linked to the information available. Information is essential when it comes to asset valuation for each of the different methods (list of rents, the price per square meter etc.). The difficulty in the valuation process does not come from the methodology but from the availability of relevant information. To complete his/her analysis of the real estate deal, the expert can also consider the future instead of the past contained in historical data.

For example, the value of the real estate can be obtained by estimating the growth rate of future rents. Today, artificial intelligence (AI) can be used to develop new valuation models are based on machine learning (ML) algorithm.

How to invest in the real estate sector?

Real estate investment consists of acquiring a property not for the purpose of living in it, but as a savings investment to earn an income from it. It is considered as one of the most stable and profitable investments in the long term. For this reason, investing in real estate is not a trivial gesture: you must know enough about the state of the market and the different investment possibilities not to put your money in risky options.

Several reasons can push you to proceed to a real estate investment. First, it is a great way to build up a tangible and lasting estate. Secondly, investing in real estate enables to finance a property with the aim of making it your main residence later on, by means of rental investment. And lastly, it improves your purchasing power by collecting additional income.

There are several possibilities when it comes to investing in real estate. Among them, there is direct investment which means creating a property portfolio. Indeed, any private individual can firstly invest and acquire a property as a primary residence and later on acquire other properties for the purpose of making a rental investment in order to collect the rents. In the other hand, other types of investment such as indirect investment. The concept of indirect investment consists in buying shares of property company or Real Estate Investment Trust’s (REITS) which aims at the constitution, management and exploitation of a real estate portfolio. Therefore, this company manages real estate assets on behalf of its shareholders. Lastly, a real estate investment company (SCPI) is a collective investment vehicle which is very similar to REITS. Except that in return for this investment, investors receive social shares. Unlike company shares, these units are not listed on the stock exchange. These savings vehicles offer a very good market return in return for a moderate risk.

About the author

Article written in March 2021 by Ghali El Kouhene (ESSEC Business School, Global BBA, 2019-2022).

Ponzi scheme

February 26, 2021 by Louis VIALLARD

Ponzi scheme

This article written by Louis Viallard (ESSEC Business School, Master in Management – Economic Tracks, 2020-2022) presents the basics of a fraudulent financial scheme: the Ponzi scheme. The famous and recent Madoff Affaire is used to illustrate this financial fraud.

In the Letter 142 of The Persian Letters, Montesquieu tells us the mythological tale of the son of Aeolus, god of the wind, who decides to travel the world to sell air-filled otters. The French author presents us with his reflections on a new discipline in gestation in the 17th century that already fascinates minds: modern finance. Indeed, Montesquieu’s work was written in 1720, the same year as the bursting of one of the first financial bubbles of our history following a speculation around the Royal Bank and the Mississippi Company in which Montesquieu, a contemporary of the crash, was interested. The example used in The Persian Letters with the metaphor of the wind to qualify financial speculation and certain fraudulent financial mechanisms is perfectly suited to define a sadly famous fraudulent scheme: the Ponzi Scheme.

Money makes money – What is a Ponzi scheme?

A Ponzi scheme is a form of financial fraud in which participants are paid with money invested by subsequent participants, not by actual profits from investments or business activities. Investors are attracted by windfall dividends that are paid by the entry of new investors into the system to pay the first ones and so on.

The organizers of a Ponzi scheme generally attract investors by offering higher returns than any legitimate business can offer. The rate of growth of new inflows must be exponential in order to be able to remunerate members, and the system inevitably breaks down when the need for funds exceeds new inflows. Most participants then lose their investments, even though the first participants – including the founders – can benefit from high returns or exceptional annuities provided that to have withdrawn from the scheme in time.

Fraudsters organizing such schemes often target groups that have something in common, such as ethnicity, religion or profession, in the hope of exploiting their trust. The example of the Rochette Affaire in 1908 illustrates this well. Henri Rochette managed to capture the small provincial savings by relying on the wave of investment in coal mines at the beginning of the 19th century and by selling the merits of his (fictitious) companies through investment advice journals that he himself controlled.

An example of a Ponzi Scheme – The Madoff scandal

Bernard Madoff was born in 1938. This American broker immersed himself in finance at a very young age and quickly earned a good reputation among the greatest financiers. Reputed to be intuitive, ultra-fast but also very “ethical”, he had finally established himself in the financial community, which earned him the position of President of Nasdaq from 1990 to 1991. Socially-minded, jovial, he managed to capture the confidence of his future clients.

Through his fund (Bernard Madoff Investment Securities), Mr. Madoff received capital to manage, which he supposedly invested in a complex investing technique: the split-strike conversion strategy (see Bernard and Boyle (2009)). It is a three-step technique. First, you buy a portfolio of securities (the S&P100 index in the case of the Madoff). Second, you purchase out of the money put options with a nominal value on the underlying asset equal to the value of your portfolio. The objective is to limit the risk of loss of the portfolio. Third, you write out of the money call options on the underlying asset with a nominal value equal to the value of your portfolio. The sale of calls finances the purchase of puts.

When the performance was not there, instead of reducing the return distributed to investors, Madoff simply took the money from the new investors and used it to pay the old ones. As a result, he gave the impression of an exceptional performance in terms of risk-return trade-off (relatively high performance but delivered regularly year after year). Such an investment track record allowed Mr Madoff to attract more and more investors, but year after year, he squandered the capital they had entrusted to him.

When the stock market crisis broke out in 2008, many investors wanted to withdraw their funds from Madoff investment. Too many at the same time. Mr. Madoff could not give their money back. He informed his son of the situation and he warned the authorities. On December 11th 2008, Bernard Madoff was arrested by the FBI and was then sentenced to 150 years in prison.

Economic and financial damage

Ponzi schemes are expensive for most participants and divert savings from productive investment. If left unchecked, they can grow disproportionately and cause great economic and institutional damage, undermining confidence in financial institutions and regulators and putting pressure on the budget in the event of bailouts. Their collapse can even lead to economic and social instability.

In the case of a Ponzi Scheme detected, there is a need for a rapid government response. However, the authorities often struggle with not only detecting these scams at an early stage but also put an end to it. There are several reasons why it is difficult to stop these practices. Often, neither the leaders nor the schemes are licensed or regulated. In many countries, supervisory authorities do not have appropriate enforcement tools, such as the right to freeze assets and block systems quickly. On the one hand, once a Ponzi scheme has grown, authorities may be reluctant to stop it, because if they do so – thus preventing it from meeting its repayment obligations – subscribers may blame them rather than the inherent flaws in the system. It is not uncommon to see investors supporting the authors of these chains, trusting them blindly. But on the other hand, when the system collapses of its own accord, experience shows that the authorities can be criticized for not acting more quickly.

“Trust does not preclude control” – The necessity to regulate

To prevent Ponzi schemes, authorities must be prepared to intervene on several fronts. Here are the main ideas when it comes to fight Ponzi schemes:

Investigate. Ponzi schemes are generally difficult to detect due to their opaque or even secretive operation, as members are required to maintain confidentiality. In order to detect them, regulators need to develop effective and sophisticated ways to identify this type of fraud. New technologies can provide an answer through an automatic analysis model that identifies (legal) pyramid schemes that would require further analysis.

Intervene urgently. The procedures required for the prosecution of a person alleged to be the perpetrator of a Ponzi scheme are very lengthy. So much time is left for the perpetrator to disappear. It is necessary to have the legal possibility to immediately stop any activity that is proven to be a Ponzi scheme (freezing of assets, protection of spyware interests, etc.).

Arrest. Heavy penalties must be imposed on crooks, including criminal action (as was the case for Bernard Madoff, who was sentenced to 150 years in prison).

Coordinate and cooperate. It is necessary that the financial authorities must collaborate with the legal system to penalize and regularize. To combat scams, financial regulators need effective mechanisms for information exchange and cooperation. To achieve this, the role of the International Organization of Securities Commissions (IOSCO) is central to the articulation of global standards.

Inform. Financial training can be a barrier to scams. It is also essential for financial regulators to inform and educate the public about the main methods used to deceive savers. In the name and shame concept, creating lists of persons or organizations that may or may not be licensed to engage in financial activities, as well as a database describing the actions taken against certain persons and entities, is also a good way to counter any malicious activity.

