Corner of Volkswagen

January 15, 2021 by Akshit GUPTA

The corner of Volkswagen (2008)

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the real life case of the Corner of Volkswagen, which is a very infamous example of market manipulation in financial markets.

Introduction

Cornering refers to the attempt of manipulating the market by acquiring a significant portion of stocks of a particular company in order to gain a controlling interest in the market and influence the market in the manipulator’s favor.

Such a manipulation was seen in 2008 when the world’s famous automaker Porsche tried to corner the market of the shares of Volkswagen. This attempt of cornering made Volkswagen the world’s most valuable company in terms of market capitalization for a brief period. It is considered as one of the greatest attempts of cornering ever made in global financial markets.

Volkswagen cornering

In 2008, Porsche made an attempt to acquire Volkswagen by cornering the shares of the company in a unique manner. As per the Volkswagen shareholders’ structure, 20% of the shares of Volkswagen were held by the State of Lower Saxony in Germany while the other 80% were owned by retail and institutional investors.

Wendelin Wiedeking, the then CEO of Porsche, had dreamt of acquiring the Volkswagen group and started accumulating the shares of the company in order to gain controlling interest in Volkswagen. In 2005, Porsche held a 20% stake in the Volkswagen group which later grew to 30% by 2007. As per the rules for mergers and acquisitions, Porsche had to make a mandatory purchase offer to Volkswagen, which was later denied by the shareholders of Volkswagen.

As the 2008 financial crisis hit financial markets, equity markets throughout the world went into a turmoil. Short sellers started increasing their positions in the auto industry since the auto sales faced a sharp decline after the crisis. In particular, short sellers started taking large sell positions in the stocks of Volkswagen in the expectation of a decrease in prices of the company’s shares. But to the short-seller’s misfortune, the share prices of Volkswagen saw an upward curve against the market predictions.

In October 2008, the price of Volkswagen share started representing the weak fundamentals of the industry and saw a downward trend making the short sellers optimistic. But a Porsche’s press statement about its holding position in Volkswagen equity hit the financial markets and panic started building up amongst traders. Over a span of few years, Porsche acquired around 42% of the outstanding shares of Volkswagen by purchasing them from the open market and also purchased option contracts on the Volkswagen shares amounting to 32% of additional shares resulting in potential holdings of more than 74% of the total shares of the company at the expiry of those options.

Press Release:Porsche

Short sellers were holding a position of 12% of the total shares outstanding for the Volkswagen company, but there was only 6% of shares available for public trading (74% were held by Porsche and 20% by the Lower State of Saxony). This created a short squeeze in the market.
Short sellers panicked and had to pay huge amounts of money to cover their positions in the market. This resulted in a sharp increase in the Volkswagen share price, which reached a high of $999 within a span of a few days.

The panic then subsided, and the share price returned to its pre-crisis average trading range of $200. But the sudden upward trend made many traders lose millions worth of investments due to the manipulation done by Porsche.

Source: Bloomberg

Owing to Porsche’s greed, the company fell short of cash to settle the option contracts at the time of expiry and was not able to acquire 75% of the outstanding shares of Volkswagen to trigger an acquisition. The debts that Porsche took to manipulate the shares of Volkswagen and falling car sales, led to the bankruptcy proceeding for the company. In late July 2009, Volkswagen bailed out Porsche and later Porsche merged with Volkswagen.

Aftermaths

Although the two famous automakers merged at the end, the failed attempt made by Porsche to acquire Volkswagen is a classic example of cornering practices used by a company to manipulate the share prices of another company. Wendelin Wiedeking, the former CFO of Porsche, had to face market manipulation charges and the company faced legal proceedings with claims amounting to more than $1 billion for the losses that were incurred by small traders and hedge funds for this unjustifiable act.

Technical terminology

Short squeeze is a market situation where a mismatch of demand and supply (high demand and low supply) of an asset results in the prices of the assets to rise significantly. In generally seen instances, when the share prices of a company start rising, the short sellers rush to close their positions in order to avoid heavy losses. The sudden increase in demand is mismatched with the market supply, driving the prices of the assets upwards in a frenzy manner.

Link with the SimTrade Certificate

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

About theory: by taking the Financial Leverage course, you will understand how leverage is taken by investors to increase the size of their market position.
About practice: by launching the Sending an Order, you will understand how financial markets really work and how to act in the market by sending orders.

Useful resources

NASDAQ (01/05/2010) When Porsche Cornered Volkswagen: A Legitimate Complaint

New York times (26/09/2005) Porsche Says it Plans to Amass a 20% Stake in Volkswagen

About the author

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

Financial Analyst – Job Description

January 15, 2021 by Akshit GUPTA

Financial Analyst – Job Description

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2022) presents the job description of a Financial Analyst.

Introduction

A financial analyst is an individual who is responsible for making financial and investment decisions for a company. The work involves a broad area of expertise and a financial analyst generally works in corporate and investment roles. In the corporate roles, a financial analyst is responsible for making the revenues, costs, budgets and forecasting reports. In the investment side, financial analysts are generally responsible for gathering information about a company to compute their fundamental value. They are employed by different companies including corporates, investment banks, investment firms, hedge funds, equity research firms and mutual funds to serve their specific purpose.

Types of financial analysts

Depending on the company or bank a financial analyst is employed at, he/she can have different roles and responsibilities. Two of the most notable profiles of a financial analyst include:

Buy-side analyst

Buy-side analysts generally work in asset management firms, investment funds, and trading firms, which buy and hold onto securities for a fixed time frame on the basis of the financial analysts’ reports.

The analyst is responsible for gathering financial and non-financial data of a company and make future predictions about its earnings and growth prospects in form of a report. The reports are then given to the asset managers and traders who use the information to execute trades in the financial markets.

Buy-side analysts are commonly more prestigious than sell-side analysts. The competition is stiffer and entry into this job requires a knowledge of corporate finance and a strong experience in the sector followed.

Sell-side analyst

Sell-side analysts are generally employed by the research division of investment banks, investment firms and brokerage houses.

Sell-side analysts are responsible for producing reports on the future performance of a company and making predictions about the financial results that will be published by them in the near future. The reports made by the sell-side analysts are not used by their employer but instead sold to private investment companies and retail investors, who use this information to make informed decisions about their own investments. The sell-side analysts usually specialize in a particular sector or a geographical region and produce reports within that area.

How the work is done?

The job of a financial analyst includes researching and gathering of quantitative and qualitative financial and non-financial information about a company, organizing the data, making forecasts about the future course, and presenting the results to the different stakeholders in form of reports. The stakeholders depend on the company the financial analyst is working for but generally includes internal divisions (portfolio managers, traders, and quantitative analysts) and external clients (private investment firms, retail investors, individual traders, etc.).

Studying market trends A financial analyst is expected to be aware of the past and current market trends based on which the investment decisions are to be made.

Data gathering In the data gathering phase, the financial analyst gathers financial and non-financial information about a company from different sources, which include company annual reports, media releases, financial platforms (Bloomberg, Capital IQ, etc.), investor relation departments of the companies, or reports by other brokerage firms.

Financial modelling The information is then analyzed to build financial models (generally on a spreadsheet like Excel) and do predictions about the company’s future performance.

Using the reports Once the financial models are made, the findings are produced in form of a report which is issued to different internal or external stakeholders.

With whom does a financial analyst work with?

A financial analyst works in collaboration with a lot of different teams:

Brokerage firms and Investor relations department of companies for gathering data for the reports
Sales and Trading Divisions for selling the reports produced by the sell-side analysts and executing
trades on basis of reports made by buy-side analysts
Portfolio managers – to advise them on different assets
Sector specialists and Economists – to gather information about specific sectors and economies

How much does as financial analyst earn?

The remuneration of a financial analyst depends on the type of role and organization he/she is working in. As of the writing of this article, an entry-level financial analyst working in a bank earns between €38,000–50,000 in the initial years of joining (source: Glassdoor).
As the analyst grows in experience, he/she earns an average salary of €60,000–70,000 including bonuses and extra benefits.

What training to work as a financial analyst?

An individual working as a financial analyst is expected to understand the different financial statements and their analysis, financial modelling (commonly on Excel), accounting and budgeting techniques, advance research skills and interpersonal skills.

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

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

Relevance to the SimTrade Certificate

By taking the Market information course in Period 2 of the SimTrade Certificate, you will understand how information is incorporated into market prices and the associated concept of market efficiency.

Market maker – Job Description

February 16, 2025January 15, 2021 by Akshit GUPTA

Market maker – Job Description

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) describes the job of a Market Maker.

Definition

A market maker is a market participant in the financial markets that simultaneously buys and sells quantities of any particular asset by posting limit orders. The market maker posts limit orders in the market and profits from the bid-ask spread, which is the difference by which the ask price exceeds the bid price. They can exist in all the different markets (including foreign currency, bonds, equity etc.), but generally markets maker play a significant role in the equity markets. Due to the high quantity of securities needed to ensure the required volume of trading and huge capital, market makers are generally large institutions like investment banks and asset management firms.

A market maker plays a significant role in the financial markets throughout the world. They benefit in the financial markets by maintaining a sizable bid-ask spread for every security they trade in. By holding a large number of shares, a market maker is able to provide liquidity to the market for an asset. If investors or traders are selling in a market with low trading volumes, market makers buy the assets to provide liquidity, and vice versa. Market makers help in maintaining a balance between the demand and supply of an asset in the market. Their role includes taking a position in the opposite side of whatever direction the market is moving in at any given point in time.

Thus, with this strategy, they are able to fulfill the market demand for a stock and facilitate its circulation. Market makers help the financial markets and its participants to buy or sell shares easily by providing them with liquidity.

Two types of market makers:

Activity for a bank (proprietary trading) The bank thinks that is a profitable activity
Contract for a firm to provide liquidity for the market of the stocks issued by the firm. A service provided for firms

Duties of a market maker (for a firm)

Providing liquidity by being present on the buy and sell sides of the market (by posting limit orders)
Matching orders in the order book
Providing depth to the asset’s market

Risks of the activity of market making

Market makers have to undertake high risks while executing trades in the market as the market can move in the opposite direction of their positions in no time. If a seller is willing to sell shares of a company by sending a sell market order, the market maker is be ready to buy by posting buy limit orders to provide liquidity to the market. However, if the number of sellers keep on increasing in the market, the share price will eventually go down against the market maker’s position. This can lead to huge losses for the market makers, increasing the associated risks of this activity.

Who does a market maker work with?

A market maker works in collaboration with different teams and individuals who are responsible for providing him with the right knowledge and inputs.

Normally, a market maker works with:

Brokerage firms – Market makers work with the brokerage firms who help them in executing orders in the
financial markets
Research Teams – They also work in collaboration with the research teams who are responsible for providing them with financial and non-financial information about different assets.
Sector Specialists – They help market makers in gathering information about different sectors and geographical markets.

How much does a market maker earn?

The remuneration of a market maker largely depends on the type of organisation and sector he or she works in. The practical experience in financial markets is a major deciding factor while calculating the remuneration of a market maker. As of the writing of this post, an entry level market maker can earn between $35,000-$45,000 per annum in the initial years.
A market maker is also entitled to bonuses and extra benefits depending on the organisation he or she works at and the profits he or she generates.

What training do you need to become a market maker? ?

To become a market maker, an individual is required to have at least a bachelor’s degree with a specialization in finance. He or she is expected to have the basic understanding of financial markets and different financial instruments. Also, good level of interpersonal skills is required to communicate with different stakeholders on a daily basis.

