Could the COVID-19 debt be wiped out?

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Could the COVID-19 debt be wiped out?

img_SimTrade_Photo1_Raphael_Roero_de_Cortanze

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

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

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

How does public debt work in Europe?

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

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

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

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

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

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

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

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

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

What could be the consequences of such a cancellation?

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

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

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

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

Key concepts

Eurozone

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

Eurosystem

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

Useful resources

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

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

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

What to do with Covid debt?

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

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

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

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

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

About the author

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

How has the 21st century revolutionized financing methods?

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How has the 21st century revolutionized financing methods?

img_SimTrade_Photo1_Raphael_Roero_de_Cortanze

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

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

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

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

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

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

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

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

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

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

Since the 1970s: the development of new financing methods

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

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

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

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

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

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

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

Key concepts

Overdraft

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

Deposit insurance scheme

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

Useful resources

John Hicks (1974) The Crisis in Keynesian Economics.

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

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

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

Henri Bourguinat (1992) Finance internationale.

About the author

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

Portfolio manager – Job description

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Portfolio manager – Job description

Akshit Gupta

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

Introduction

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

Types of portfolio managers

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

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

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

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

Buy-side portfolio managers

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

Sell-side portfolio managers

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

Duties of a portfolio manager

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

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

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

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

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

With whom does a portfolio manager work?

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

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

How much does a portfolio manager earn?

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

What training do you need to become a portfolio manager?

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

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

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

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

Relevance to the SimTrade course

The concepts about portfolio management 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.

Take SimTrade courses

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.

Take SimTrade courses

Related posts on the SimTrade blog

▶ Akshit GUPTA Trader – Job description

▶ Akshit GUPTA Financial Analyst – Job description

▶ Akshit GUPTA Economist – Job Description

▶ Akshit GUPTA Risk manager – Job description

About the author

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

Sales analyst – Job description

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Sales – Job description

Akshit Gupta

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

Introduction

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

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

Types of Sales Analyst

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

Product-specific sales analyst

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

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

Client-specific sales analyst

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

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

Duties of a Sales Analyst

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

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

Whom does a Sales Analyst work with?

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

How much does a Sales Analyst earn?

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

What training do you need to become a Sales Analyst?

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

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

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

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

Related posts on the SimTrade blog

▶ Akshit GUPTA Trader – Job description

▶ Akshit GUPTA Financial Analyst – Job description

▶ Akshit GUPTA Economist – Job Description

▶ Akshit GUPTA Risk manager – Job description

▶ Akshit GUPTA Analysis of the Wolf of the Wall Street movie

Useful Resources

Corporate finance institute What does a Sales analyst do?

Wallstreetprep Ultimate guide to sales and trading

Relevance to the SimTrade course

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

About theory

  • By taking the 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.

Take SimTrade courses

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.

Take SimTrade courses

About the author

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

Short selling

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Short selling

Akshit GUPTA

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

Introduction

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

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

This can be illustrated through an example:

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

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

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

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

Who short sells the most in the stock market?

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

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

Mechanism of Short Selling

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

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

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

Apple stock short sell

Related posts

   ▶ Akshit GUPTA Trader – Job description

   ▶ Akshit GUPTA Analysis of the Big Short movie

   ▶ Akshit GUPTA Analysis of the Margin call movie

   ▶ Akshit GUPTA Analysis of the Trading places movie

Useful resources

BusinessInsider article: What is short selling?

About the author

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

Share buy-back

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Share buyback

Akshit Gupta

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

Definition

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

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

Share buyback mechanism

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

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

Reasons for a share buyback program

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

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

Benefits of Stock buyback

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

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

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

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

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

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

Example of share buyback programs

Microsoft (2019)

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

Alphabet (2019)

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

Market reaction after the announcement of a stock buyback program

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

Useful resources

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

About the author

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

Asset management firms

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Asset management firms

Akshit GUPTA

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

Introduction

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

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

Benefits of an asset management firm

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

Types of products offered by asset management firms

Asset management firms offer many different products to their clients:

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

Types of roles provided by asset management firms

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

Services provided by asset management firms

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

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

Fee structure

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

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

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

Major asset managers in the world

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

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

Related posts

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▶ Akshit GUPTA Economist – Job Description

▶ Akshit GUPTA Sales analyst – Job description

▶ Akshit GUPTA Portfolio Manager – Job Description

Useful resources

The balance: what is asset management?