What lessons can be learned?

Many lessons can be learned from Ponzi schemes, both at the micro and macro levels.

At the micro level, it is important to remind individual investors that the analysis of an investment is essential and must follow three precise criteria: profitability, risk and liquidity (not to be neglected). It is also very wise to follow the adage “don’t put all your eggs in one basket”; portfolio diversification allows you to benefit from the “portfolio effect” due to low statistical correlation among assets.

At the macro level, it is essential for the regulator (like the Securities Exchange Commission (SEC) in the US or the Autorité des Marchés financiers (AMF) in France) to put in place tools to monitor and prevent Ponzi schemes, and to work in collaboration with the legal institutions to dissuade and to punish this type of behavior.

Useful resources

Ponzi schemes

Frankel T. (2012) The Ponzi Scheme Puzzle: A History and Analysis of Con Artists and Victims” Oxford, University Press.

Monroe H., A. Carvajal and C. Pattillo (2010) “Perils of Ponzis” Finance & development , 47(1).

Madoff’s scandal (2008)

Bernard C. and P.P. Boyle (2009) “Mr. Madoff’s Amazing Returns: An Analysis of the Split-Strike Conversion Strategy” The Journal of Derivatives, 17(1): 62-76.

Bernard Madoff’s vision about business (video)

Testimonials by Markopolos (video)

Markopolos Talks About Offering To Go Undercover To Stop Madoff (video)

Wetmann A. (2009) L’affaire Madoff, Pion.

The Rochette Affaire (1908)

Jeannenay J.-N. (1981) L’Argent caché : milieux d’affaires et pouvoirs politiques dans la France du XXe siècle Paris, Editions du Seuil.

About the author

Article written by Louis Viallard (ESSEC Business School, Master in Management – Economic Tracks, 2020-2022).

ETFs in a changing asset management industry

February 3, 2021 by Youssef LOURAOUI

ETFs in a changing asset management industry

In this article, Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2016-2020) talks about his research conducted in the field of investing.

As a way of introduction, ETFs have been captivating investors’ attention in the last 20 years since their creation. This financial innovation has shaped how investors place their capital.

Definition

An ETF can be defined as a financial product that is based on a basket of different assets, to replicate the actual performance of each selected investment. An ETF has more or less the same proportion of the underlying components of the basket, depending on the style of management of the asset manager. ETFs represent nearly 90% of the asset under management of the global Exchange Traded Products (ETP).

History

The first ETF was the Standard and Poor’s Depository Receipts (SPDR) introduced in 1993. It appears to be an optimized product that enables investors to trade it like a stock, with a price that fluctuates during the day (not like mutual funds whose value is known at the end of the day only). The main advantage of ETFs for investors is to diversify their investment with lower fees than buying each underlying asset separately. The most important ETFs in the market are the ones with the lowest expense ratio as it is a crucial point to attract money from investors in the fund.

Types of ETF

ETFs can be segmented in different types according to the asset class, geography, sector, investment style among other criteria. According to Blackrock’s classification (2021), the overall ETF market can be divided into the following classes:

Stock ETFs track a certain stock market index, such as the S&P 500 or NASDAQ.
Bond ETFs offer exposure to a wide selection of fixed income instruments.
Sector and industry ETFs invest in a particular industry such as technology, healthcare, or financials.
Commodity ETFs track the price of a commodity such as oil, gold, or wheat.
Style ETFs are devoted to an investment style or market capitalization focus such as large-cap value or small-cap growth.
Alternative ETFs offer exposure to the alternative asset classes and invest in strategies such as real estate, hedge funds and private equity.
Foreign market ETFs follow non-U.S. markets such as the United Kingdom’s FTSE 100 index or Japan’s Nikkei index.
Actively managed ETFs aim to provide a certain outcome to maximize income or outperform an index, while most ETFs are designed to track an index.

Figure 1. Volume of the ETF market worldwide 2003-2019.

Source: Statista (2021).

Figure 1 represents the volume of the ETF market worldwide over the period 2003-2019. With over 6,970 ETFs globally as of 2019 (Statista, 2021), the ETF industry is growing at an increasing pace, recording a thirty-fold increase in terms of market capitalization in the 17-year timeframe of the analysis. It reflects the growing appetite of investors towards this kind of financial instruments as they offer the opportunity for investors to invest virtually in every asset class, geographical region, sector, theme, and investment style (BlackRock, 2021).

iShares (BlackRock), Xtrackers (DWS) and Lyxor (Société Générale) can also be highlighted as key players of the ETF industry in Europe. As shown in Figure 2, Lyxor (a French player) is ranked 3rd most important player with nearly 9% of the overall European ETF market (Refinitiv insights, 2019). iShares represents nearly eight times the weight of Lyxor, which is slightly above the average of the overall European ETF volume in dollars.

Figure 2. Market share at the promoter level by Assets Under Management (March 31, 2019)

Source: Refinitiv insights (2019).

It goes without saying that the key player worldwide remains BlackRock with nearly 1/3 of the global ETF market capitalization. According to Arte documentary, BlackRock is without a doubt a serious actor of the ETF industry as shown in Figure 2 with an unrivaled market share in the European and global ETF market. With more than 7 trillion of asset under management, BlackRock is the leading powerhouse of the asset management industry.

Benefits of ETF

The main benefits of investing in ETFs is the ability to invest in a diversified and straightforward manner in financial markets by owning a chunk of an index with a single investment. It allows investors to position their wealth in a reference portfolio based on equities, bonds or commodities. It also helps them to create a portfolio that suits their needs or preferences in terms of expected return and risk and also liquidity as ETFs can be bought and sold at any moment of the day. Finally, ETFs also allow investors to implement long/short strategies among others.

Risks

Market risk is an essential component to fully understand the risk of owning an ETF. According to the foundations of the modern portfolio theory (Markowitz, 1952), an asset can be deconstructed into two risk factors: an idiosyncratic risk inherent to the asset and a systematic risk inherent to the market. As an ETF are composed of a basket of different assets, the idiosyncratic risk can be neutralized by the effect of diversification, but the systematic risk, also called the market risk is not neutralized and is still present in the ETF.

In terms of risk, we can mention the volatility risk arising from the underlying assets or index that the ETF tries to replicate. In this sense, when an ETF tries to emulate the performance of the underlying asset, it will also replicate its inherent risk (the systematic and non-systematic risk of the underlying asset). This will have a direct impact on the overall risk-return characteristic of investors’ portfolio.

The second risk, common to all funds and that can have a significant impact on the overall performance, concerns the currency risk when the ETF owned doesn’t use the same currency as the underlying asset. In this sense, when owning an ETF that tracks another asset that is quoted in another currency is inherently, investors bears some currency risk as the fluctuations of the pair of currencies can have a significant impact on the overall performance of the position of the investor.

Liquidity risk arises from the difficulty to buy and sell a security in the market. The more illiquid the market, the wider the spreads to compensate the market maker for the task of connecting buyers and sellers. Liquidity is an important concern when picking an ETF as it can impact the performance of the portfolio overall.

Another risk particular to this instrument, is what is called the tracking error between the ETF value and its benchmark (the index that the ETF tries to replicate). This has a significant impact as, depending on the overall dispersion, the mismatch in terms of valuation between the ETF and the benchmark can impact the returns of investors’ portfolio overall.

Passive management and the concept of efficient market

Most ETFs corresponds to “passive” management as the objective is just to replicate the performance of the underlying assets or the index. Passive management is related to the Efficient Market Hypothesis (EMH), assuming that the market is efficient. Passive fund managers aim to replicate a given benchmark believing that in efficient markets active fund management cannot beat the benchmark on the long term.

Passive fund managers invest their funds by:

Pure replication of the benchmark by investing in each component of the basket (vanilla ETF)
Synthetic reproduction of the benchmark by replicating the basket with derivatives products (like futures contracts).

An important concept is market efficiency (also known as the informational efficiency), which is defined as the ability of the market to incorporate all the available information. Efficient market is a state of the market where information is rationally processed and quickly incorporated in the market price.