In France, a Grand Ecole diploma with a specialization in market finance is highly recommended for an individual to get a good entry level position in a reputed bank or asset management firm.

Different trading qualification exams like AMF examination is also recommended to understand the French financial markets in a more practical sense and enter the market with sufficient knowledge.

Link with the SimTrade Certificate

The concepts about market making can be learnt in the SimTrade Certificate:

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.

About the author

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

Corner

February 16, 2025January 15, 2021 by Akshit GUPTA

Corner

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) presents the technique of Cornering, which is a type of market manipulation in financial markets.

Introduction

Cornering a market refers to the acquisition of a significant amount of an asset which gives the manipulator a controlling interest in the market. This strategy is used to manipulate the market for the asset and the manipulator has the power to move the asset price in his/her favor. Cornering has been observed in the financial markets since a long time and strong regulations and rules have been put into place by regulators worldwide to prevent such activities to happen. In the United States, the Securities and Exchange Commission (SEC) and Federal Trade Commission (FTC) supervise the trading activities in the financial markets to catch the manipulators who indulge in such practices. While cornering can be considered as legal or illegal depending on the circumstances and the intention of the individual involved, most of the times it is done to deceit the honest investors and earn illegal profits.

In cornering, the manipulator acquires a controlling stake in the asset and pushes up the prices for the underlying asset. Once the prices have reached a significant level, the manipulator exits his/her position leading to market correction and a sharp fall in the asset prices.

Short squeeze

Short squeeze is a market situation where a mismatch of demand and supply (high demand and low supply) of an asset results in the asset price to rise significantly. In generally seen instances, when the share price of a company starts rising, short sellers rush to cover their positions to meet the margin requirements and avoid more losses. The sudden increase in demand is mismatched with the market supply, driving the asset price upwards in a frenzy manner.

Practices used to corner the market

Beyond the accumulation of assets in his/her position, the manipulator usually uses many practices to manipulate the price up or down in his/her favor. The most common practices used are the pump and dump scheme and the poop and scoop scheme detailed below.

Pump and dump scheme

In the pump and dump scheme, the manipulator circulates false positive information about a particular asset which leads to an increase interest amongst the investors for the particular asset and leads to more demand. As the demand for the asset rises, the prices also go up and the manipulator exits his/her position, thereby generating high profits and crashing the market for the asset. Such schemes are generally carried on lesser-known assets which have an information asymmetry, and the manipulator has the means to manipulate the market.

Poop and scoop scheme

In the poop and scoop scheme, the manipulator circulates false negative information about an asset in the market. Hearing the negative information, other investors undertake panic selling, thereby decreasing the prices for the asset. The manipulator buys the asset once the prices fall and manipulates the market.

Silver Thursday (1980)

Silver prices

The manipulators who practice cornering in a market, hoard large quantities of a security in the initial accumulation phase. As seen in the graph above, in the silver market cornering that started in the 1970s, the Hunt Brothers bought large quantities of silver over a period of 10 years in an attempt to corner the silver market. They were holding approximately one third of the world’s deliverable silver supply. The price of silver went up drastically over this period. But as their practices came to be noticed, the regulatory bodies in the United States amended the rules and regulations regarding commodity trading, bringing an end to their manipulation practice. Then the silver market crashed on March 27, 1980, a day known as ‘Silver Thursday’.

‘Silver Thursday’ is infamous for recording one of the highest falls in the market price of silver. In the months preceding the Silver Thursday, the U.S. Federal Reserve brought in new regulations restricting banks to issue loans for commodity speculations. At the same time, the Chicago Board of Trade (CBOT) increased the margin requirements on silver futures contracts, leading to high margin calls for the Hunt Brothers. Due to lack of access to new leverage, they were unable to meet the margin requirements for the silver contracts they held. The new regulations led to the failure of the attempt made by the Hunt Brothers to corner the silver market. As soon as the news hit the market, investors starting panicking leading to a sharp selling of the silver futures contracts. This ultimately led to a fall in the silver price from around $50 per ounce to $11 per ounce over a short span of time. Hunt Brothers were charged with civil charges for manipulating the silver market over the years and artificially increasing the silver price. Due to the new regulations and stricter laws, they also had to pay heavy fines amounting to millions of dollars which led to their bankruptcy.

Conclusion

Illegal cornering has been regarding as a common market manipulation practice throughout the world and the regulators keep a tight watch to control such practices from occurring. Although many attempts of cornering the financial markets have been made by several manipulators in the past, most of them have been unsuccessful. The manipulators also take huge risks while trying to corner the market as the irregular market patterns can be observed by professional investors. The inefficiencies seen in markets manipulated through cornering can prompt other investors to take opposing positions leading to heavy losses to the manipulators.

Relevance to the SimTrade Certificate

The concept of cornering 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.

About the author

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

Price Fixing

December 19, 2020 by Akshit GUPTA

Price fixing

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

Definition

Price fixing refers to an agreement between two or more participants operating in a market to collude and set the prices of an asset to serve their interest. In financial markets, price fixing refers to a form of market manipulation where the manipulators rig asset prices by inflating or deflating them to benefit from such practices. The main markets where price fixing takes place are for the following assets: interest rates, currencies and commodities.

The price fixing practice works in contradiction to the free and fair financial market forces and hampers public confidence in the markets. The asset prices should be decided by the natural market forces of supply and demand. Price fixing is banned and deemed illegal across global financial markets and stringent regulations.

In the United States of America, several laws have been implemented including the Sherman Act of 1890, which prohibits any form of price fixing or collusion among financial institutions to fix asset prices. The market manipulation tactic of price fixing comes with severe civil and criminal liabilities along with heavy penalties (see the example of the Libor scandal below).

Mechanisms

Price fixing can take different forms: collusion among market participants and window dressing.

Collusion among market participants

In such a form of price fixing, the market participants operating on the same side of a market often collude to set the buying or selling prices of an asset to manipulate the asset prices and serve their personal interest.

Window dressing

It is often carried out to give an artificial appearance to assets offered by certain companies, done by window dressing their creditworthiness and inflating the demand for the financial products offered.

Examples of price fixing

The Libor Scandal

Price fixing came to light when the Libor scandal was uncovered in 2012.

What is Libor?

Libor (London Inter-Bank Offered Rate) is a benchmark interest rate that is decided on the basis of the average inter-bank unsecured borrowing rates over a short-term period ranging from 1 day to 1 year. It is computed on a daily basis by the ICE Benchmark Committee working under Intercontinental Exchange, which is the overseeing body for Libor. Every day, at 11:00 AM, major banks from all across the world submit their borrowing interest to the ICE Benchmark Committee.

The Libor rate is used worldwide by major financial institutions to determine interest rates for different loans (for corporations to finance their investments and operational activities, for individuals to finance their consumption and the acquisition of their home, students to finance their studies, etc.) and the flows of financial derivatives.

How the Libor is calculated on a daily basis?
As seen in the picture, 18 major banks from all across the world sends their estimated unsecured borrowing rates on a daily basis at 11 AM to the ICE Benchmark Committee.

The committee then ranks the rates in a top to down order and eliminates the top and bottom 25% of the outliers from the list. The remaining rates are then averaged out and a five decimal Libor figure is issued at 11:55 AM on a daily basis. The committee issues the Libor in 5 currencies and with 7 different maturities, thus issuing a total of 35 different rates. The three-month US Libor is generally termed as the current Libor rate.

What happened?

A pool of banks colluded to artificially inflate or deflate the Libor rate over a couple of decades. The traders working at these banks submitted higher or lower rates to the ICE Benchmark Committee than they actually paid for unsecured short-term borrowings to manipulate the Libor on a daily basis. The price fixing was carried out to benefit traders and banks who traded financial derivatives to make profits by artificially inflating or deflating the Libor, which was the reference rate for such instruments.

The Libor scandal was unearthed in 2012 when a series of international investigation uncovered the price-fixing activities that were carried out by banks that formed a major part of the group of banks submitting their borrowing rates.

The Libor is used worldwide and the price fixing impacted millions of honest people around the globe, who took loans on inflated fixed Libor, and companies, which held derivative contracts.

The investigation led to fines amounting to $9 billion for the major banks that were involved in the scandal including Citi Bank, Barclays, JP Morgan Chase, Deutsche Bank and Royal Bank of Scotland. Many individual brokers and traders working for these banks were also sued by the regulatory bodies and charged with severe punishments and fines.

To know more about price fixing

The links mentioned below provides a comprehensive picture of how price fixing works in the financial markets and also provides a deeper view of the different scandals that happened using price fixing manipulation and shook the world.

About the Libor scandal

Wikipedia Libor Scandal

About the author

Article written in December 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Spoofing

February 16, 2025December 19, 2020 by Akshit GUPTA

Spoofing

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

Definition

Spoofing is a form of market manipulation in which a trader places a large order to buy or sell a financial asset with no intention of execution of the order but to create the illusion of a change in the demand and/or supply for the asset and eventually maneuver market prices. Upon receiving the market response, the trader then cancels his or her order and then benefits from other investors’ reactions by trading on the asset thus earning huge but illegitimate payoffs. Spoofing is usually based on algorithmic trading, which allows to trade in the market at high speed.

Spoofing Mechanism

Under spoofing, the manipulator places small buy or sell orders at shorter time frames near the best bid (or ask) price in a manner that the order has very less probability of being executed in the market. The orders are placed in such a manner that creates a misleading impression of increasing liquidity in the market. The orders help in creating artificial demand/supply for the asset in the market and lures other investor’s interest towards the asset. The manipulator doesn’t have the intent of executing the order and generally takes advantage of the price movements that might result from the misleading impression of increasing liquidity that the orders created.

Spoofing and financial regulation

According to the Financial Conduct Authority, “Abusive strategies that act to the detriment of consumers or market integrity will not be tolerated” and Spoofing, being a type of market manipulation, is an illegal practice in UK accompanying penalties. In U.S. too, as per the Dodd-Frank Act of 2010, Spoofing is unsanctioned by law. Despite the criminal liability, however, some institutions and individuals continue to get involved in it for undue gains.

Spoofing and high frequency trading

Spoofing has been around for decades as traders attempt to take advantage of other market participants by artificially inflating or deflating the price of an asset. Spoofing became more prominent in the 2010s with the rise of High Frequency Trading (HFT) which is a powerful, automated way to transact a large number of orders at very high speed. HFT provides opportunities for price manipulation through spoofing as orders can be placed and canceled very quickly. However, with time, it also attracted the notice of financial regulators and law enforcement officials as the following case will explain.

The ‘2010 Flash Crash’

On May 6, 2010, a dramatic decline was seen in the US stock market as the Dow Jones Industrial Average index fell more than 1,000 points in 10 minutes along with other stock market indexes such as the S&P 500 and Nasdaq Composite. Over one trillion dollars of market capitalization were wiped out, though 70% was regained back by the market before the end of the day. This dramatic event has been named the ‘2010 Flash Crash’.

Among a frenzy of speculation, the cause for this market crash was attributed to some big HFT bets on the Chicago Mercantile Exchange. London-based futures trader Navinder Sarao was actually spoofing in the e-Mini S&P 500 contracts.

The US Commodity Futures Trading Commission (CFTC) alleged that Sarao’s use of the dynamic layering technique contributed to an order book imbalance between buy-side and sell-side orders, which created downward pressure on prices in the market, especially given the size of orders he was placing. The CFTC said that Sarao made $879,018 in net profits in the e-Mini S&P 500 contracts that day.