The balance: Top 10 asset management firms in 2020

About the author

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

Growth investment strategy

by

Growth Investment strategy

Akshit GUPTA

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

Introduction

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

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

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

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

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

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

Indicators to practice Growth investment strategy

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

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

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

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

Related posts ont eh SimTrade blog

   ▶ All posts about financial techniques

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Useful Resources

Corporate finance institute A guide to growth investing

About the author

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

Risk Manager – Job description

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Risk Manager – Job Description

Akshit Gupta

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

Introduction

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

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

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

Types of risk managers

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

Credit risk manager

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

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

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

Market risk manager

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

Operational risk manager

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

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

With whom does a risk manager work?

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

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

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

How much does a risk manager earn?

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

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

What training do you need to become a risk manager?

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

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

Useful resources

Efinancemanagement article: Introduction to financial risk

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Relevance to the SimTrade course

The concepts about risk management 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.

Take SimTrade courses

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.

Take SimTrade courses

About the author

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

The GameStop saga

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The GameStop saga

Alexandre VERLET

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

Speculation on GameStop

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

Figure 1. GameStop share price.
GameStop share price
Source: Source: Google Finance.

Short selling

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

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

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

Political issues and future challenge for regulators

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

GameStop – Power to the playersGameStop - Power to the playersSource: GameStop

Related posts on the SimTrade blog

   ▶ Shruti CHAND WallStreetBets

   ▶ Raphaël ROERO DE CORTANZE Gamestop: how a group of nostalgic nerds overturned a short-selling strategy

   ▶ Raphaël ROERO DE CORTANZE How do “animal spirits” shape the evolution of financial markets?

Useful resources

WallStreetBets

Robinhood

GameStop (GME) (Yahoo Finance)

About the author

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

Fixed-income products

by

Fixed-income products

Jayati WALIA

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

Introduction

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

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

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

Types of fixed-income products

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

Treasury bills

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

Treasury notes and bonds

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

Corporate bonds

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

Asset-backed securities

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

Benefits of fixed-income products

For issuers

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

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

For investors

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

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

Risks associated with fixed-income products

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

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

Useful resources

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

Blackrock Education: What is fixed income investing?

Corporate Fiannce Institute: Fixed-income securities

Related posts

About the author

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

What is an Institutional Investor?

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What is an Institutional Investor?

img_SimTrade_Photo1_Raphael_Roero_de_Cortanze

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

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

What is an Institutional Investor?

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

Institutional investors include:

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

Institutional investor VS Retail Investor

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

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

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

The impact of Institutional Investors

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

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

Key concepts

Bond

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

Credit Union

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

Mutual Funds

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

Options

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

Commodities

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

Forex

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

Futures contracts

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

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

About the author

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

What is an Activist Investor?

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What is an Activist Investor?

img_SimTrade_Photo1_Raphael_Roero_de_Cortanze

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

What is an Activist Investor?

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

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

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

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

Modus operandi

The typical modus operandi of activist investors is the following:

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

The Danone case

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

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

Activist investors: good or bad for shareholders?

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

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

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

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

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

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

Useful resources

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

Related posts

Film analysis – Other People’s Money

Film analysis – Wall Street: Money Never Sleeps

About the author

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

In the shoes of a Corporate M&A Analyst

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In the shoes of a Corporate M&A Analyst

img_SimTrade_Photo1_Raphael_Roero_de_Cortanze

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

My internship at Scor

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

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

SCOR Paris

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

What is a Corporate M&A Analyst?

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

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

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

What does a Corporate M&A Analyst do?

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

M&A tasks consist of:

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

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

How can you become a Corporate M&A Analyst?

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

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

Key concepts

Trading comparable

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

Precedent transaction

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

Discounted cash flow

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

Dividend discount model

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

Divesture

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

Property & Casualty insurance

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

Life & Health insurance

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

Reinsurer

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

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   ▶ Basma ISSADIK My experience as an M&A Analyst Intern at Oaklins Atlas Capital

   ▶ Louis DETALLE A quick presentation of the M&A field…

   ▶ Suyue MA Analysis of synergy-based theories for M&A

Useful resources

Sources: Investopedia, Wikipedia, Corporate Finance Institute, Scor

About the author

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

Covid-19 and its effect around hospital

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Covid-19 and its effect around hospital

Subhasish CHATTERJEE

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

Impact of the Covid-19 crisis on hospital operations

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

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

Before Covid-19

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

My experience during my internship

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

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

Figure 1. Covid-19’s impact on hospital systems’ finances
Covid- 19 Impact on hospital systems finance
Source: AMGA surveys.