It is in the heart of the preoccupations of fund managers and analysts to unfold any efficiency in the market because the degree of efficiency impacts their returns directly (CFA Institute, 2011). Fama (1970) proposed a framework analyzing the degree of efficiency in a market. He distinguishes three forms of market efficiency (weak, semi-strong and strong) which correspond to the degree in which information is incorporated in the prices. Earning consistently abnormal returns based on trading with information is the opposite view of what an efficient market is.

The weak form of market efficiency refers to information composed of past market data (past transaction prices and volumes). In a weakly efficient market, past market information is already included in the current market price, and investors will not be able to distinguish any pattern or prediction of future prices based on past data.
The semi-strong of market efficiency refers to publicly available information. This includes market data (as in the week form) and financial disclosed data (financial accounts published by firms, press articles, reports by financial analysts, etc.). If a market is considered in the semi-strong sense, then it must be in a weak sense as well. In this context, there is no additional gain in determining under or overvalued security as all the public data is already incorporated in the asset price.
The strong of market efficiency refers to all information (both public and private). Markets are strongly efficient when they reflect all the available information at any time in the asset prices.

Useful resources

Academic resources

Fama, E. (1970) “Efficient Capital Markets: A Review of Theory and Empirical Work” Journal of Finance 25(2), 383–417.

Business

Arte documentary (2014) “Ces financiers qui dirigent le monde: BlackRock”.

BlackRock (January 2021) ETF overview.

Refinitiv insights (2019) Concentration of the major players in the European ETF market.

About the author

The article was written in February 2021 by Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2016-2020).

Markets

February 16, 2025February 3, 2021 by Juan Francisco RODRIGUEZ RODRIGUEZ

Markets

This article written by Juan Francisco Rodriguez Rodriguez (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021) presents the basics of markets and details two types of market microstructure: the fixing procedure and the limit order book.

What is a market?

The market is a process that operates when there are people who act as buyers and sellers of goods and services, generating an exchange. There is a market if there are people with the intentions to buy and sell, and when participants agree to exchange goods and services at an agreed price. For the market to work, you need buyers and sellers, and these two parts are what make up the market.

Buyers

On the one hand, the buyer is the person who acts in a market with the intention of acquiring a good or service by paying an amount of money (or in exchange for another good or service). Therefore, when someone buys, this person considers that the good or service he is receiving is worth more than the money he is paying for.

Sellers

On the other hand, the seller is the person who is willing to deliver a good or service by accepting a quantity of money (or in exchange for another good or service). The seller considers that the money that she is receiving has more value than the good or service that she offers.

Supply and demand

In a market, the price of the product is determined by the law of supply and demand. If the price is high, few people will be willing to pay for it but many will want to produce it; if the price is low, many will be willing to buy it but few willing to produce it. The price will be eventually at an acceptable level for both parties.

Financial markets

Market used to be a physical place where the processes of exchange of goods and services took place, but due to technology markets no longer need a physical space.

Add two images: one for a physical market, one for a digital market (guys in front of computers) for Wall Street

Market with a fixing procedure

The fixing procedure is a form of trading securities in financial markets by fixing single prices or “fixing”. This procedure is commonly based on auctions. At the close of each auction the orders are crossed to maximize the quantity exchanged between buyers and sellers, and the new price is set.

Auctions are periods in which orders are entered, modified, and canceled. No negotiations are executed until the end of the auction. During this period, an equilibrium price is set based upon supply and demand, and negotiations take place at the end of the auction at the last equilibrium price calculated to maximize the quantity exchanged between buyers and sellers.
The fixing procedure is used for securities presenting a low level of liquidity. It is also used to set the opening and closing prices for continuous markets.

Market with a limit order book

A limit order book is a record of pending limit orders waiting to be executed against market orders.

A limit order is a type of order to buy or sell a security at a specific price. A buy limit order is a buy order at a fixed price or lower. When your buy limit order arrives to the market, it is confronted to the other side of the order book: the “Sell” side of the order book. If the sell orders in the order book are at the same or lower price than the price limit of your buy order, a transaction takes place. Similarly, a sell limit order is a sell order at a fixed price or higher. When your sell limit order arrives to the market, it is confronted to the other side of the order book: the “Buy” side of the order book. If the sell orders in the order book are at the same or higher price than the price limit of your sell order, a transaction takes place.

When the price limit of a buy limit order arriving to the market is lower than the best proposition on the “Sell” side of the order book, it is simply recorded in the order book, and is carried out as long as it has reached the market price. When the price limit of a sell limit order arriving to the market is higher than the best proposition on the “Buy” side of the order book, it is simply recorded in the order book, and is carried out as long as it has reached the market price.

Relevance to the SimTrade Certificate

These terms are very relevant to the SimTrade Certificate because they lay the foundations for us to know how financial markets work and the different ways in which a transaction can be carried out, whether to buy or sell an asset. I definitely think this will add value to my career in finance and help me make better investment decisions in the future.

The SimTrade platform uses a market with a limit order book, which corresponds to the current standard for real financial markets organized around the world.

The concept of markets relates to the SimTrade Certificate in the following ways:

About theory

By taking the Discover SimTrade course, you will discover the SimTrade platform that simulates a market with a limit order book.
By taking the Trade orders course, you will know more about the different type of orders that you can use to buy and sell assets in financial markets.

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 Market order simulation and the Limit order simulation, you will practice market orders and limit orders that are the two main orders used by investors to build and liquidate positions in financial markets.

More about SimTrade

Article written by Juan Francisco Rodriguez Rodriguez (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2021).

Quote stuffing

February 16, 2025January 23, 2021 by Akshit GUPTA

Quote stuffing

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2022) presents the concept of quote stuffing which is a type of market manipulation practice seen across financial markets.

Introduction

Quote Stuffing is the practice of entering huge number of buy or sell orders for a security within a short time frame (i.e. milliseconds or nanoseconds) and immediately cancelling them. For example, a company practicing quote stuffing can make more than 2000 transaction in a second to manipulate the market. It is one of the recent practices seen to be used by traders to manipulate the financial market. As the technology is improving and traders have quick access to the order books of the exchanges with the help of technology driven brokerage firms, the possibility for the use of quote stuffing is increasing as it is very easy to enter and cancel orders at a high frequency.

The mechanism

Under quote stuffing, the manipulator stuffs the order book of a security and distorts the bid-ask spread for that security by placing massive orders and increasing the quantities at the sell and buy sides of the order book for that security. The practice is used to deceive other traders by creating an artificial view about the market depth and liquidity for a security. The practice may be done by the manipulator to slow down the processing of data, cause high latency problems (a delay in the processing of orders at the exchange) and disrupt the exchange trading system.

Honest investors can make trades under the false impression of increased liquidity for a particular security. But as soon as the trades are executed, the false orders are cancelled using the algorithms and the liquidity disappears from the market for that security, harming the investor’s position by decreasing the liquidity in the market.

Structure in US financial markets

High frequency trading firms in USA have a direct access to the stock exchanges operating in a financial market and receive data flows from them directly. Whereas in the case of retail traders/investors, SIP (Securities Information Processors) receive data from stock exchanges and creates the NBBO (National Best Bid and Offer) which is then shown to these retail traders/investors.

(Securities information processors are organizations that help in collecting, processing, consolidating and disseminating all the bid/ask prices from traders and issuing real time quote or trade information to the market participants.)

(National Best Bid and Offer is the highest price on the bid side and lowest price on the ask side available for the traders of any security in the financial markets.)

The quote stuffing strategy can also work by creating a latency arbitrage trading opportunity for the High Frequency Trading firms which send false quotes to the exchanges and profits from the time delay that results when the SIP updates the order book for the retail traders by adding and deleting the orders created by the HFT firms.

Latency refers to the time delay between which an order is requested and responded to in a marketplace. Latency Arbitrage Trading refers to the use of low latency trading by HFT trading firms to shorten the request and response time in the financial market and earn profits by having the time advantage over high latency traders.