Relevance to the SimTrade certificate

The concept of spoofing relates to the SimTrade certificate in many 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.

Market manipulation

December 5, 2020 by Akshit GUPTA

Market manipulation

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

Definition

Market manipulation refers to a deliberate attempt made by a person or a group of people to artificially inflate or deflate the price of stocks, commodities or currencies, and hamper the free and fair operations of the financial markets. It is a type of market abuse which is done to ensure personal profits and gains. The person doing market manipulation has the intent to influence the prices of the stocks, commodities or currencies in his favor.

Market manipulation is banned in almost all the developed financial markets around the globe including USA (under Section 9.a.2 of the Securities Exchange Act of 1934) and the European Union (under the Article 12 of Market Abuse Regulations on insider trading and market manipulation). With the rising complexity and trade volumes in the financial markets today, it is becoming increasingly difficult for market regulators to catch the culprits who practice market manipulation. However, the laws for market manipulation are very strict and often comes with severe repercussions which involves both civil as well as criminal liabilities for the person or group involved.

Forms of market manipulations

Market manipulation can take different forms. Some of the most common types of market manipulation activities involve:

False information

The rise of technology and digital media in the recent years has spiked up the amount and reach of false or fake news that circulates in the market on a regular basis. The false news that is circulated to benefit certain investors or companies leads to market manipulation and comes with severe repercussions for the culprits.

Pump and dump

This is one of the most common form of market manipulation which involves inflating the prices of a lesser known company such as a microcap or a nanocap company by circulating misleading information and dumping the stocks once the prices of such companies has risen. The manipulator (or promoter) of such schemes has the intention to create artificial demand for such stocks and thereby generate quick profits.

Insider trading

This form of market manipulation involves an insider (a person related to the company or any of its employee with access to sensitive information) who uses non-public confidential information about a company, and generates profits or avoid losses by executing trades in the market based on such information.

Spoofing

In this form of market manipulation, a trader places large volume of buy or sell orders
without the intention of executing them. The orders are placed to attract the attention of other investors who would try to bet in the stock seeing the large order in the trading book. Such acts are usually carried out using high frequency algorithms and help the trader to manipulate the market in his favor.

Cornering

In cornering, an investor or a group of investors buy significantly large volume of commodities or shares in order to sway the market in their favor and create a monopoly by controlling the prices and the supply for the asset.

Wash trading

In this form of market manipulation, a trader or a group of traders continuously buy and sell securities within themselves to hype up the trade volumes for such assets. This attracts the attention of other market participants and creates a false illusion about the asset and helps in increasing the demand.

Bear raiding

The traders who enter long positions in the market, sometimes use stop loss orders to protect their position from a significant price decline (risk management). Bear raiding involves selling large quantities of stocks of a company thereby decreasing its stock price. This downward trend in the stock price usually triggers the stop loss orders of traders with long positions, and further decreases the stock price in mechanical way.

Examples of market manipulation

WorldCom (2002)

A formerly world-renowned telecommunications company came under the scanner of U.S. financial regulators in early 2000s. The company was charged for manipulating their financial books by showing high profits and thereby manipulating the stock prices for the company. The ‘Book Cooking’ fraud done by WorldCom amounted to $3.8 billion. After the charges were proved, the company had to bear severe repercussions and eventually filed for bankruptcy in July 2002.

JP Morgan Chase (2020)

Many investors filed a case against JP Morgan Chase for manipulating the prices for the silver futures and US Treasury markets, and harming the interests of honest investors by artificially lowering down the prices of these securities. The bank made huge profits over the years and recently agreed to such charges and paid a penalty amounting to $920 million to settle the investigation carried by market regulators and law enforcement authorities. The manipulation involved ‘spoofing’ carried out by employees at J.P. Morgan Chase, many of whom are now facing criminal proceedings.

About the author

Article written in December 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Analysis of the movie Wall Street: Money Never Sleeps

February 16, 2025December 5, 2020 by Akshit GUPTA

Analysis of the movie Wall Street: Money Never Sleeps

This article written by Akshit Gupta (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) analyzes the movie Wall Street: Money Never Sleeps (2010) and explains the key financial concepts related to this movie.

The Wall Street: Money Never Sleeps movie released in 2010 is an American financial drama film and a sequel of the famous Wall Street movie (released in 1987). The story of the movie is set around the 2008 financial crisis and depicts the financial markets prevalent in the USA.

Key characters in the movie

Gordon Gekko: a famous Wall Street investor
Winnie Gekko: the daughter of Gordon Gekko and the owner of a non-profit news website
Jacob Moore: a famous trader at Keller Zebel Investments
Louis Zabel: Managing Director at Keller Zabel Investments
Bretton James: Head of Churchill Schwartz
Bud fox: a former investor at Bluestar Airlines

Summary of the movie

The movie starts by showing the release of Gordon Gekko, in 2001, from the Otis Federal Prison where he has been serving his 8-year long prison sentence owing to his involvement in insider trading and securities fraud in late 1980s. During his time in the jail, Gordon Gekko had been working on a book named “Is Greed Good?” which he started promoting in 2008, signaling the market about a possible economic downturn. The television promotion done by Gordon was seen by her daughter, Winnie Gekko, who is running a small non-profit news website and is dating a famous trader working at Keller Zabel Investments, named Jacob Moore.

Jacob, an idealist stock trader, is helping Dr. Master, in-charge of a fusion research project at United Fusion Corporation, to raise money and help the world move towards a cleaner source of energy.

As predicted by Gordon Gekko, the US financial markets starts dwindling and Keller Zabel Investments loses 52% of their market capitalization within one week and is forced to seek a bailout package from other banks on the Wall street. But to his dismay, his efforts are proved worthless when Bretton James, the head of a rival firm named Churchill Schwartz, blocks his efforts by stopping other banks to provide a bailout package stating moral hazards. Bretton had a long ongoing rivalry with Louis which dated back to the early days of the DotCom Bubble when Bretton’s firm had a significant exposure to the tech companies. His bank approached Keller Zabel Investments for a bailout, which was rejected by Louis James. Following the fall of Keller Zabel Investments, Louis commits suicide by jumping in front of a train at the station. Everyone in the industry is shocked by the sudden demise of the managing director of Keller Zabel Investments.

Hearing the news about Gordon Gekko’s lecture at Jacob’s alma-mater, Jacob decides to give it a visit. He gets inspired by the speech given by Gordon Gekko and tries to meet him. Soon, Gekko tells Jacob about the involvement of Bretton James in the fall of Keller Zabel Investments (KZI) and the death of his mentor, Louis James. Learning about this, Jacob and Gordon enter into an agreement where Jacob agrees to arrange for a meeting between Gordon and her daughter, and Gordon agrees to dig in for more information about Bretton’s involvement in the fall of the KZI.

Motivated to seek revenge, Jacob spreads false information and rumors to manipulate the market for the stocks of Churchill Schwartz which leads to Bretton losing over $120 million. Impressed by Jacob’s confidence, Bretton offers him a job in his company. Soon, Jacob wins the trust of Bretton when he pulls in a huge amount of investments from Chinese Investors for his Fusion Research Project.

The financial markets start to bleed globally when the subprime mortgages market crashes. Bretton’s company asks for a bailout package from the US Government. Soon Jacob comes to know that Bretton is diverting the funding received from the Chinese Investors to some other solar project and he decides to leave the firm. He visits Gordon who informs him about the profits Bretton has made by betting against the subprime mortgages market by using credit default swaps (CDS) before the crash and at the same time received a bailout package from the US Government.

As said ‘Money Never Sleeps’, Gordon soon deceits his future son-in-law Jacob by wrongfully diverting the funds held in her daughter’s bank account in a Swiss Bank by misleading Jacob. Hearing this news, Winnie breaks up with Jacob and moves on.

Gordon utilizes the $100 million that he received by deceiving Jacob and starts an investment firm in London. He becomes a famous person again with his firm generating $1.1 billion returns on the initial investments.

With the motive to seek revenge, Jacob gathers all evidence against Bretton for his involvement in different frauds and asks Winnie to publish the news on her website. Once the news comes out, Bretton is convicted of several charges and gets fired from his company, Churchill Schwartz.

Following the removal of Bretton, Gordon’s firm enters into a partnership agreement with Churchill Schwartz. The tables turned and Gordon becomes a famous player in the market. In the end, Gordon apologizes to her daughter and Jacob, and is shown to be living a happy life.

The relevance of the Wall Street: Money Never Sleeps movie for the SimTrade course

The Wall Street: Money Never Sleeps movie relates to the SimTrade certificate in many 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.

Famous quote from the Wall Street: Money Never Sleeps movie

“Bulls make money. Bears make money. Pigs? They get slaughtered.” – Gordon Gekko

Trailer of the Wall Street: Money Never Sleeps movie

About the author

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

My experience as a portfolio manager in a central bank

November 29, 2020 by Youssef LOURAOUI

My experience as a portfolio manager in a central bank

During my studies at ESSEC Business School, I had the chance to attend the SimTrade course. This course helped me to secure an internship as a risk manager at Bank Al-Maghrib (the central bank of Morocco) as I was asked during my interviews technical questions about financial markets that were covered during the course.

In this article, Youssef LOURAOUI (ESSEC Business School, Global Bachelor of Business Administration, 2020) shares his experience as an intern in the risk management department (middle office) at the Central Bank of Morocco (Bank Al-Maghrib) in 2020.

Bank Al-Maghrib

The central bank of Morocco was founded in 1959 after Morocco proclaimed its independence. It is a 100% state-owned bank that regulates the markets and the economy by implementing monetary and economic policies to ensure the welfare in terms of the parity of prices and the control of inflation. Inflation is a major economic indicator that possesses strategic importance and is part of the major focus for the central bank.

Bank Al-Maghrib

I describe below my experience at Bank Al-Maghrib.

My internship at Bank Al-Maghrib

I was affected at the middle office department, which is in charge of measuring risk exposures and profits and losses on the positions taken by the bank on an investment portfolio of 27,4 billion euros of foreign reserve. One of the key risk exposure metrics is volatility measured by the standard deviation statistically defined as the dispersion of a random variable (asset prices or returns in my case) from its expected value. The standard deviation indicates how much the current return is deviating from its expected historical returns. It is one of the most widely used metrics for investors when analyzing the risk of an investment. Among other key exposures metric, there is what it is called the VaR (Value at Risk) at 99% and a 95% confidence level for 1-day and 30-day positions. In other words, the VaR is a metric used to compute how much loss can the portfolio incur at a % degree of confidence for a given time horizon.

Every day, the Head of the Middle Office organizes a general meeting where he talks about global debriefing of the main financial news that happened overnight and debriefing the middle office desk for the “watch out” assets that could have a potential investment opportunity. Accordingly, the team has also the task of staying in line with the investment decision that characterizes the organization, as it does not operate as an investment banking corporation nor a hedge fund in the risk and leverage used. As the central bank has the special task of keeping safe the national reserve and searching for a good mix to invest in a low risk asset (AAA bonds from European countries coupled with American treasury bonds).

My task aimed to get a hand on the investment mechanism in the middle office of the bank. The investment mechanism consists of the division of the overall portfolio into three main tranches where each one has its characteristics. The first tranche (called also the security tranche) is calculated by analyzing the national need for a currency that needs to be kept safe to establish welfare on the exchange market (based mainly on short term position in low-risk profile asset (Liquid and high rated bonds). The second tranche is based on buy and hold and a market strategy. The first one consists of taking a long position on more risky assets than the first tranche till maturity, there is no selling during the lifetime of the asset (riskier bonds and gold). The second strategy is based on buying and selling liquid assets for an expectation of yielding higher returns.