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

Figure 2. Covid-19’s impact on independent medical group finances
Covid- 19 Impact on independent medical group finances
Source: AMGA surveys.

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

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

Key concepts

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

Ebitda

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

Some expenses of hospitals:

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

Some revenue of hospitals:

  • Patient service revenue
  • Research revenue
  • Academic revenue

Profit before and after tax

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

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

Related posts on the SimTrade blog

   ▶ All posts about Professional experiences

About the author

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

Veolia and Suez: the epitome of a hostile takeover bid

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Veolia and Suez: the epitome of a hostile takeover bid

Raphaël ROERO DE CORTANZE

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

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

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

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

August 2020: the beginning of hostilities

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

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

September 2020: Engie accepts Veolia’s offer

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

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

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

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

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

Have the negotiations reached a dead-end?

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

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

Key concepts

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

Defense strategy

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

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

Public takeover bid

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

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

Useful resources

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

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   ▶ Akshit GUPTA Regulations in financial markets

About the author

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

My experience as a sell-side equity research analyst

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My experience as a sell-side equity research analyst

Tanmay DAGA

In this article, Tanmay DAGA (ESSEC Business School, Global Bachelor of Business Administration, 2017-2021) introduces equity research, shares his internship experience at a top sell-side equity research company named Kotak Securities and gives his opinions on what the future holds for the industry.

About Kotak Securities

Kotak Securities was founded in 1994 as a subsidiary of Kotak Mahindra Bank and is headquartered in Mumbai, India. It is headed by Mr. Jaideep Hansraj who is a leading figure and has over 20 years of experience in the equity research industry. The company has over 1.7 million customer accounts and handles over 800,000 trades every single day making it one of the biggest brokerage houses in the country. The company handles operations in over 394 cities in India and is well poised for further expansion helping it expand its customer base. Kotak Securities offers stock broker services, portfolio management services, depository services, research expertise, dynamic market data and international reach for clients looking for investment opportunities overseas.

Kotak Securities

What is equity research?

It is a mainstream finance position which entails fundamental analysis and subsequent recommendation of public securities. Fundamental analysis is a method of evaluating the intrinsic value of an asset (future cash flows discounted to the present) and analyzing the factors that could influence its price in the future. Hence, equity research is an investigation based upon the core business drivers of a particular business which are reflected in its financial statements. Hence, equity researchers use financial statements combined with other industry and macroeconomic reports to form their opinion about a certain company or a universe of companies (also called coverage list). Investors such as money/managers use this information to better investigate their potential or existing investment decisions. To conclude, the main purpose of equity research is to provide investors with detailed financial analysis and recommendations on whether to buy, hold, or sell a particular stock. The professionals working in brokerage firms which sell analysis reports to investors are called sell-side analysts. Professionals working for mutual funds or hedge funds and who make direct investment decisions are called buy-side analysts.

Read an interesting interview with an industry expert who shares his experience of working in the industry.

Me and Finance

I had gotten enrolled in ESSEC’s GBBA in 2017 owing to my curiosity in finance and the university’s premier status, especially in finance. At the end of the first year, I had the opportunity to apply my mind and practically learn a few things along with it. It had always been my mission to work in finance, particularly in valuation. My fascination with valuation is simple – you are allowed to deem the situation as you see fit provided you have a logical reasoning behind it. Nothing can narrow the scope of your thoughts as long as they are realistic and reasonable. It is a great way for individuals to look at things from a broader perspective and develop an analytical mindset to help comprehend several moving parts simultaneously. It does take time getting used to the idea of having to dig into minute details but it’s worth it! Valuation is not purely science per se. It is a blend between sound analytical reasoning that helps you come up with a story (forecast as experts call it) and simple objective mathematics to help validate your story’s credibility. The fact that valuation today in investment banking and other fields looks so complicated is partly to mask the simplicity involved in the process so big banks can continue to charge hefty fees for what they do. Moreover, it is not a skill that will ever go in vain. The mindset a sound valuer develops helps him/her analyze the pros and cons any situation better than a counterpart. It is a skill that I recommend everyone to acquire.