For example, a HFT firm practices quote stuffing on the stocks of Company A. Seeing an increased liquidity in the stocks of Company A, a trader enters a sell limit order for the stock of company A at $10 on NYSE. The exchange will send the data to the SIP feed (which will then create the NBBO and send it to the other traders in the market) and HFT firms simultaneously. The HFT firms will look for the best buy price across all exchanges. They find the stock of Company A available at an ask price of $9.95 on Nasdaq. The firm will immediately buy the share and sell it to the retail investor at $10, earning a $0.05 on the trade caused due to quote stuffing. The amount may seem insignificant but if the volume of such trades is taken into consideration, the HFT earns huge profits using quote stuffing.

Rules and Regulations

Considered a market manipulation practice, quote stuffing has been made illegal across many stock exchanges throughout the world. Many instances of potential quote stuffing have been observed in the financial markets but since complex algorithms are involved in such practices, it is very difficult to find evidence to prove the intent of the firms/individuals practicing it.

The Commodity Future Trading Commission (CFTC) has banned quote stuffing under Rule 575 implemented in May 2013. Although no official laws have been enacted by market regulators, quote stuffing is still a major issue in the financial markets. Also, many proposals to put a minimum time period between entering an order and cancelling it are in consideration, which will prevent HFT firms to cancel the orders immediately after the initial request.

Real life example

The Flash Crash of 2010 has been an infamous example of the repercussions of HFT and quote stuffing techniques used by the HFT firms. The practice of quote stuffing hampers the natural price discovery mechanism in the market. It also distorts the bid-ask spread and provides a false signal about the movement of the prices of a security. The regulatory bodies around the world are working hard towards protecting the interest of all the investors in the market and providing free, fair and equal access to them by keeping a check on such market manipulation.

Relevance to the SimTrade Certificate

The concept of quote stuffing relates to the SimTrade Certificate in the following ways:

About theory

By taking the Trade 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 January 2021 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Insider trading

January 23, 2021 by Akshit GUPTA

Insider trading

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2022) presents the concept of Insider Trading.

Definition

Inside information refers to non-public information about a listed company, that can significantly affect its stock price if made available in the public domain. Insider trading refers to “buying or selling a security, in breach of a fiduciary duty (the mutual relationship of trust, confidence and reliance that exists between the different parties) or other relationship of trust and confidence, on the basis of material, non-public information about the security” as defined by the Securities and Exchange Commission (SEC) in the United States of America. Insider trading can be legal or illegal depending on the time the information is used to execute the trades (or passed on to third party to execute trades). Illegal insider trading has severe repercussions for the person/group using or supplying such confidential information and carries penalties or imprisonments if found guilty. Different countries have several provisions in place to stop such acts from taking place that undermine the rights of honest investors by destroying market integrity.

The following are the examples of infamous acts of insider trading which gained a lot of traction from international public and media:

Ivan Frederick Boesky (1987)
Martha Stewart & ImClone (2001)
Robert Foster Winans (1984)
Raj Rajaratnam (2009)

Economic/moral effects of insider trading

From an economic point of view, in the short term, illegal insider trading improves the market efficiency in their strong form. In the strong form, stock prices reflect all the public and private information about the company. The use of inside information (a part of private information) by some investors leads to more efficient prices, which are important for all investors for their asset allocation.

From a moral point of view, insider trading is considered as unethical and unfair as it creates illicit profits for some investors who use their access to privileged information, and it deprives honest investors with the basic rights of fair participation and access to information that has the potential to significantly affect the stock prices for a publicly listed company. The people in possession of insider information make unfair gains or avoid losses by trading on such news. These trades break the flow of financial markets and may render honest investors unwilling to participate in further trades.

Rules to respect for the top management team

As per the rules defined under the Insider Trading Policy of 2013 by the SEC, no person on directorial, managerial or employee level should carry out any transaction on the basis of material non-public information that can significantly impact the stock prices for the listed company.

More specifically, according to the SEC guidelines, “Investment by the Company’s directors, officers or employees in Company securities is encouraged, so long as such persons do not purchase or sell such securities in violation of this Insider Trading Policy. In furtherance of the goals underlying the Company’s Insider Trading Policy, the Company’s directors, officers (those required to make filings under Section 16 of the Securities Exchange Act of 1934) and all employees at the Vice President level and above, as well as all employees in the accounting group are prohibited from buying or selling Company securities at all times, except during the period extending from the third (3rd) through the thirteenth (13th) business day following the release of the Company’s earnings for the immediately preceding fiscal period to the public (the “Trading Window Period”). The grant or exercise of stock options to purchase the Company’s stock is permitted outside Trading Window Periods.”

Trading in the securities of other entities is also prohibited for any director, manager or employee of a company, who’s future course of actions, information about which is still not available in the public domain, have the capability of affecting the value of the underlying entity. For example, this is the case before a merger or acquisition takes place.

Laws / Regulations for different Countries

Illegal Insider Trading comes with severe repercussions and the penalties/fines for such acts have been significantly increased globally over the course of time.

USA

In USA, illegal insider trading can be a civil and a criminal offense charging and individual or an entity depending on numerous factors involving the scale for the offense, intentional violation of the law etc.
As per the Securities Exchange Act of 1934, a person/entity can face criminal sanctions wherein, “The maximum prison sentence for an insider trading violation is now 20 years. The maximum criminal fine for individuals is now $5,000,000, and the maximum fine for non-natural persons (such as an entity whose securities are publicly traded) is now $25,000,000” and/or civil sanctions which involves, “Persons who violate insider trading laws may become subject to an injunction and may be forced to disgorge any profits gained or losses avoided. The civil penalty for a violator may be an amount up to three times the profit gained or loss avoided as a result of the insider trading violation” and “The Company faces a civil penalty not to exceed the greater of $1,000,000 or three times the profit gained or loss avoided as a result of the violation if the Company knew or recklessly disregarded the fact that the controlled person was likely to engage in the acts constituting the insider trading violation and failed to take appropriate steps to prevent the acts before they occurred.”

European Union (FRANCE)

European Union has issued several guidelines commonly known as directives for curbing illegal insider trading from distorting the smooth functioning of the global financial markets. The rules and regulations for insider trading are adapted by each country and requires a law to be passed by respective Parliament at their own discretion.
Insider trading regulations are mostly uniform throughout Europe and the rules have been transposed from the European Union’s Market Abuse Directive of 2003. In France, the laws against insider trading were first implement by means of an Ordinance passed by the French Government on 28th September 1967 making disclosure of insider trading compulsory for every listed company. However, the law was later scrapped off since it was limited in terms of its scope and companies still practiced illegal insider trading.

The French Monetary and Financial Code was passed in 2000 defining insider trading and regulations were made to state the penalties for such activities. The sanctions under the law are imposed by the Autorité des Marchés Financiers (AMF) which oversees the French financial markets. The law imposes a maximum imprisonment of 2 years and a fine amounting to €1,500,000, which could be increased to up to ten times the amount of profit. The French Laws has been progressing and several amendments have been implemented thereafter making the regulations even more stringent.

Movies related to insider trading

Wall Street (1987)

The movie shows the use of insider information by a famous investor named Gordon Gekko, related to BlueStar Airlines and how he capitalized on the private information to earn huge profits.

Trading Places (1983)

The movie shows the use of insider information related to ‘orange crop report’, given by United States Department of Agriculture, by Duke Brothers to capitalise on the gains in the commodities market.

September 11
Examples of Insider Trading

Article written by Akshit GUPTA (ESSEC Business School, Master in Management, 2022)

Examples for illegal insider trading

January 23, 2021 by Akshit GUPTA

Examples for illegal insider trading

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents famous examples of insider trading seen across financial markets.

As discussed in the previous post, Illegal Insider trading refers to “buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, non-public information about the security” as defined by the Securities and Exchange Commission (SEC) in the United States of America. Insider trading can be legal or illegal depending on the time the information is passed on to any unrelated party or when it is used to execute the trades.