During my time at the middle office desk, I’ve managed to develop a tool to represent the investment mechanism used for asset allocation. The tool, developed in an Excel spreadsheet, is an intuitive and simplified model that enables the understanding of the investment mechanism. Indeed, it is capable of continuously refreshing the data by importing the most recent quotations (from data providers like Bloomberg or Reuters as the two main financial data providers) to allow for an update of the different exposures and thus allow to respect the proportions of portfolio allocations. It has also a dynamic risk management tool to effectively compute draw-downs (a peak-to-trough decline during a specific period for an investment) and stressed conditions, as I experienced how the markets reacted to the novel Covid-19 pandemic with one of the most historic market movements in a long time.

Some of the key learning outcomes:

The introduction to data analysis by manipulating large datasets

Portfolio optimization based on the Markowitz efficient frontier

Dynamic portfolio allocation based on the fundamentals of the modern portfolio theory

The theory of efficient markets to understand how the markets evolve and move in a different direction as a reaction to events.

Front office, middle office and back office

My internship was also a good opportunity to discover the different departments of the bank: the front office, the middle office, and the back office:

The front office directly deals with the individual or corporate clients of the bank. Salespeople propose adequate products and solutions to the clients (they are in front of them!). Traders intervene in the financial markets on behalf of the clients or for the bank itself (proprietary trading). To answer the demand of clients, financial engineers and quants also develop new products and the associated mathematical models to price them. One of the main trends that are emerging in the front office is the automatization with the help of AI and algorithmic trading that is taken some room in the trading desks. At this time the bank didn’t implement any technology based on high-frequency trading, but it is taking the financial industry by surprise and it goes a long way back, nearly decades ago since the first usage of algorithmic trading.

The middle office situated between the front office and the back office (somewhere in the middle!) deals with the risk management of the bank. Risk managers control the traders’ positions (respect of constraints such as value-at-risk limits and stress tests) and compute the profits and losses (P&L) on traders’ positions daily.

The back-office deals with the conformity and the security check of every trade to ensure a proper settlement.

Note that the frontiers between the front, middle, and back-office may change from one bank to another. And last but not the least, the IT people are also supporting all three departments to make the whole system work. In other words, they are in charge of the maintenance of the technical infrastructure that the bank uses daily to operate fluently, as all the departments are dependent on internal software to intermediate and operate in the market or to communicate between each department of the bank or with another organization. The IT desk has great importance in offering a flawless experience for the employees when using the internal electronic infrastructure. There is the backbone of the bank skeleton.

All in all, the SimTrade module served me well as I managed to gain quickly the necessary knowledge and bridge the gap that I had to be in the best position to achieve the missions I’ve been affected. I especially used the content of Period 2 of the SimTrade certificate, which deals with market information. The concepts of trading and investing were also obviously useful for the development of my portfolio management tools.

Useful resources

Bank of Morocco

About the author

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

Film analysis: Too Big To Fail

October 8, 2024November 14, 2020 by Marie POFF

Film analysis: Too Big To Fail

Foreward

A pervasive moral stigma follows the financial sector, which has a dogged reputation for unethical and illegal behaviour. However, the ethical lapses often associated with finance are not always intentional. Instead, a contributing factor is that the teaching of finance and other business disciplines presents the challenge of linking theories and conceptual models to the “real world”. Entertainment media – such as films or books – are useful in this aspect as case studies; they provide students with an organisational frame of reference to better understand both situational contexts, and importantly, the human dimension behind financial numbers.

This article written by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020) analyzes the Too Big To Fail film and explains the related financial concepts.

“Too Big to Fail” is a dramatic retelling of the near collapse of the US banking system during the 2008 financial crisis. No-one saw the financial crisis coming, nor knew how to deal with the disaster when it arrived. This film follows financial leaders US Treasury Secretary Henry Paulson and Ben Bernanke as they try to protect a faltering U.S. economy, and eventually offer a no strings bailout, but leaves Paulson wondering if banks will lend. The issue of moral hazard is explored and begs the question, should banks really be too big to fail?

Film summary

“Too Big to Fail” gives a behind the scenes look at the conversations between major players during the 2008 financial crisis from March to mid-October. In 2008, Lehman Brothers were on the verge of collapse and its CEO Richard S. Fuld Jr. blamed the declining share price on short sellers, refusing to recognize his bank’s weaknesses. Instead, he sought a cash fill from Warren Buffett, and even pursued mergers with Bank of America (BOA) and Barclays. Treasury Secretary Henry Hank Paulson rejected the use of public money to save Lehman, and so in September 2008, Lehman filed for bankruptcy. However, shortly afterwards, Paulson announced AIG’s $85bn bailout, confusing investors with this message. Lehman could fail, but AIG couldn’t? In response to a deteriorating economy, Paulson pushed forward a plan where the US government purchased $500bn worth of toxic assets. After failing to pass congress, he redrafted the plan to assume direct ownership of stocks in banks. The Troubled Asset Relief Program (TARP) was hence created to normalise banks and increase investor confidence, putting the market back on the path to recovery.

The Wolf of Wall Street movie

Financial concepts from the Too Big To Fail film

Too Big to Fail (TBTF)

The name of this film is a financial term referring to institutions which are so large and essential to the functioning of the economy that they cannot be allowed to collapse, no matter the cost to the taxpayer. This was the logic behind the $182 billion bailout the US government provided to AIG, for example, along with the relief funds directed to titans like JPMorgan Chase, Citigroup, and the Big Three automotive companies.

Moral hazard

Moral hazard is a term used to describe how if a party is protected from risk, they will increase their risk tolerance and act less cautiously. In the context of banking, if the leaders of major banks feel confident that they are too big to fail – that is, that the government will bail them out – they will make increasingly risky decisions with the confidence that taxpayer dollars will rescue them if their bets go bust.

Bear Stearns

One of the first banks to fail, Bear Sterns’ hedge funds had accumulated over $20 billion in collateralised debt obligations (CDOs) and exposure to other toxic assets. In March 2008, due to the subprime mortgage crisis, Moody’s downgraded Bear’s MBS to Grades B and C (junk bond levels) and triggered a bank run leaving Bear with only $3.5 billion in cash. As Bear relied on repurchase agreements (short-term loans) – meaning it traded its securities to other banks for cash – Bear imploded when other banks called in their repos and refused to lend more. Bear’s insolvency forced a rescue organised by the Federal Reserve, where JPMorgan Chase bought out the bank for $2 a share (one month prior to this share price was $48). Bear’s demise triggered a panic on Wall Street and caused a banking liquidity crisis, where banks became unwilling to lend to each other. This is often used as a marker for the beginning of the 2008 financial collapse.

Lehman Brothers

On September 15th, 2008, the investment bank Lehman Brothers filed for bankruptcy. It was the biggest filing in U.S. history, with Lehman’s holding $691 billion in assets at the time. By the end of trading that day, $700bn had been wiped off the global stock markets. The Dow Jones had plummeted 500 points, its biggest drop since the terrorist attacks of 9/11. Lehman then sold its IB and capital markets operations to Barclays, kickstarting a global liquidity crisis.

Government Bailout (TARP)

A $700 billion bank bailout bill was signed on October 3, 2008 and was used to establish the Troubled Assets Relief Program (TARP). The fund was used to launch the Capital Purchase Program, which included buying $105 billion in preferred shares in Chase, Wells-Fargo, Goldman and five other leading banks. The insurance giant AIG had also become a major seller of credit default swaps to boost its profit margin, which insured the assets that supported corporate debt and mortgages. If AIG went bankrupt, it would trigger the bankruptcy of many of the financial institutions that had bought these swaps. TARP funds contributed $67.8 billion to the $182 billion AIG bailout, and also used $80.7 billion to bailout the Big Three auto companies.

Homeowner Affordability and Stability Plan

In addition to the TARP, $75 billion was put aside to help homeowners refinance or restructure their mortgages. HOPE NOW required the Treasury Department to both guarantee home loans and assist homeowners in adjusting mortgage terms.

Great Financial Crisis (GFC)

Although TBTF banks were not the sole cause of the recent financial crisis and Great Recession, given the scale of job losses, home foreclosures, lost savings and costs to taxpayers, there is no question that their presence at the centre of the financial system contributed significantly to the magnitude of the crisis and to the extensive damage it inflicted across the economy.

Key insights for investors

Banking reform

Major changes were made to prevent another financial crisis, including introducing stricter capital requirements and ensuring banks are less interconnected or vulnerable to contagion. However, some familiar risks are creeping back, and new ones have emerged as global debt continues to grow – for many countries, the combination of large debts in foreign currencies and weakening local currencies is becoming harder to sustain.

Significance of politics

A key takeaway is the intertwined relationship between politics and finance. Moral hazard asserts that ties between bankers and politicians create dangerous incentives for both parties and indicates the importance of observing not just numbers in our market research, but also non-quantifiable factors which influence expectations.

Learn from the Past

Note that “too big to fail” is a phrase still used today in finance and big business. For example, “Is Facebook too big to fail?” As well, while significant progress has been made to strengthen financial systems internationally, the biggest banks are most likely still too big to fail. It’s useful to be aware of this potential risk to an economy when considering the roles that massive companies and institutions play in our society. Economists will always speculate that we may be “overdue” for another crisis and learning from the past is the best way to prepare for the next crisis.

Relevance to the SimTrade certificate

SimTrade is your introduction to the global financial market; through a combination of theory and simulations, you learn to develop your confidence in your decision making and critical thinking skills. The course teaches you how to analyse the impact of events on expectations and stock prices, eventually teaching you how to build a position and make the market work for you.

Famous quote from the Too Big To Fail film

Paul Giamatti: “I spent my entire academic career studying the Great Depression. The depression may have started because of a stock market crash, but what hit the general economy was a disruption of credit. Average citizens unable to borrow money, to do anything. To buy a home, start a business, stock their shelves.”

Trailer of the Too Big To Fail film

About the author

Article written in November 2020 by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020).

Film analysis: The Wolf of Wall Street

October 8, 2024November 14, 2020 by Marie POFF

Film analysis: The Wolf of Wall Street

Foreward

This article written by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020) analyzes the The Wolf of Wall Street film.

The movie The Wolf of Wall Street is the true story of how rags-to-riches trader Jordan Belfort started with an OTC brokerage firm using pump and dump schemes, but eventually became a main player on Wall Street, where he launched the IPOs of several large companies. This black comedy shows Belfort’s rise to the high-life and excess of Wall Street, followed by a sharp fall involving crime and corruption – all while being seriously entertaining.

Film summary

The movie The Wolf of Wall Street follows one of Wall Street’s most infamous brokers, Jordan Belfort, who makes a fortune by defrauding investors out of millions. Directed by Martin Scorsese, the film starts with Belfort as an entry-level stockbroker at a Wall Street brokerage firm, where he is schooled on their cut-throat selling techniques. After a major market decline, he loses his job and goes to work for a small business selling penny stocks. After discovering the higher commission on penny stocks, he establishes his own firm, Stratton Oakmont, where he sells penny and IPO stocks with speculative returns. Jordan builds a business empire by presenting himself as a polished entrepreneur and training his employees on effective selling techniques. He is soon living the high life and becoming one of the major players on Wall Street, but soon discovers the dark side of success when he blurs ethical boundaries, quickly falling into a world of crime and corruption.