My internship in Kotak Securities

In 2018, at the end of my first year of my GBBA at ESSEC Business School, I did an internship at Kotak Securities equity research division in Mumbai, India. I was 18 years old and comparatively new to equity research. Resulting, I witnessed a steep learning curve requiring me to learn and apply several concepts in a short span of time. My main responsibility was to help the fundamental research team carry out due diligence (financial analysis to analyse the true or intrinsic value of an asset and all other factors affecting this value) for the companies under our coverage universe. This was done by performing rigorous research for the company’s business, its supply chain, its value drivers and all other factors that affect its value and ultimately its stock price. The conclusions were to be presented to the senior management and the sales team along with a thorough explanation behind the rationale of selecting a particular stock for client recommendation. Based on the findings, recommendations were to be published in a bi-monthly analysis report which also included other important topics like the economic analysis of the current situation and trends in the currencies traded in foreign exchange (FX) market. As the organization was agile and flexible with what responsibilities members could take, I had the opportunity of working with several other departments aside from fundamental research. Some of the other projects I worked on were developing a proprietary algorithm based on analysis of trading patterns for index companies alongside the technical analysis team (which is the motivation for me in selecting the SimTrade course) and a model project on sentiment analysis – how news and company perception (especially on Twitter) affect the stock price in the short run. I learnt several hard skills such as modelling in Excel, literacy in reading company’s financial statements and intermediate level of coding in Python. Overall, it was a great work experience for me.

Key takeaways from my internship

During my time at Kotak, I have come across some important financial concepts that I believe every individual, irrespective of their affiliation with the finance industry, must truly understand. They will help you better understand financial issues and make sound investment decisions.

Inflation

Inflation refers to the sustained increase in the price of goods and services in an economy. This increase in price is hard to pinpoint at any one factor but more often than not, it is a combination of various factors. This could range from increase in labor prices to jump in raw material costs. As prices rise due to inflation, you’ll be able to afford less and less over a given period of time. That’s why it is imperative to understand that long-term savings must be invested in a manner by which the returns surpass the inflation rate. That’s the only way one can continue to afford to buy more in a definite time period in the future. In many countries, the only reliable way to beat inflation is investing in stocks/equities. As Bonds or Bank savings do not offer any positive real interest realization.

Diversification

Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. A diversified portfolio contains a mix of distinct asset types and investment vehicles in an attempt at limiting exposure to any single asset or risk. The rationale behind this technique is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security. This is a widely approved method for protecting capital against unexpected events in the global markets. By using the primary study of correlation, investors can diversify certain risk away. However, data on correlation is historical and thus, backwards looking, and might not always hold true in the future. For instance, during the shutdown of the global economy in March 2020, multiple assets like stocks, commodities and bitcoin (which have not been positively correlated in the past) collapsed together. All have had a positive recovery together since (again implying positive correlation as opposed to results from previous studies).

Time Value of Money

The time value of money (TVM) is the concept that money you have now is worth more than the identical sum in the future due to its potential earning capacity. This core principle of finance holds that provided money can earn interest, any amount of money is worth more the sooner it is received. For instance, assume a sum of $10,000 is invested for one year at 10% interest. The future value (FV) of that money is: FV = $10,000 x (1 + 10%) = $11,000. The formula can also be rearranged (reversed) to find the value of the future sum in present day dollars. For example, the present value (PV) of $5,000 one year from today, compounded at 7% interest, is: PV = $5,000 / (1 + 7% ) = $4,673.

TVM is also sometimes referred to as present discounted value. This is a fundamental pillar on which company valuation is based. The true value of a company is the future free cash flows the company generates, discounted to the present time using an appropriate discount factor.

Future of equity research: my personal view

Equity research is an important role that has come into prominence since the bull market in the 1950s. Thousands of fund managers handling trillions of dollars in assets under management often use sell-side research to get an outsider’s opinion before making investment decisions. Certainly, the size of the industry has shrunk significantly since buy-side and IB analysts are being better compensated, causing a shift in the workforce. However, things are not bad. Companies are now letting analysts focus more on analysis than on sales. This is certainly going to attract new talents who want to focus purely on analysis.

Read this interesting counter-view on the future of the industry.