Ivan Frederick Boesky (1987)

Ivan Boesky, a stock trader in the US, is infamous for his role in an insider trading scandal that shook the American markets during the late 1980s. Boesky started a stock brokerage company named Ivan F. Boesky and Company during 1976 and used to speculate on corporate takeovers. Within a span of few years, his company started generating huge profits and Boesky became a renowned broker. He received new buy-in investments from many partnership agreements he signed. But later, Boesky was sued by his group of partners for deceptive clauses stated in their partnership agreement. The case came under the scanner of the SEC and eventually Boesky was convicted of profiting from M&A takeovers based on privileged inside information from corporate insiders leading him to an imprisonment of 3 years and a fine of $100 million. He then became an aide to the SEC, helping the staff in cracking other high-profile scandals taking place in the US.

Martha Stewart & ImClone (2001)

Martha Stewart is an infamous investor who was convicted of insider trading by the SEC in the early 2000s. Stewart owned the stocks of the biopharmaceutical company, ImClone Systems. The Foods and Drugs Administration (FDA) rejected ImClone’s experimental cancer treatment drug, Erbitux. Stewart had the privileged access to this information by her broker before it came into the public domain and acted on it. By selling the stocks before the news became public, she was able to avoid losses nearing $50,000 that she would have incurred otherwise. Eventually, Stewart was convicted guilty for trading on grounds of inside information and was sentenced an imprisonment of 5 months.

Robert Foster Winans (1984)

Robert Foster Winans was a former journalist at the Wall Street Journal and penned the influential “Heard on the Street” column for the newspaper during early 1980s. His column in the newspaper had the power to move prices for the stocks he was mentioning in his column. He was convicted by the SEC for supplying confidential information about his upcoming articles to brokers who used to trade the shares on his behalf. The case was complex to crack due to lack of concrete evidence in the favour of insider trading being followed by Winans, but in the end, he was convicted of stealing confidential information belonging to the Wall Street journal and was sentenced to an imprisonment of one year.

Raj Rajaratnam (2009)

Raj Rajaratnam was the founder and former manager of the hedge fund group named Galleon Group based out in New York founded in 1997. Owing to his successful investments in healthcare and technology industry, Rajaratnam grew up the market ranks very quickly and gained a huge reputation in the global markets. He made ties with several corporate executives from leading companies and received insider tips and information on a regular basis.

Rajaratnam was convicted of making illicit profits amounting to $60 million by trading on non-public material information and was found guilty for 14 counts of securities fraud. He was sentenced to 11 years of imprisonment and a penalty amounting to $10 million. His prison time was the longest term given for crimes involving insider trading and was a wake-up call for all the individuals involved in such a vicious cycle.

About the author

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

Securities and Exchange Commission (SEC)

February 3, 2024January 23, 2021 by Akshit GUPTA

Securities and Exchange Commission (SEC)

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2023) presents the structure and functioning of Securities and Exchange Commission (SEC).

Introduction

The Securities and Exchange Commission (SEC) is a federal agency responsible for overseeing and administering the financial market’s laws and regulations in United States of America. It was created in 1934 under the Securities Exchange Act as part of a response measure to revive the financial markets in the USA following the Great Depression that took place after the stock market crash of 1929. The SEC’s primary objective is to monitor and regulate the financial markets in the country by imposing rules, guidelines, liquidity controls and ensuring safety of the markets by means of issuing sanctions in case of non-compliance of rules or any malpractices. They have the responsibility to monitor all the participants in financial markets including investment management firms, publicly listed companies, brokerage houses, dealers and investment banks. It is the backbone of the financial system in the USA and maintains the integrity and transparency of the system and ensures investors’ interest is taken care of adequately.

Organizational structure

The headquarters for the Securities and Exchange Commission is based out the Washington DC and the commission is led by a chairperson, selected from a group of five commissioners who are directly appointed by the President of the United States and work under his/her jurisdiction. Each commissioner is appointed for a tenure of five years and can stay for additional 18 months until a replacement is found. The team also consists of several lawyers, accountants, economists, analysts and engineers, who keep a check on the different market players to ensure investors’ interest protection and compliance with different federal security laws. Each commissioner oversees a specific division of the commission:

Market and Trading Regulations
Investment Management
Law enforcement
Economic and Risk Analysis (including strategy and financial innovation)
Corporate Finance

Administration of security laws

The SEC monitors and regulates the financial markets by adhering to 7 laws that are essential for the smooth functioning of the system,

The Securities Act of 1933

The law ensures protection of investor rights by guaranteeing them the equal access to all financial information and records and prevent fraudulent misconducts and activities like insider trading, market manipulation etc.

The Securities Exchange Act of 1934

The law states the rules, regulations and guidelines that govern the American financial markets and states the various aspects of supervision that the market participants must adhere to.

Public Utility Holding Company Act of 1935

The law regulates the interstate public utility companies that are involved in the business of providing electric utility or distribution of natural or manufactured gases.

Trust Indenture Act of 1939

The law regulates the issue and sale of bonds, debentures, notes and other such debt instruments with a combined value of more than $5 million without the issue of a written formal contract. The contract is referred to as trust indenture and is signed between the debt issuer and an independent trustee to protect the rights of the debt holder.

Investment Company Act of 1940

This law helps SEC regulate the activities of private or public investment management companies whose primary business involves investing and trading in financial securities. However, the act is limited in its scope since it does not allow the SEC to supervise the day to day activities of the company.

Investment Advisors Act of 1940

The law helps SEC in regulating the activities of companies who act as an investment advisor to other investors and earn the income from the same business model. The SEC keeps a check on the functioning of these firms to ensure compliance with the rules and maintain market integrity.

Sarbanes-Oxley Act of 2002

The law was passed in 2002 after a series of financial accounting frauds and misconducts were discovered within the American financial system. The law gives SEC powers in terms of regulating the financial reporting standards and practices within the companies by making the corporate executives more responsible for the internal company controls and imposing heavy sanctions for any misconducts.

Sanctions and penalties

The SEC has been vested with the power to impose sanctions on participants within the financial markets by the following means:

Injunction

Statutory orders that governs the actions of the receiving party and prohibits the violations of rules and regulations in the future. By means of injunctions, SEC contains the future violation of regulations and maintains the smoothness and integrity of the financial markets.

Civil money penalties (CMP)

SEC has the power to impose civil monetary penalties on individuals or companies to make them pay back money made through illicit means and ensure the payment of damages to the harmed investors.

Whistle-blower Program

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Whistle-blowing program was put into place to encourage individuals to share information regarding malpractices and frauds by ensuring them confidentiality and monetary benefits amounting to 10%-30% of the total proceeds from the successful sanctions.

Relevance to the SimTrade Certificate

The activities of the SEC relate to many topics covered in the SimTrade Certificate:

The different players supervised by the SEC (listed companies which issued stocks then traded on an exchange, investment services providers such as brokers which provide access to the market, asset management companies which buy and sell securities on the market) are the participants to the market introduced in Period 1 of the SimTrade certificate.
Insider trading and market manipulations are linked to the concept of market efficiency introduced in Period 2 of the SimTrade certificate. These illegal activities have an impact on market prices.
Short selling is introduced in Period 3 of the SimTrade certificate. Short selling allows to speculate on the market by making a profit when the stock price decrease.

Useful resources

U.S Securities Exchange Commission (SEC)

About the author

The article was written in January 2021 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2023).

Regulations in financial markets

January 23, 2021 by Akshit GUPTA

Regulations in financial markets

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2022) presents the regulations that exist in financial markets.

Definition of financial regulation

Financial regulation is a type of regulations or laws that help in maintaining the stability, integrity and transparency of the financial system of a country by subjecting financial institutions to several set of requirements, procedures and guidelines and ensuring adherence to such rules.

Supervision involves monitoring the performance and daily operations of the financial system in order to ensure its compliance with the rules and regulations specified under the financial framework and keep a check on the safety and financial health of the system. Thus, supervision is a part of the financial regulation framework and is needed to ensure the compliance of different parts present within the financial system including financial institutions, investment firms, banks etc. with the regulations.

Several kinds of financial regulations have been put into place by different countries in order to ensure fair and smooth functioning of the financial systems. The primary set of financial regulations includes:

Banking regulations

Banking regulations have been put into place to strengthen the global banking system and ensure its smooth and coordinated functioning. Basel Norms referred to as International banking regulations were introduced by the Basel Committee on Banking Supervision as part of a coordinated effort to fulfil the gap between the different banking regulations and provide a platform for the respected parties to mitigate risk and ensure smooth functioning of the financial systems.