The Wolf of Wall Street movie

Financial concepts from the The Wolf of Wall Street film

Penny stocks

Penny stocks are low-priced stocks that do not trade on major stock exchanges and are issued by companies that typically do not publish financial statements. These trade anywhere from a fraction of a cent to a few dollars, and because the market capitalization, stock price, and the daily volume of these stocks are quite low, they are highly vulnerable to manipulation. For example, a sudden large volume of purchase or sale could cause the price to drop by triple-digits in a single day.

‘Pump and Dump’ schemes

‘Pump and Dump’ penny stock schemes are explained as the manipulation of the market through the accumulation of shares from penny stock or other companies, which are then stored in secret accounts. Investors are then ‘cold called’ to convince them that these companies are potential stocks for investments. The influx of purchasing orders would rapidly inflate the price, assuring investors that the shares are showing bullish behaviour. Belfort’s firm was a type of boiler room, with a team that pressured investors to place their money into highly speculative securities. At its peak, the firm is said to have employed about 1,000 stockbrokers overseeing more than $1 billion worth of investments.

Sales vs financial advisors

While working at L.F. Rothschild in the 1980s, Belfort is quickly taught that a stockbroker’s only goal is to make money for himself. Brokers seemed to focus on selling stocks and generating sales commissions, instead of advising clients on the financial risk of an investment or suitability for their portfolio. Belfort and his team are depicted as sales professionals, not financial ones, who are trained to sell investments at the expense of the client. Today, it’s still debatable whether financial professionals should be held to a fiduciary standard, requiring them to act in the best interest of a client, rather than simply providing a product.

Key insights for investors

Too good to be true: be your own investment expert

As the saying goes; if it sounds too good to be true, it probably is. Especially for beginners to the stock market, it’s important to remain clear-headed about your investment decisions and do your own research. Many of Belfort’s victims trusted him and invested all their life savings in ‘guaranteed’ stocks. Even with an advisor, it’s useful to understand financial markets and strategies, perhaps by at first investing small and diversifying your portfolio.

Legal vs ethical behaviour

Legal standards are the rules which govern the financial sector; but while something can be legal, it may not always be ethical. Belfort’s company was within the law when selling penny stocks, but not fully disclosing the speculative nature of the stocks was completely unethical. While he started by simply blurring this line, Belfort soon crossed the line and was convicted for not following securities regulations. Ethical business practices are the foundation of trust and goodwill; it’s important to take responsibility for your actions.

The road to success

While perhaps not the best role model, Belfort shows that long-term success is not a straight road. He experienced both failures and successes before reaching the height of his career on Wall Street. Losing his job lead to him starting as a stockbroker, and even after going bankrupt and serving time in prison, Belfort finished his sentence and turned his strength in sales and communications into a career as a motivational speaker. Financial mistakes can be rectified and instead become lessons for success. The most important step a person can take, is the next one.

Relevance to the SimTrade certificate

SimTrade allows you to make mistakes in a simulated setting, without suffering the financial consequences of trading with your personal funds. This course teaches you how to analyse the impact of events on stock prices and understand important concepts like market efficiency. As well as theory, you practice building a position, liquidating a position, and how to make the market. SimTrade is the best way for you to take risks, make mistakes, and learn how to make the best decisions for your portfolio.

Famous quote from the The Wolf of Wall Street film

Jordan Belfort: “Sell me this pen.”

Trailer of the The Wolf of Wall Street film

About the author

Article written in November 2020 by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020).

Film analysis: The Big Short

October 8, 2024November 14, 2020 by Marie POFF

Film analysis: The Big Short

Foreward

This article written by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020) analyzes the The Big Short film and explains the related financial concepts.

The film “The Big Short” recounts the subprime housing bubble which lead to the financial crisis in 2008. Through a compelling storyline, the complexities of the financial market – including CDOs, mortgage backed bonds, and the reckless trading of complex derivative instruments – lead to the subsequent financial collapse of the US housing market.

Film summary

“The Big Short” directed by Adam McKay and based on the best-selling book by Michael Lewis, explains how the subprime housing bubble, caused by increasingly risky subprime mortgage bonds, lead to the 2008 financial crisis. The danger was hidden such that only a few players predicted the collapse and used it to “short” the market. Once the bonds failed, the value of billion-dollar securities dropped to nothing, which bankrupted major investment banks and forced a government bailout to prevent economic collapse.

The film is presented as three concurrent stories about the investors who realised the risk of the subprime housing bubble and predicted the 2007 housing market crash. Wall Street investor Michael Burry realised that many subprime home loans packaged in the bonds were in danger of defaulting, and bets against the market with one billion dollars in credit default swaps. We also follow the stories of banker Jared Vennett, hedge-fund specialist Mark Baum, and two younger investors – Charlie Geller and Jamie Shipley – who work with retired banker Ben Rickert. After reading Burry’s findings, they also make a series of successful bets and profit off the downfall of the economy.

The subprime housing bubble caused worldwide chaos as banks entered a liquidity crisis, stock markets crashed, reputable companies collapsed, and millions suffered in the wake of the disaster. The crisis was felt worldwide, irrespective of your position and whether you benefited, survived or lost everything you’d worked towards. This movie helps those who aren’t in the financial sector, understand exactly what happened.

The Big Short film

Financial concepts from the The Big Short film

Financial derivatives

Leverage

Financial leverage can be used to increase (expected) profits but also increases risk by accentuating the gains and losses of a market position. When the largest banks and financial institutions in the world leveraged using derivatives, CDOs and other highly complex securities – the exacerbated losses can lead to collapse.

CDO

A Collateralised Debt Obligation (CDO) is essentially the repackaging “old” products as new, by the securitisation of loans into a product sold to investors on the secondary market. Another example are synthetic CDOs, which essentially bets on the direction the market is going to take and amplifies the monetary gain of a bullish market, but heavily exacerbates the losses from a bearish one.

Subprime Mortgage Backed Securities

Subprime mortgages are a loan to borrowers with a low credit rating, which increases the risk that they will default. Tranches in subprime mortgage-backed bonds are when subprime mortgages are mixed with top-rated mortgages, which effectively hides their risky nature from unsuspecting customers. These top-rated securities could not stand when the subprime mortgages failed, but the danger was looked over even by the banks who sold them.

‘Shorting’ the market

By predicting the danger of mortgage-backed securities and expecting defaults on subprime mortgages, some investors profited from the crisis through credit default swaps. However, this does not mean shorting the market is a good idea. As said by J.M. Keynes; the market can stay irrational much longer than you can stay solvent. Due to unpredictable factors such as politics, going short is a bet that can run out of time – even with a simple options strategy, your options will eventually expire. Sticking with a long term, value-based approach eliminates that problem. Keep short investments on the side to meet short term cash flow needs, but also know that a quality company will generate profits, dividends, and market returns over the long term, without ever expiring.

High Risk vs High Reward

Why did the banks making the loans expose themselves to subprime borrowers at such high levels? Because high-risk borrowers also offered high rewards. Before home prices imploded and the labour market tanked, banks were able to charge sufficiently high interest rates on loans to subprime borrowers which more than overcame the costs of their higher default rates. This combined with the banks’ ability to securitize loans and sell them meant that banks thought their risks were mitigated. Instead they focused on how higher subprime interest rates could boost their margins and profits. However, those default rates eventually grew too high for any interest rate to justify the risk, and the entire system collapsed.

Impartial assessors

Impartial regulators and assessors are critical to the safe functioning of the financial sector. A contributing factor to the crash was years of financial malfeasance and incompetence among the top salesmen and executives among Wall Street’s largest banks. Conflicts of interest and abuse of power by the banks meant credit rating agencies as well as professionals supposedly managing CDOs for the benefit of the customer, were in fact working in the bank’s interest. This fraudulent system meant the credit rating agencies were rating housing debt securities highly, right up until the crash.

Counter-party risk

This simply means the risk of the other party, if their investments are not able to pay out when the time comes. An example is how Baum and Geller bet against the banks, but when the crisis hit the banks eventually went bankrupt – these two investors had to be careful about receiving payment before the banks became insolvent.

Key insights for investors

Trust your instincts

It’s important to do your own homework and trust your instincts. Despite external pressure, the investors shorting the market held their ground, ensuring their investments paid off in the long-term. When the numbers go up and down, it’s important to be patient and study the reasons behind any change. While investment advice is useful, the incentives of others may conflict with yours. It’s your money, and just because an opinion is popular, doesn’t mean its correct.

See the reality

When buying securities, it’s vital to understand the reality of what the numbers represent – real people, real companies. In the film, we see workers paying off loans for three properties at varying rates, and how the incentive system cushioned bank managers’ salaries, helping the mortgage market expand. “No-one can see a bubble; that’s what makes it a bubble” – people lost their ability to see the forest for the trees. They were the weak link in the chain, which once broken, caused the crisis. Your finances are only as strong as their weakest link, so it’s important to diversify your risk.

Mentors

In the film, Geller and Shipley asked their mentor and retired trader Rickert for his support to meet the ISDA threshold. More than that, he taught them that greed is not good, and that their win was at the expense of millions of Americans who would lose their jobs. Have a mentor to guide you both morally and financially.

Opportunity in adversity

A final lesson from this movie, albeit a dark example, is that you can find the good in adversity. By shifting your mindset when facing failures or disasters, you can learn to find opportunity in anything.

Relevance to the SimTrade certificate

Through the SimTrade course, as well as a strong understanding about trading platforms and orders, you are taught about information in financial markets and how to use this to make successful trades. Several case studies teach you how to analyse market information to make valuations, and correctly assess how market activities will affect your own trades. The simulation and contest allow you to compete against others in the course and deepen your understanding of how a market reacts to different players.

Famous quote from the The Big Short film

An investor: “No one can see a bubble. That’s what makes it a bubble.”

Trailer of the The Big Short film

About the author

Article written in November 2020 by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020).

Film analysis: Rogue Trader

October 8, 2024November 14, 2020 by Marie POFF

Film analysis: Rogue Trader

This article written by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020) analyzes the Rogue trader film and explains the related financial concepts.

Based on a true story, ‘Rogue Trader’ details how risky trades made by Nick Leeson, an employee of investment banking firm Barings Bank, lead to its insolvency. This film explores how financial oversight and a lack of risk management from Leeson’s supervisors, lead to irrecoverable losses and the eventual fall of the banking giant.

Film summary

‘Rogue Trader’ recounts the exploits of Nick Leeson and his role in the downfall of Barings Bank, one of the single largest financial disasters of the nineties. Directed by James Dearden, this film encapsulates the economic and social changes of a tumultuous period. Leeson is a young derivatives trader sent to work in Singapore for Barings Bank, a major investment bank at the time. After opening a Future and Options office in Singapore, Leeson is placed in a position of authority where he takes advantage of the thriving Asian market by arbitraging between the Singapore International Monetary Exchange (SIMEX) and the Nikkei in Japan. He begins making unauthorised trades, which initially do make large profits for Barings – however he soon begins using the bank’s money to make bets on the market to recoup his own trading losses. At first, he tries to hide his losses in accounts, but eventually loses over $1 billion of Barings capital as its head of operations on the Singapore Exchange. He eventually flees the country with his wife, but inevitably, he must face how his actions lead to the bankruptcy of Barings Bank.

The Rogue Trader film

Financial concepts from the Rogue Trader film

Financial derivatives

For any new investors, financial derivatives describe a broad class of trading instruments that have no tangible worth of their own, but “derive” their value from a claim to some other financial asset or security. A few examples include futures contracts, forward contracts, put and call options, warrants, and swaps. Derivative trading started from the practice of fixing contracts ahead of time, as a way for market players to insure against fluctuations in the price of agricultural goods. Eventually the practice was extended to cover currencies and other commodities. As exchange rates became increasingly unstable, the derivatives trade facilitated huge profits for those estimating the future relative value of various commodities and currencies, through the buying and selling complex products.

Barings Bank

Founded in 1762, Barings Bank was the second oldest merchant bank in the world before its collapse in 1995. Barings grew from being a conservative merchant bank to becoming heavily reliant on speculation in the global stock markets to accumulate its profits. The derivatives market was somewhere this could be done in a very short space of time. Following the stock market crash of 1987, derivatives became central to the banks’ operations as they sought to offset their declining profits. The volume of their derivative trading soared from less than $2 trillion in 1987, to $12 trillion in 1993. As finance capital became increasingly globalised, Barings branched out to exploit these new markets in Latin America and the Far East.

Tiger Economies

The term “tiger economies” is used to describe the booming Southeast Asian economies of South Korea, Taiwan, Hong Kong, and Singapore. Following export-led growth and especially the development of sophisticated financial and trading hubs, Western interest spiked for these untapped markets in the 1990s.

Arbitrage

Profitable arbitrage opportunities are the result of simultaneously buying and selling in different markets, or by using derivatives, to take advantage of differing prices for the same asset. In the film, Leeson makes a profit by exploiting the small price fluctuations between SIMEX in Singapore and the Nikkei 225 in Japan.

Cash neutral business

A cash neutral business means managing an investment portfolio without adding any capital. For Leeson, any money made or lost on the trades should have belonged to the clients, and only a small proportion of the trades were meant to be proprietary. However, Leeson used Baring Bank’s money to make bets on the market to recoup his trading losses.

Short straddle position

A short straddle is an options strategy which takes advantage of a lack of volatility in an asset’s price, by selling both a call and a put option with the same strike price and expiration date, to create a narrow trading range for the underlying stock. Lesson used this strategy but sold disproportionate amounts of short straddles for each long futures position he took, because he needed to pay the new trades, the initial margin deposits, and meet the mounting margin calls on his existing positions.

Errors account

An errors account is a temporary account used to store and compensate for transactions related to errors in trading activity, such as routing numbers to an incorrect or wrong account. This practice allows for the separation of a transaction so that a claim can be made and resolved quickly. Leeson used this accounting to conceal the losses to Barings Bank which eventually amounted to over £800 million, though the account was supposedly activated to cover-up the loss made by an inexperienced trader working under Leeson’s supervision.

Key insights for investors

Don’t Lose Sight of Reality

An important insight is noticing how Leeson forgot to consider the real-world impact of his trades. He reflects on seeing trading as just artificial numbers flashing across screens, “it was all paid by telegraphic transfer, and since we lived off expense accounts, the numbers in our bank balances just rolled up. The real, real money was the $100 I bet Danny each day about where the market would close, or the cash we spent buying chocolate Kinder eggs to muck around with the plastic toys we found inside them.” Leeson saw the Kobe earthquake as nothing more than an opportunity and conducted more trading in one day than he ever had before as the market was butchered. Investors can avoid Leeson’s mistake by keeping a firm grasp on reality, and remembering the real companies and people represented by the stock exchange.

Destructive Practices

Other employees at Barings Bank most likely relied on internal auditors to discern wrongdoings or mistakes made by others, but as can be seen from Leeson’s case, regulators can be slow to catch on to any wrongdoing – especially when there are large profits involved. The lesson here is that an investor must be aware and proactive in helping to prevent other investors from engaging in destructive trading practices. This is especially true when it comes to newer markets or products, where regulators are unsure what entails best practice.

Tacit Agreement

While Leeson is assumed to be the villain, consider how Barings was able to contravene laws forbidding the transfer of more than 25 percent of the bank’s share capital out of the country for nearly every quarter during 1993 and 1994? Ignorance is not an excuse – tacit agreement is as effective as active engagement. A lesson here is that investors should remain informed on all their business engagements regardless of how much profit it being made.

Relevance to the SimTrade certificate

Famous quote from the Rogue trader film

Nick Lesson: “Despite rumours of secret bank accounts and hidden millions, I did not profit personally from my unlawful trading. To be absolutely honest, sometimes I wish I had.”

Trailer of the Rogue trader film

About the author

Article written in November 2020 by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020).

Film analysis: Other People's Money

October 8, 2024November 14, 2020 by Marie POFF

Film analysis: Other People’s Money

This article written by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020) analyzes the Other People’s Money film.

“Other People’s Money” is a film about a near obsolete publicly traded company, the New England Wire and Cable Company, interwoven with romance and community spirit. Issues arise because the original wire and cable division has become an obsolete parent firm of an otherwise profitable group of subsidiaries, but it employs much of the town’s population. While exploring the world of hostile corporate takeovers and the market for corporate control, this film shows the human impact of shareholder decisions. Good capitalism and greed clash in this fight to keep shareholders satisfied and save the factory from a dying industry.

Film summary

“Other People’s Money” directed by Norman Jewison, delves into the hostile takeover of New England Wire and Cable Company (NEWC) by Garfield Industries, where corporate raider Lawrence “Larry the Liquidator” Garfield is president. New England Wire is a publicly traded, debt-free company founded and managed by the Jorgenson family. Garfield arrives offering a peaceful takeover, explaining that the wire and cable division is in a dying industry, and is harming the profitable subsidiaries by depressing the share price. He believes that liquidating the harmful wire division is necessary to act in the best interest of the shareholders. However, Jorgenson denounces this offer as a death sentence for the employees and their town, arguing that companies should protect their community and have social responsibility. However, the market value of the company’s common stock decreases to equal less than the underlying value of its assets. Garfield then makes a takeover attempt, which culminates at the company’s annual shareholders’ meeting with Garfield succeeding in closing the wire and cable division of NEWC. The film ends with Kate Jorgensen calling with good news from a Japanese automobile company, who are interested in hiring the NEWC to product stainless steel wire cloth instead of wire.

Otehr peoples's money film

Financial concepts from the Other People’s Money film

Other People’s Money

Other people’s money (OPM) is a slang term referring to financial leverage, whereby using borrowed capital it’s possible to increase the potential returns, but also increase the risk, of an investment. In the film, the NEWC had an inefficient capital structure with no debt to leverage the company. Instead the company had a high amount of cash and liquid assets, as well as a fully funded pension plan for its employees, but had a debt-to-equity ratio of zero. There are trade-offs to having a higher debt-to-equity ratio, but in this case, leveraging OPM would have allowed the NEWC to remain in business by transitioning into a more profitable industry.

Corporate restructuring

Corporate restructuring is a process where the structure or operation of a company is significantly modified, usually in periods of significant distress and financial jeopardy. This could involve for example, mergers, takeovers, or divestiture. In this film, Garfield persuades the shareholders to divest of the failing division by selling the division and its remaining assets. Kate Jorgensen offers a better solution – a Japanese automobile company which will hire the NEWC to produce stainless steel wire cloth, allowing the company’s assets to be repurposed instead of liquidated.

Corporate takeovers

A corporate takeover refers to when one company makes a bid to acquire or take control of another, without necessarily obtaining the actual title. A takeover is usually done by purchasing a majority stake in the shares of the target company. In the film the NEWC is debt-free, making it attractive to corporate raiders or ‘takeover artists’, who aim to provide shareholders with a better return for their money.

Market for corporate control

The market for corporate control is the role of equity markets in facilitating corporate takeovers, and mainly refers to the market for acquisitions and mergers where there is competition for control rights. In this film, takeover artist Garfinkle is blocked from purchasing more shares in the NEWC by a judge’s injunction. He fights this as he believes that a free market for corporate control is needed to enable restructuring essential for the company to remain competitive. As a value-focused individual, Garfinkle believes in market dynamism as an effective tool for poor management, where market forces put pressure on managers to perform or risk sale of the company.

Creative destruction

Creative destruction is the union of evolutionary natural selection and economics. Resources are necessarily scarce, so the world advances only when outdated industries are encouraged to die quickly, allowing capital to be reallocated to more efficient and innovative industries. In this film, cable and wire is a dying industry due to the widespread adoption of fibre optics, so Garfield encourages shareholders to sell to him and reallocate their money towards a more productive venture. The underlying assumption is that though a transitioning industry will cause disruption, there is more to gain than lose when capital is put to best use and assets are used in an economically rational manner.

Key insights for investors

Wealth maximisation vs Social responsibility

As investors, the main goal is often to maximise wealth, and the game of making money can make it all too easy to value a business solely on its share price. However, this film shows that behind the numbers are the people who keep the business afloat, and who in turn rely on employment at the NEWC to support themselves. Jorgensen’s focus is on his social responsibility to the employees whose livelihoods depend on the wire plant, while Garfield believes in free enterprise and shareholder wealth maximisation. It’s clear that a balance between the two is required to create ‘good capitalism’, where all parties involved are treated fairly and humanely.

Many sides to every story

A meaningful insight from this film is that both players had valid reasons for their actions. While Garfield is painted as profit-focused at the expense of the employees, he’s also acting in the best interests of the shareholders – he refuses to take a “greenmail” bribe because he believes it would be immoral to sell out and victimise the shareholders whose funds are not being put to best use. Conversely, while Jorgensen is painted as the town’s hero, he is also neglecting his obligation to the shareholders by failing to recognize that his company was in a shrinking market, and would become obsolete if he did not accept innovations in the industry. This dual perspective is an introduction to business ethics, showing how utilitarian thinking can clash with other ideals pushing social responsibility and awareness. As investors, this is a reminder that there are always many perspectives to an issue, and real life is never black and white.

Relevance to the SimTrade certificate

SimTrade is a course designed to teach investors how the market works, including how to make orders and build a market position, while also teaching investors how to interpret and understand what these numbers represent in the real world. A combination of theory and practice helps you to understand the complexities of the stock market – including firm valuations, the impact of events on stock prices, and how to appreciate the degree of market efficiency.

The Other people’s money concept is introduced in Period 3 of the SimTrade certificate:

The Financial leverage course
The series of simulations about market making

Famous quote from the Other people’s money film

About leverage: “I love money. I love money more than the things it can buy. There’s only one thing I love more than money. You know what that is? Other people’s money.”

Watch Garfield making his point about wealth maximisation at the shareholders’ Annual Meeting of their company.

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

Trailer of the Other People’s Money film

About the author

Article written in November 2020 by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020).

Book review: Barbarians at the gate

October 8, 2024November 14, 2020 by Marie POFF

Book review: Barbarians at the gate

This article written by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020) analyzes the Barbarians at the gate book.

“Barbarians at the Gate” is a book title which quickly became a catchphrase in the finance industry. It describes how the once benevolent business practice of leveraged buyouts (LBOs), morphed into something more sinister under the influence of Wall Street in the 1980s. This book describes in detail the LBO and subsequent failure of the RJR Nabisco merger, and dives deeper into a Wall Street culture driven by greed and excess. An exciting read, with valuable lessons which still apply to investors today.