Preventing systematic risk

Systematic risk refers to the risk to the health of the entire financial system of an economy sparked by the failure of one or more financial institutions. With the global financial markets becoming more integrated, the financial institutions have become more inter-connected and dependent on each other. The complex financial structure of companies can be affected severely if a single company faces any disruption. Financial regulations are brought into enforcement to oversee and prevent such systematic risks from happening and affecting the health and integrity of the entire financial system.

Insider trading

Illegal Insider Trading refers to the use of material non-public information by an individual or a group of people to enter into unfair trades and gain illicit profits by breaching the trust and confidence of other investors. For example, Ivan Boesky, an infamous stock trader in the USA, was charged by SEC against allegations of trading in companies, that are about to undergo an M&A activity, with the use of insider information. He was sentenced to 3 years of imprisonment with a fine amounting to $100 million. Insider trading carries serious repercussions in today’s financial system, and stringent financial regulations have been implemented to avoid such incidents from happening.

Dispute resolution

Financial regulations help in the effective dispute resolutions between investors and entities or amongst entities in form of monetary and business disputes by means of arbitration processes. Several regulatory bodies like the Consumer Financial Protection Bureau in USA have been raised up within the financial regulation framework which acts as a mediation platform between different parties and help in implementing resolution controls and plans.

Investor protection

Financial regulations have been set up to protect the rights of every investor present in the financial system by bringing in better transparency and enhancing the quality of services offered to investors by different institutions. Standardized rules and procedures have been designed for the financial products offered by various investment management firms to offer investors with an equal base to evaluate the different product offerings. As part of a legislative framework to protect investor interest and promote transparency in the marketplace, Markets in Financial Instruments Directive (MIFID II) was implemented by the European Union in 2018 to regulate the financial markets and ensure investor protection by safeguarding their rights. The regulation aims to promote better transparency by regularizing unorganized trading activities and transactions that were earlier not captured within the earlier financial system. Also, the directive aims to strengthen the potential risk mitigation strategies for investments done in the modern marketplace, using high frequency trading or algorithm-based trades, by means of implementing circuit breakers.

Objectives of financial regulation

Financial regulations serve as basic code of conduct that is required to be followed by all the market participants with a primary purpose of ensuring market integrity and stability. Different countries have several financial regulatory institutions that ensure that the markets function in a transparent way and the following objectives for setting up the regulations have been achieved:

Maintaining stability and integrity
Improving market confidence
Bringing fairness and transparency
Enhancing consumer protection
Ensuring compliance with rules and procedures
Preventing frauds

Structure of supervision

Over the past few decades, many reforms have been passed by different countries to ensure the smooth functioning of financial systems in this rapidly evolving and integrating global markets. The structure of supervision of the financial markets differ from country to country, but the broader framework behind the structure is primarily defined by unified global bodies (like the Basel Committee for supervision) and adherence to these structures is essential for every financial system.
We deal below with two examples: France and the United States of America.

Organization of financial regulation in France

In France, the following structure of hierarchy is followed to ensure smooth functioning of the financial system:

European Central Bank (ECB)
The European Central Bank has the primary responsibility to supervise all the 6000 banks operating in the euro zone within the defined framework of Single Supervisory Mechanism (SSM) under the European Union Law.

L’Autorité de contrôle prudentiel et de résolution (ACPR)
The ACPR is an institution integrated under the Banque de France and acts as a Lead Bank Supervisor for the French financial system. The ACPR has been set up with the primary function of supervising, monitoring and controlling the French financial system including its participants and ensuring stability therein. It has the authority to grant licenses to financial institutions and at the same time impose sanctions for any misconducts under the broad framework of its statutory powers.

L’Autorité des marchés financiers (AMF)

The AMF is an independent financial institution and administrative authority which possesses regulatory powers over the financial and banking industry in France. It was created under the Financial Security Act of 2003 with the primary purpose of ensuring protection of investor interest and smooth operations within the financial markets.

Organization of financial regulation in the United States of America

The figure below presents the structure for supervision within the United States of America. This figure illustrates the complexity of the supervision with many national and state regulators.

Source:https://blog.gao.gov/2016/07/21/6-years-after-dodd-frank-oversight-of-financial-services-industry-still-needs-streamlining/

Securities Exchange Commission (SEC)

The Securities and Exchange Commission is a federal agency responsible for overseeing and administering the financial market’s laws and regulations in United States of America. It was created in 1934 under the Securities Exchange Act as part of a response measure to revive the financial markets in USA following the Great Repression that took place after the stock market crash of 1929.

Commodity Futures Trading Commission (CFTC)

The Commodity Futures Trading Commission was founded in 1975 as a federal agency regulating and supervising the activities in the commodity and the options market in the US financial industry. The commission was founded under the Commodity Futures Trading Commission Act of 1974 and has the primary objective of maintaining the integrity and efficiency of the commodity market in the USA. It is also embodied with the task of ensuring investor protection and safety from any illegal and fraudulent practices.

Movies about Financial Regulation In Financial Markets

The Wolf of Wall Street – Market Manipulation
The movie shows how Jordan Belfort, a famous stock broker, manipulates the market of penny stocks by spreading false information in the market and thereby operating a ‘Pump & Dump scheme’.

Trading Places (1983) – Insider Trading
The movie shows how the Duke Brothers made use of the insider information regarding the ‘Orange Crop Report’, which is set to be released by the United States Department of Agriculture, to manipulate the commodity futures markets.

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

AMF

January 22, 2021 by Akshit GUPTA

Autorité des Marchés Financiers (AMF)

This article written by Akshit GUPTA (ESSEC Business School, Master in Management, 2022) presents the structure and functioning of Autorité des Marchés Financiers (AMF).

Introduction

The Autorité des Marchés Financiers (AMF) is an independent financial institution and administrative authority which possesses regulatory powers over the financial and banking industry in France. It was created under the Financial Security Act of 2003 with the primary purpose of ensuring protection of investors’ interests and smooth operations within the financial markets.

The authority has an independent legal identity and exercises authority, regulations, controls and sanctions over the players in the French financial system. In 2003, the AMF was formed as part of a merger between several financial regulators including Conseil de discipline de la gestion financière (CDGF), Conseil des marchés financiers (CMF) and Commission des Opérations de Bourse (COB).

The AMF is embodied with the primary objective of protecting the investors’ interests and savings in the financial markets along with monitoring and regulating the markets by issuing rules, guidelines, control measures and ensuring transparent flow of information. The authority is also responsible for issuing sanctions and penalties to market players in case any malpractices occur.

Organizational Structure

The Autorité des Marchés Financiers (AMF) primarily consists of 2 bodies namely, Le Collège and a Sanctions commission.

The Collège is headed by the President of the AMF, who is directly nominated by the President for the Republic of France for a non-renewable tenure of five years, along with a team of 16 people appointed directly by the public authorities. The operations and administrative work for the AMF is carried out by the Secretary General who is appointed by the President of the AMF and works under his supervision. The Collège has the powers to open sanctions and injunction proceedings against financial participants. The body is also responsible for defining the job framework, setting the budgets and staff remunerations for the AMF.

The Sanctions commission is an autonomous decision-making body that is responsible for exercising the sanctions on behalf of the AMF. The Commission consists of 12 people who are directly appointed by the public authorities.

The executive committee (Comité exécutif or Comex) is an additional body responsible for presenting proposals for the smooth execution of operational and strategic objectives for the AMF. The body is chaired by the President of the AMF and brings in an additional viewpoint to streamline the processes of the AMF.

Powers and responsibilities

The AMF is responsible for overseeing and regulating the activities in the French financial system and its players including listed companies, credit institutions, investment banks, investment firms and asset managers. It also looks after the financial products offered by the stated players in order to ensure the protection of investors’ interests and rights.

The AMF carries the above stated activities by means of enacting rules and regulations, authorizing products offered by financial players, issuing sanctions, implementing control measures and offering mediation system to ensure the smooth flow of market operations. It has the powers to investigate transactions carried out by any market participants to ensure the compliance of such transactions with the financial regulations of the French financial system.