Book summary: Barbarians at the Gate

“Barbarians at the Gate” written by investigative journalists Bryan Burrough and John Helyar, follows Ross F. Johnson as he merges two of America’s biggest brands in the 1980s, RJR and Nabisco, becoming the CEO and president of tobacco and food corporation RJR Nabisco. What follows is the leveraged buyout (LBO) of RJR Nabisco, with a frenetic Wall Street bidding contest between members of the RJR Nabisco management, the investment banking firm Shearson Lehman Hutton, and the LBO firm Kohlberg, Roberts and Co, for the takeover of the company. This takeover was the peak of a wave of LBOs in the 1980s, and after a competitive bidding process, private equity firm Kohlberg Kravis Roberts & Co. (KKR) put in a winning $24.5 billion bid. This netted Johnson over $60 million and put millions more into the hands of executives, lawyers, and bankers involved in the deal.

Barbarians at the Gate Book

Financial concepts from “Barbarians at the Gate”

Leveraged Buyout (LBO)

A leveraged buyout is a financial transaction where a company is purchased using a combination of equity and debt, and where the company’s cash flow is the collateral used to secure and repay the sum borrowed. LBOs started as a work-around by the wealthy to avoid estate taxes; investors would create a shell company and acquire the target company using bank loans and insurance bonds, with only 10% coming from the personal funds of the investors.

Wall Street and LBOs

In the 1980s, the word LBO became synonymous with corporate greed – a representative of the unhinged excess of Wall Street. At the time, the US Internal Revenue Code allowed deductions of interest tax, but not dividends, encouraging companies to go into debt and pay interest, rather than operate at a profit. As well as this, junk bonds – speculative investments with a higher risk of defaulting – then made it possible to raise massive sums of money quickly. This further enabled the transformation of an LBO from a slow financial loophole, to a process used in hostile corporate takeovers.

The Downsides of LBOs

The use of LBOs for hostile takeovers left a heavy debt burden on companies and sparked widespread criticism. Government officials warned that a leveraged takeover one day could mean bankruptcy the next. The original shareholders would thus see their investment value crumble as the company took on enormous debt. The human cost was of course the employees of the targeted companies – many of whom would lose their jobs.

The RJR Nabisco Fiasco

In 1985, Nabisco and RJR merged into RJR Nabisco because of the growth opportunities it would afford both companies. However, the flashy behaviour of the Northern US company, Nabisco, conflicted with the values of its Southern counterpart, RJR. For example, employees at the RJR factory rarely saw limousines, whereas it was the preferred mode of transportation for Nabisco managers. In 1988 there was an LBO takeover for the firm, and the dramatic bidding process put millions into the hands of those involved in the deal, but left the company crippled with a $30 billion debt. Private equity firm KKR agreed to insane terms to win the deal, including giving a huge cut to CEO Johnson, and agreeing to ensure the maintenance of certain departmental budgets and retirement packages. These concessions compromised the austerity measures which enable an LBO, such as downsizing departments to repay the debt. Crippled with debt, RJR Nabisco didn’t survive the long-term effects of the LBO, and in 1999 split back into tobacco and food companies.

Negotiation fees

An overlooked aspect of an LBO are the fees involved; in the case of RJR Nabisco, the upfront fees for advising, moneylending and a ‘success fee’ was upwards of $200 million alone. In all negotiations there are administration and other costs affecting the bottom line of the deal.

Wall Street in the 1980s

It’s worth mentioning the differences between Wall Street in the 1980s and today. The world moved slower without the internet, and newspapers were the most influential (though much slower) medium for financial reporting. A Time cover story condemning the lavishness of Wall Street – “Greed on Wall Street” – was enough to influence the outcome of a deal. Many of the big players on Wall Street wanted above all else to maintain their luxurious lifestyles, often at the expense of others; they truly epitomize the greed and excess of Wall Street in the 1980s.

Key insights for investors

Stay updated

As an investor your primary concern is a return on your investments, so it pays to be aware of any changes to company structure or management, for example changes in the debt/equity structure, which could affect the longevity of the company. By staying aware of mergers, buyouts or other changes involving companies you own, you can better decide if it’s a hold or sell by considering the long-term impact on your investment.

Detrimental effects of greed

Whether it’s the go-go 1980s or the sub-prime wave of the 2000s, greed is a recurring factor when it comes to detrimental financial practices. In the book, KKR was desperate for a piece of the LBO pie, and blinded by the promise of profit, agreed to extremely disadvantageous terms. Johnson also made a bid, but executive Charles Hugel saw how much he aimed to profit at the expense of thousands of Nabisco employees, and appalled by Johnson’s greed, accepted KKR’s lower bid. The lesson here is that numbers should never be the only consideration when making a deal. Taking Forstmann’s “real people, real money” approach, it’s clear that KKR’s bid of “phoney junk bond crap” only lead to fast profits for the dealmakers, and destroyed the long-term health of the company. As investors, it’s important to consider the real-world impact of our investments; by investing into people and ideas, we can help grow the companies of tomorrow, maintain the health of our business sectors, and make reliable long-term profits in the future.

The relevance of the Barbarians at the Gate book for the SimTrade course

An important aspect of finance is learning how the market is directly influenced by the expectations and actions of others. In the SimTrade course, after learning how the market works through the limit order book, prices and transaction volumes, students engage in a simulated market situation where they learn how to send orders, and see first-hand how this directly influences the market. SimTrade also teaches students to understand how a firm is valuated, the impact of events on stock prices, and the real-world effects of your investments. SimTrade is an incredible learning opportunity for those who want to both understand the market, and practice market activities safely in a simulated environment.

About the author

Article written in November 2020 by Marie POFF (ESSEC Business School, Global Bachelor of Business Administration, 2020).

The animals of finance

October 30, 2020 by Akshit GUPTA

The animals of finance

This article written by Akshit GUPTA (ESSEC Business School, Master in Management, 2022) analyzes the animals of finance used as metaphors.

Financial markets are a common marketplace where trading of different securities (stocks, bonds, foreign currencies, derivatives, etc.) takes place between prospective buyers and sellers. They play a pivotal role in the functioning and growth of an economy by allocating limited resources and generating liquidity. They consist of several terminologies, associating animals to define key characteristics of different market scenarios and types of investors.

Bulls
A bull is used to define an investor or a market scenario where the traders are optimistic about the markets and expect an upward trend or movement in stock prices. A bullish investor takes a long position in the market and expects to generate a profit by selling the stocks at a higher price. Also, investor confidence is high when the market shows a bullish trend and more capital usually flows into the market increasing market capitalization.
Bears
A bear is used to define an investor or a market scenario where the traders are pessimistic while having negative sentiments about the markets and expect downward trends in the short term. A bearish market shows a lack of investor confidence and comes into existence for a short period followed by a bullish trend. A bearish market is the polar opposite of a bullish market and investors make use of different techniques including short-selling to profit from such trends.
Ostriches
Based on the concept of an ‘Ostrich Effect’, Ostriches represent investors who avoid bad market news and bury their heads inside the sand just like an ostrich to avoid facing such unfavorable situations. Such investors fail to react to negative news at the correct time in anticipation of good times ahead. The strategy employed by them often leads to heavy losses and lower confidence in financial markets.
Stags
Stags are used to define investors who take long positions during the initial public offerings (IPO) of a company and profits by selling the stocks once the shares are listed. These investors aren’t much affected by the bullish or the bearish market trend and place speculative bets on the short term market movements.
Chickens and Pigs
Chicken refers to investors who are risk-averse in nature and have a very conservative approach while dealing in the financial markets. Such investors usually stay away from equity stock investments and prefer safer investments in bonds, fixed deposits, and government securities. The risk appetite for these investors is very low and they look for secured returns.

Pigs are used to define investors who are greedy and resort to taking high risks in anticipation of making huge profits. Their trading style is not based on any fundamental or technical stock analyses but rather on trending stock tips and hearsay. The undisciplined style of investment is what makes these investors most vulnerable to market volatilities and they are the ones to lose most of their investments when the prices move in unfavorable directions.
Wolves
Wolves are used to define investors who are powerful and greedy and resort to unethical and illicit means to generate huge returns in the market. Most of the time, wolves are involved behind the development of high-level scams which disrupts the financial markets and leaves a long term impact on genuine investor’s confidence.

About the author

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

Warren Buffett – The Oracle of Omaha

October 30, 2020 by Akshit GUPTA

Warren Buffett – The oracle of Omaha

This article written by Akshit Gupta (ESSEC Business School, Master in Management, 2022) presents a portrait of Warren Buffett – The Oracle of Omaha.

Introduction

Warren Buffett or commonly referred as the ‘Oracle of Omaha’ by global media outlets, was born on August 30, 1930 in the town of Omaha, Nebraska, United States. He is a profound US-based investor, a business tycoon and moreover, the #3^rd richest individual in the world as per Forbes Billionaires List 2019.

Having started investing at a mere age of 11 years, Mr. Buffett went on to become the largest shareholder and CEO of one of the greatest investment companies around the globe, named Berkshire Hathaway. Originally started as a textile company in 1950s, the company was purchased by him in 1962 and then, converted into a holding company with a portfolio ranging across several industries.

Investment philosophy

Often referred to as ‘a man who values simplicity and frugality’, Mr. Buffett has based all his investments on a long-term strategy of value investing. In the Shareholder’s Annual letter of 1997, Mr. Buffett said “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”

The strategy followed by him is based on a fixed set of principles which include:

Looking for long term investments in stocks which are undervalued based on their fundamental value
Seeking out for competent and ethical corporate leadership
Investing in companies with strong earnings, where the long-term growth potential can easily be predicted

As per him, buying stocks at a discount to their intrinsic value would give investors a market-beating return only if the corporate leadership is dedicated to the company’s mission and shareholder’s welfare. Owing to his strategy of investing in companies with easy to understand business models, he didn’t suffer any significant losses during the dot-com bubble burst in the early 2000s since the internet businesses were new and difficult to comprehend.

Relevance to the course

SimTrade course teaches us about the use of market information, different types of orders, and firm valuation to execute trades in the market. The strategies followed by Mr. Warren Buffett correlate with the concepts of firm valuation and its use in value investing. He emphasizes upon the use of fundamental analysis of companies with high growth potential and easily understandable business models. He also teaches us to think beyond numbers in financial markets and translate the effects of non-financial factors, like honest and ethical corporate leadership, into economic gains. If learned and applied in day to day practices, these principles would give every investor a slight edge in building their portfolios efficiently and thereby, increasing their wealth.

Article written by Akshit GUPTA (ESSEC Business School, Master in Management, 2022) – October 2020.

Remuneration in the finance industry

October 30, 2020 by Akshit GUPTA

Remuneration in the finance industry

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) analyzes the remuneration in the finance industry.

Introduction

“Remuneration is a compensation that an individual or an employee receives for the work or service they have provided to the organization.” A good remuneration is a primary tool used by almost every company to attract well-qualified professionals and make them perform their duties efficiently and effectively. A satisfactory remuneration impacts both work performance and job satisfaction of an employee, thereby upsurging their morale and motivating them to work even harder. Over the years, many studies have shown a direct relationship between employee contentment and the respective compensation they are provided with. The remuneration employee gets may not only be in the form of cash-in-hand but also in the form of other incentives based on employee stock ownership, commissions, bonuses, etc. Apart from the monetary incentives, employees also look forward to other intangible rewards in the form of work-life balance, personal development, company culture, and responsibilities allocated to them.