Sanctions and penalties

The AMF is vested with the powers to issue sanctions and penalties to market professionals who act in contradiction to the rules and regulations of the financial system. The power to issue sanctions by AMF is split between the two primary bodies of the AMF that are the Collège and the Sanctions commission.

If any breach is found to have happened, the Collège is vested with the powers to decide upon the initiation of legal proceedings. If the Collège agrees upon initiating the legal proceedings, the Sanctions commission is responsible for deciding the quantum and degree of the sanctions to be inflicted upon the suspected individual/individuals.

The kind of malpractices that can take place in the financial system involves insider trading, stock price manipulations, circulation of false information, etc. which can affect the investors and possess a threat to their investments or financial safety.

The AMF can issue injunctions and individual sanctions to financial professionals (including individuals or firms) depending on the nature and magnitude of the breach that took place.

The Sanctions commission has the power to issue disciplinary sanctions which involve ban on practicing or reprimands and financial penalties amounting to 100 million euros or 10 times the amount of profits made by any individual or organization. The degree of such penalties depends upon the magnitude of the financial crimes involved and the advantages or benefits gained by the suspects.

Relevance to the SimTrade Certificate

The activities of the AMF relate to many topics covered in the SimTrade certificate:

The different players supervised by the AMF (listed companies which issued stocks then traded on an exchange, investment services providers such as brokers which provide access to the market, asset management companies which buy and sell securities on the market) are the participants to the market introduced in Period 1 of the SimTrade certificate.
Insider trading and market manipulations are linked to the concept of market efficiency introduced in Period 2 of the SimTrade certificate. These illegal activities have an impact on market prices.
Short selling is introduced in Period 3 of the SimTrade certificate. Short selling allows to speculate on the market by making a profit when the stock price decrease.

Useful resources

Autorité des Marchés Financiers (AMF)

Autorité des Marchés Financiers (AMF) Impose Sanctions

About the author

The article was written in January 2021 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2023).

Trader – Job description

January 22, 2021 by Akshit GUPTA

Trader – 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 Trader.

Definition

Trading in financial markets refers to the buying and selling of financial assets (stocks, bonds, currencies, commodities, etc.) in order to make money from capital gains that result from the increase or decrease in asset prices. In financial markets, a trader is a person who deals in the purchase and sale of securities. Traders try to maximize the capital gains on their trades by thoroughly analyzing the markets for the assets they trade in and accounting for the risk and return strategies.
Traders are generally hired by investment banks, investment firms, brokerage firms and commercial banks (currency trading).

Types of traders

There are different types of traders depending on the type of trades they execute and the clients or companies they serve for. We usually classify traders into three broad categories:

Flow traders

Flow traders are responsible for executing the trades on behalf of the bank’s clients and use client’s money to take positions in the market. They act as an agency trader and a proprietary trader at the same time. For example, if a client wants to buy the shares of an investment bank XYZ where the flow trader works, the trader will sell the shares of the bank XYZ to the client and serve the interest of both the parties.

Agency traders

The agency traders, also known as brokers, act as an intermediary between the bank’s clients and the proprietary or flow traders. Such traders generally take instructions from the clients and are responsible for skillfully executing trades to generate profits for the clients. The trader is responsible for searching for counterparties for their client’s demand and trade on the basis of the instructions received. The company earns fees and commissions on the trades the agency trader settles on behalf of the company’s clients.

Proprietary traders

Unlike agency traders, proprietary traders are hired by the banks and execute trades on behalf of them. Such traders are engaged in the buying or selling of financial securities by using the bank’s own money. Their objective is to generate profits for the bank. Proprietary traders generally possess more freedom than the agency traders in terms of the autonomy they hold to execute trades as per their discretion. They are also more accountable for the actions they undertake.

Types of securities

The trading activities of a trader depends on the securities they specialize and deal in. With the world of financial products becoming more complex, investment firms and banks have categorized different departments based on financial products they trade in. Some of the major investment categories include:

Equities

Traders working in equity products work in collaboration with the research team which is responsible for collecting and analyzing data about different companies and presenting the findings to the trading team. The traders act on behalf of the inputs received from the research team and execute the trades. In some firms, the equity trading desk is also subdivided as per sector specialization.

Fixed income

Traders working in the fixed income category generally deal in the bonds, government securities, treasury notes etc. They generally follow the macroeconomic trends of different geographies and trade in the fixed income products of a geography or a company on the basis of their interest rate policies and ratings.

Currencies

Different banks and investment firms deal in currency hedges to mitigate the risk associated with cross border transactions. Traders working for these firms or banks trade in foreign exchanges and generally focus on mitigating the financial risks to the bank associated with currency fluctuations.
Some individual traders also deal in foreign exchanges on the basis of their knowledge about the geographical trends.

Derivatives

The traders working the derivates segment of trading specialize in one of the many categories of derivatives which involve equity futures and options, fixed income options, commodity futures, structured products etc. They work in collaboration with the respective research and structuring teams which are responsible for providing inputs on behalf of the current market trends.

Types of stock trading

The type of stock trading varies depending on the financial products they trade in and also on the type of trade a trader wants to execute. Generally, every trader skillfully executes a trade after thinking about the various factors including the financial burden, the risk appetite, the return expectations and the duration for which he/she wants to hold the trade for. Every trade comes with a financial cost and it is imperative for every trader to lay out the basic requirements before entering into any trade.

Some of the most common types of stock trading different traders across different financial products practice are:

Day Trading
Positional Trading
Scalping
Momentum Trading
Swing Trading
Market Making

With whom does a trader work?

Traders work in coordination with different teams which are responsible for feeding the trader with adequate research and data regarding the stocks the bank can invest in. In general, the trader works with the research team which is responsible for providing a summary of the company’s financials for which the trades will be entered. For structured finance products, a trader works with the quantitative, sales and structuring teams for getting the right inputs about the structuring of the products. They also work alongside risk analysis teams, to ensure risk adjusted returns on their portfolios.

How much does a trader earn?

The salary of traders varies upon the type of bank they are employed at and the relevant market experience they have. As per the figures given by Glassdoor, a novice stock trader earns a yearly salary ranging between €40,000-€60,000 in the initial years of their joining. As the trader gains experience, they earn an average salary of €70,000-€75000 euros excluding bonuses and extra benefits. The bonuses and extra compensations vary from bank to bank and the performance of the specific trader but are usually very high.

What training to become a trader?

In France, an individual who wants to work as a trader is highly recommended to have a Grand Ecole diploma with a specialization in market finance. The knowledge of coding languages like Python and R is also a very desirable skill in the current world driven by technology and automation. To start a career as a trader, it is advised to start the career as an intern or an apprentice at a French or an International bank while pursuing the diploma. This can help in building a strong foundation as a successful trader and learn directly from the industry practitioners.

What positioning in the career?

A career in trading generally involves long working hours and requires excellent research and execution skills for entering trades at the right time. A trader forms the backbone of every investment bank, investment firm, commercial banks, exchanges, treasury departments of companies and brokerage houses and is highly required for their proper functioning. The remuneration of a trader seems lucrative but comes with challenging situations and often requires strong analytical, research and communication skills, long working hours, financial knowledge, and IT expertise.

With the advent of algorithm-based trading, the trading floors across the world have shifted to high frequency trading and all major investment banks have reduced the size of their workforce working as a trader. With increasing liquidity across equities and fixed income products, algorithms have become more advanced and trades executed using such algorithms have become simpler. Advanced skills including knowledge of financial products and writing codes for the algorithms provides the person with an edge over the other applicants.

For more information regarding the remuneration and pay scale of a trader, you can refer to my previous post “Remuneration in the finance industry”

Useful resources

Glassdoor

About the author

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

Was there insider trading before September 11?

January 22, 2021 by Akshit GUPTA

Was there insider trading before September 11?

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the case whether there was insider trading before September 11?.