Businesses in the finance industry

The Financial services industry encompasses a broad list of businesses ranging from insurance firms, stock brokerage firms, investment funds, investment banks to accounting companies where the pay-scale varies from one business category to another. Amongst all the businesses, Investment Banking, Retail/Commercial Banking, Stock Brokerage, and Investment Funds continue to dominate the industry.

Investment banking

Investment banks are intermediaries that help companies to carry out complex financial transactions including Mergers and acquisitions, IPOs, restructuring, etc. Some of the biggest names in investment banking include J.P. Morgan, Goldman Sachs, Citi, and Barclays, who hire great minds from all across the world. The kind of jobs that continue to attract students to this domain includes an M&A Analyst, a Financial Advisor, an Underwriter, etc. Given below is a table showing the average remuneration received by analysts at some of the top investment banks operating in London.

Screenshot 2020-04-21 at 4.57.34 PM

Based on the above report by Dartmouth Partners, the average pay scale for an entry-level Analyst amounts to £50,000 in base salary and £30,000 in bonuses with a median bonus pay-out of £38,000. The above pay-scales do sound very lucrative and appealing but as it is said that money doesn’t come easy, the working hours in a typical banking job exceed 80 hours per week with late-night shifts and working weekends.

Brokerage firms

Stock Brokerage firms continue to be another one of the most attractive business domains in the finance industry. A stock brokerage firm is a financial institution that advises and helps in buying and selling of financial assets including equity stocks, commodities, forex, etc. Some of the biggest names in this business domain include Fidelity Investments, Charles Schwab, Wells Fargo Advisors, TD Ameritrade, etc. Given below is a table by Glassdoor, a leading recruitment site, showing the average base salary for an entry-level stockbroker in USA. Apart from the base salary, the broker is also entitled to bonuses and commissions, the percentage of which varies across different companies.

Screenshot 2020-04-28 at 6.03.18 PM

Investment management firm

An investment management or asset management firm is a financial institution that pools in money from big investors and invests in various asset classes ranging from equity, bonds, real estate, commodities, etc. Some of the biggest asset management firms in the world include Blackrock, The Vanguard Group, UBS Group, and Capital Group with Assets under management (AUM) as high as $6 trillion. The most popular jobs in this domain include, a hedge fund Analyst, an investment analyst, and a research analyst.

Given below is a table showing the average salary paid by Blackrock, the largest asset manager, to its employees working at various positions.

Screenshot 2020-04-28 at 5.48.53 PM

Recent trends in the industry

Financial services are going through a digital transformation phase due to changing consumer demands and demographics. With the evolution of FinTech and blockchain technology, financial companies and retail banks have been able to serve their clients in a better way with a unique customer experience that includes automated chatbots, spending trackers, seamless credit facilities, etc. Since technology is gaining a tight grip on this industry, new career paths have opened for the upcoming aspirations including jobs for technology enthusiasts, risk analysts, and software experts. The role of a data scientist has been increasing in the financial context due to data being the fuel of this industry. The ever-growing datasets provide key information useful in managing risks, preventing frauds, building customer relations, and algorithms to ease the process. With increasing focus on machine learning, the jobs for data scientists would keep on rising to serve the purpose of building new algorithms and crunching even bigger datasets.

About the author

Article written in October 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

High-frequency trading

October 30, 2020 by Akshit GUPTA

High-frequency trading

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2022) analyzes high-frequency trading.

Introduction

High-frequency trading is a system that executes buy and sell orders by utilizing an algorithm-based computing platform. The turn of the millennium saw the advent of High frequency trading becoming popular with around 10% of all the trades being executed using algorithms. Initially, the time for execution of trades using HFT was several seconds which eventually shrunk to microseconds and subsequently to nanoseconds by 2012 with the invention of Nano Trading Technology.

The new technology was launched into the market by a firm named Fixnetix and was powered by a microchip executing trades in nanoseconds. By 2012, around 70% of all the US equity traded were executed using HFT platforms. Propagators of this technology credit it with increasing the market liquidity and narrowing the bid-ask spread in financial markets, thereby making markets more efficient.

The Flash Crash (6^th May 2010)

A flash crash refers to a rapid decline in the prices of securities or commodities triggered due to several reasons, automated trading being a primary one.

The computer-based trading technology suffered a lot of criticism during the year 2010 when an algorithm-driven sale of $4.1 billion worth of E-mini futures, resulting from political tensions arising in Greece, brought short term turbulence in the US markets. The futures sale triggered a rapid 1000 point or 9.2% drop in the Dow Jones Industrial Average which was unprecedented in history. The initial sell order resulted in a wave of other sell-offs triggered by the designed algorithms, causing a big downfall in the market. The orders resulted in a whip off of around $1 trillion in the total market value. However, the dip didn’t last very long and the markets recovered by the end of the day, closing at 3% lower than the previous closing price. But the sudden crash made SEC aware of the dangers the algorithm-based trading carry and made them skeptical about its usage.

The Flash crash of 2010 has resulted in HFTs being subject of regulatory discussions, with critics citing it as a major reason for increased volatility and uncertainty in the markets. Also, HFT has been regarded as a bane for the modern financial markets as it gives an unfair advantage to large scale firms, not providing a fair playing field to small scale investors.

Relevance to the course

With most of the big firms employing computer-based technology to execute trades, the concept of high frequency trading dominates the financial market in the present days. The Simtrade platform encompasses courses on exchanging orders and the different types of orders a trader can enter to execute his position. Coupled with algorithm-based platforms, basic knowledge of orders can provide a trader with an excellent opportunity to execute 1000s trades simultaneously across different markets. With more and more regulations coming in, the evolution and increased usage of HFT’s can play a key role in increasing the overall value of a trader’s portfolio.

An interesting video to understand the 2010 crash:

About the author

Article written in October 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2022).

The bankruptcy of Lehman Brothers (2008)

October 30, 2020 by Akshit GUPTA

The bankruptcy of Lehman Brothers (2008)

This article written by Akshit GUPTA (ESSEC Business School, Master in Management, 2022) analyzes the bankruptcy of Lehman Brothers (2008).

Introduction

A financial crisis refers to a situation in which financial assets in an economy experience a steep decline in their value triggered mainly by investor panic and irrational behavior resulting in bank runs where investors are keen to unwind their positions. It generally begins with a stock market crash, currency crisis, or bursting of a financial bubble. The global economy has faced many such financial crises in the recorded past starting from the infamous Tulip Mania in 1637 to the most recent financial crisis of 2008.

The crisis of 2008 was not unusual, but it led to the extinction of some of the giants in the investment banking industry, including the 4^th largest investment bank of the USA, Lehman Brothers.

Screenshot 2020-05-19 at 1.07.46 AM

The Bankruptcy

Lehman Brothers, founded in 1847, was a global financial services firm dealing in a wide variety of financial businesses ranging from investment banking, investment management to equity and commodity trading. The firm was a victim of the great financial crisis of 2008, one of the most devastating crises, that swept away trillions of dollars from the US equity markets.

lehman brother

In the early 2000s, Mortgage-Backed Securities (MBS), a type of asset-based security, became a trending investment class with collateral debt obligations (CDO) gaining traction. In a CDO, different tranches of home loans were pooled in depending on their credit rating. As the instrument started gaining attraction of big investment banks, demand for mortgages started increasing leading to the issue of subprime category mortgages (mortgages with high default risk), which played a key role behind the crash. Easy lending standards and the issue of subprime home loans lured customers from all the segments of the economy, thereby driving up the housing prices, which peaked in 2006. With the boom in the market, Lehman acquired some big mortgage lenders in the market to issue loans at an increased pace. By 2007, the bank was generating huge profits to the tune of around $4.2 billion in net income and $19 billion in revenues.

Soon, the subprime mortgage borrowers, lacking payment capacity, started defaulting on their loans and the CDOs, which were based on these mortgages, started seeming overvalued. As loan defaults kept on rising, the instruments started losing value with banks facing difficulty in unloading their heavy positions in these assets. The bubble busted and the entire US economy came at the brink of collapsing. In the middle of all this, Lehman Brothers, who held a huge position in these assets faced a stiff liquidity crunch. The business model followed by the company involved high leverages and investments in very risky asset classes like subprime mortgages and real estate. Failing to undertake a firm restructuring or receive a government bailout, the bank filed for Chapter 11 bankruptcy protection on 15 September 2008 with around $619 billion in debts and $639 billion in assets, making it the largest bankruptcy in US history.

Soon after the declaration of bankruptcy, Barclays purchased the North American investment banking and capital market business of Lehman Brothers at a mere valuation of $250 million, giving them entry to the Wall Street.

The role of FED

The Central Bank of the USA raised interest rates in 2006, making it difficult for the homeowners to make their monthly payments. The increase resulted in a series of loan defaults, driving the market towards a crisis. Although the fall of Lehman Brothers was a by-product of their poor risk management, still the role of the FED, chaired by Ben Bernanke, in not bailing out such a giant financial institution is still questioned by many till date. Having provided bailouts to other banks such as AIG and Bear Stearns, the FED’s actions were called as highly discriminatory. Concrete efforts were made to sell the bank to other players like Korea Development Bank, Bank of America and Barclays, but nothing turned successful. The then-Secretary of the Treasury, Henry Paulson, a former CEO of Goldman Sachs, said it would be illegal to provide a bailout to the bank, stating insufficient collateral held by the bank as the primary reason for not extending the funds.

The role of Rating Agencies

Credit rating agencies play a pivotal role in shaping the financial markets around the globe. They impart credit risk ratings to various institutions and asset classes to reduce the information gap, based on which investment types are deciphered. These ratings are provided on the basis of various grounds ranging from background checks, risk reports, and performance evaluations. During the crisis of 2008, the role played by credit rating agencies is still criticized by many. Days before the fall of Lehman Brothers, big rating agencies like Standard & Poor’s and Moody’s maintained an A rating for most of the assets of the firm which later turned out to be toxic. The ratings made the assets into investment-grade opportunities and provided a false image of its true value. The CRAs were believed to have given biased ratings and had a serious conflict of interest.

After-effects of this event

The bankruptcy of Lehman Brothers triggered the financial crisis of 2008 as investors started losing trust in the financial institutions and started cashing in on their investments to preserve liquidity. The crisis brought a serious recession in the global markets and the unemployment rates reached 10.2% in the USA by the end of 2009. The Federal Reserve took immediate measures to combat the situation and flooded the market with liquidity, reduced interest rates, and bailout funds, to protect large financial institutions. The financial measures were followed by the enactment of the Dodd-Frank Act in 2010, placing heavy regulations on the risk exposure of large financial institutions, in anticipation of reducing the likelihood of such events in the future. The crash took away the life savings for many retail and small investors, thereby decreasing the cumulative consumer wealth. To safeguard the interest of investors and oversee the financial products offered to consumers, a new Consumer Financial Protection Bureau was also set up. Over the period, the crash has changed the dynamics of how people used to save or borrow globally.

Securitization Process of Credit Structured Products

Key Financial Terminologies

Mortgage-Backed Securities (MBS)- These are asset-based securities that are secured by a collection of mortgages. The mortgages held by commercial banks are sold to investors, which are mostly institutions, who combine them into MBS which can be further sold to individual investors. The MBS can be mainly divided into two types namely pass-through certificates and collateral debt obligations.
Collateral Debt Obligations (CDOs)- Mortgages belonging to different risk categories, also called tranches, are combined into bundles based on their credit ratings, time to maturity, and payment terms. These securities have quite complex structures, making it difficult to regulate them.

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About the author

Article written in October 2020 by Akshit GUPTA (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

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