Introduction

The plane crash on the World Trade Center on 11 September 2001 is an infamous occurrence of a terrorist attack that is etched in the hearts of every individual in the world. The attack had a severe impact on the global stock markets. The markets across USA saw a sharp sell-off as seen by the sharp decline of 14% in S&P 500 index in the first week after markets opened on September 17,2001. The market chaos was caused by the panic amongst investors and the loss in value the crash brought to the economy. The airlines and the insurance industries were the ones that were most affected by this crash.

The abnormal pattern in financial markets

During the investigation of the attack, political, economic and financial impacts of the crash were considered. Concerning the financial impact, an unusual pattern of trading was found to have happened in the stocks of major airline companies including United Airlines, American Airlines, Delta Airlines and KLM Airlines. The question of whether an abnormal trading pattern was observed in the financial markets, gauged the interest of common people.

As per the analysis done by market analysts, a discrepancy in the put-call options on the stocks of the mentioned airlines were discovered. As per Bloomberg data as quoted by Snopes, “On September 6, 2001, the Thursday before that black Tuesday, put-option volume in UAL (the parent company for United Airlines) stock was nearly 100 times higher than normal: 2,000 options versus 27 on the previous day.”

(Options are a form of derivative instruments that have an underlying stock and gives the investor a right to buy or sell the stock (not an obligation) at a previously agreed upon price and time. The options can be classified into two categories: put options and call options. The Put options give the investor the right to sell a stock at a predetermined price and time and is generally used by an investor when he/she anticipates a fall in the prices of the underlying stock in the near future. Whereas, a Call option gives the investor the right to buy a stock at a predetermined price and time (not an obligation) and is used by an investor when he/she anticipates a rise in the prices of the underlying stock in the near future.)

The analysis raised questions about the possibility of an insider trading activity that took place before the infamous plane crash. The chances of traders being aware about the possible terrorist attack on the World Trade Center was a cause of worry.

Conclusion

After exhaustive investigation, the various federal agencies including Securities & Exchange Commission (SEC) and Federal Bureau of Investigation (FBI) found no conclusive evidence on the stated abnormalities and no person was found involved in connection to the prospective act of insider trading which might have resulted in illegally generated high profits for some individuals.

But as far as the high level of trades are concerned, some level of abnormalities can be seen in the high put call ratio ranging between 25-100 times of the ratio seen in normal trading days. However, the lack of conclusive evidence led to no sanctions or penalties to the people who could have been involved in these activities. I would be happy to receive your opinions on the same. What do you all think about the trading patterns and the abnormalities observed in the months preceding the day of the attack?

Useful Resources

Academic research

Poteshman A. M. (2006) Unusual Option Market Activity and the Terrorist Attacks of September 11, 2001 The Journal of Business, 79(4): 1703-1726.

Other

Wikipedia September 11 attacks advance-knowledge conspiracy theories

Snopes (October 3, 2001) Were Stocks of Airlines Suspiciously Shorted Just Before 9/11?

Business Insider (April 18, 2017) An author and economist says a reader once approached him with a chilling story

About the author

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

High Close

February 16, 2025January 15, 2021 by Akshit GUPTA

High close

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2022) presents the technique of High Close, which is a type of market manipulation in financial markets.

Definition

High close is a form of market manipulation where manipulators send market orders to buy small quantities of financial assets just before the end of the trading session in order to inflate the closing price of these assets. The price increase created by the execution of these orders may attract the attention of more market participants, leading them to buy the assets. Manipulators use this tactic to create a false image about the asset in the market.

The targeted assets are usually microcap (stocks with a market capitalization between $50 million to $300 million) or nanocap stocks (stocks with a market capitalization less than $50 million). Such stocks –usually penny stocks– present low trading volume, low liquidity and high volatility, which make the trades of manipulators have a big market impact. Generally, manipulators target assets that are less popular, and investors don’t have much information about the market for these assets. But seeing the sudden spike in the closing prices for these assets, investors often get trapped in such assets due to the manipulation.

Mechanism

Under high close, manipulators send small market orders at a high frequency before the end of the trading session to increase the price for a given stock. The tactic gives an artificial appearance to the stock prices and lures other investors to invest in the assets, thereby creating an artificial demand and helping manipulators exit their position by selling at a higher price.

Detection

To spot and stay away from market manipulation strategies executed by manipulators, honest traders have to be extra cautious while investing in microcap or nanocap assets and carry out proper fundamental and technical analysis for securities that have information asymmetry. In the case of high close, studying the Japanese Candlestick chart of any stock can be an effective way to spot abnormal trading activities and artificially created high prices at the end of any trading session.

Financial regulation

High close is a common practice that is used by market manipulators to hamper the free and fair environment and distort the prices and trading momentum in the financial markets. Although, the regulatory bodies such as the Securities exchange commission (SEC) in the United States keep a tight watch to curb the extent of such manipulations, certain perpetrators can still manage to escape the liabilities and penalties.

Example: Athena Capital Research

The SEC convicted Athena Capital Research (a small trading firm based out in New York City) in 2014, with the charges of manipulating the prices of thousands of stocks during a 6-month period from June to December 2009 and giving the prices of these stocks an artificial appearance.

The firm indulged in the market manipulation tactic of “high close” and used sophisticated algorithms to trade in stocks at NASDAQ just before the end of the trading sessions. The traders at the firm used to place many small buy market orders a few minutes before the closing of the day after the NASDAQ issued the “Net Order Imbalance Indicator” showing the order imbalance in the buy or sell orders for the securities before the end of the trading session (the indicator helps in filling all market or limit on-close orders at the best price).

Athena Capital Research generated huge profits by artificially increasing the prices of the stocks by the end of the trading day and infusing liquidity in the market for that stock. The strategy helped the firm create a false image about the stock in the market and drew the attention of other market participants. The firm was later fined by the SEC $1 million for indulging in market manipulation and distorting the prices of thousands of stocks, thereby decreasing investor confidence.

Relevance to the SimTrade Certificate

The concept of high close relates to the SimTrade Certificate in the following ways:

About theory

By taking the Trade 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 Send 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.

More about SimTrade

Useful resources

SEC document about the Athena Capital Research case (2014).

Talis J. Putnins (2009) “Closing price manipulation and the integrity of stock exchanges, PhD Thesis.

Carole Comerton-Forde and Talis J. Putnins (2011) “Measuring closing price manipulation” Journal of Financial Intermediation, 20, 135-158.

Wikipedia article on “Market_manipulation”

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

Introduction to bonds

What is a bond?

What are the main characteristics of a bond?

Example

What are the different types of bonds?

Types of issuers

Government bonds

Municipal bonds (“munis”)

Corporate bonds

Technical characteristics

Fixed-rate bonds

Floating-rate notes

Zero-coupon bonds

Convertible bonds

Useful resources

Rating agencies

Related posts

About the author

Economist – Job Description

Introduction

Duties of an economist

Whom does an economist work with?

How much does an economist earn?

What training do you need to become an economist?

Example of an economist’s report – BNP Paribas

Related posts on the SimTrade blog

Useful Resources

Relevance to the SimTrade certificate

About theory

About practice

About the author

Is smart beta really smart?

The smart beta industry

Traditional approach in portfolio management

The Smart beta approach

Performance and impact factor

Is smart beta really smart?

Related posts on the SimTrade blog

Useful resources

Academic articles

Business resources

About the author

Financial leverage

Definition of financial leverage

How does financial leverage work in real life?

How is financial leverage measured?

Example of financial leverage in action

Advantages of financial leverage

Disadvantages of financial leverage

Conclusion

Related posts on the SimTrade blog

Relevance to the SimTrade certificate

About theory

About practice

Useful resources

About the author

Palantir: a potential and controversial rising decacorn

Introduction

Still no profits

The financial and health crisis: an opportunity not to be missed

A price correction

A bright future for data and Palantir

Conclusion

Capital structure

Key concepts

Unicorn, decacorn and hectocorn

Start-up valuation

Initial Public Offering (IPO)

Secondary market

Useful resources

Relevance to the SimTrade Certificate

About theory

About practice

More about SimTrade

About the author

SimTrade: an inspiration for a career in finance

My mission

Relevance to the SimTrade certificate

About the author

Private banking: evolving in a challenging environment