Relevance to SimTrade

This course helps in understanding the other side of the same coin – technical analysis (using price movements and other factors to predict the future of a security). Participants of this course can expect to gain practical knowledge about stock trading by using a real-world like simulator where multiple strategies can be applied and tested. Other benefits include gaining a broad understanding of the financial markets and concepts.

Related posts on the SimTrade blog

   ▶ All posts about Professional experiences

   ▶ Louis DETALLE My experience as a Transaction Services intern at EY

   ▶ Aastha DAS My experience as an investment banking analyst at G2 Capital Advisors

   ▶ Basma ISSADIK My experience as an M&A/TS intern at Deloitte

Useful resources

Kotak Securities

Corporate Finance Institute Example of equity research report

About the author

The article was written by Tanmay DAGA (ESSEC Business School, Global Bachelor of Business Administration, 2017-2021).

Introduction to bonds

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Introduction to bonds

Rodolphe Chollat-Namy

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

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

What is a bond?

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

What are the main characteristics of a bond?

A bond has several characteristics:

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

Example

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

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

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

What are the different types of bonds?

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

Types of issuers

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

Government bonds

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

Municipal bonds (“munis”)

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

Corporate bonds

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

Technical characteristics

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

Fixed-rate bonds

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

Floating-rate notes

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

Zero-coupon bonds

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

Convertible bonds

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

Useful resources

Rating agencies

S&P

Moody’s

Fitch Rating

Related posts

   ▶ Rodolphe CHOLLAT-NAMY Bond valuation

   ▶ Rodolphe CHOLLAT-NAMY Bond risks

   ▶ Rodolphe CHOLLAT-NAMY Bond markets

   ▶ Bijal GANDHI Credit Rating

   ▶ Jayati WALIA Credit risk

About the author

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

Leading and Lagging Indicators

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Leading and lagging indicators

Bijal GANDHI

In this article, Bijal GANDHI (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) elaborates on the concept of leading and lagging indicators. This reading will help you understand in detail the meaning of the leading and lagging indicators.

Leading indicators

Indicators that precede economic events and help predict the direction of an economy are termed as “leading indicators”. These indicators prove to be critical when the economy is heading from one stage to another in the business cycle. A single indicator may or may not be accurate to forecast the health of the economy. Therefore, these indicators are analyzed in conjunction through a composite index to predict the trend. In this post we deal with the U.S. case.

Composite index of leading indicators

The Composite Index of Leading Indicators is published monthly by The Conference Board to help market participants (traders, investors, financial analysts, central bankers, etc.) gauge the overall direction of the economy in the near-term future. It is a comprehensive index calculated with leading indicators based on their impact on the economy. This index is also known as the Leading Economic Index (LEI) in the U.S., and it comprises ten components detailed below.

The following is a snapshot of the LEI and the CEI for the United States. CEI refers to the coincident economic index which is based on the coincident indicators. Economic indicators that describe the current state of the economy within a particular segment (such as the job market or the market for goods and services), are termed “coincident indicators”. Coincident indicators move simultaneously along the changes in business cycles of the economy. Here we can see that the LEI increased for the month of February. The CEI also increased, following the LEI.

Bijal Gandhi
Source: The Conference Board.

Yield curve

Daily yields compare the return on short-term investment instruments like Treasury bills to long-term instruments like Treasury bonds. Generally, in the yield curve, the yields over the short term are lower than those over the long-term. When the yield curve inverts, it is a signal that the investors are expecting uncertainty over the long term. This may also be an indicator of a downturn in the economy or a recession.

Source: worldgovernmentbonds

Credit spreads

Credit Spread refers to the difference in yield between a risk-free instrument and a corporate bond over the same maturity. Credit spreads fluctuations are caused due to changes in other economic indicators like inflation, liquidity, etc. A widening credit spread would reflect investor concern and vice versa.

Stock market

The stock market is a leading indicator as stock prices are highly dependent on the future growth and expected earnings of companies. Investors may sell their stocks if they are not confident about the future of the company. The S&P 500 stock index for the U.S. is a close estimation of the total value of the business sector and therefore it is used to comprise the LEI.


Source: TradingView.

Durable goods orders

Durable Goods Manufactures’ report refers to the total capital goods purchased by companies. An increase in the volume of purchases is an indication that companies are confident about the future. It is classified under the leading indicator as business orders change much before an actual change in the business cycle.

Manufacturing jobs

The manufacturing jobs survey is also classified as a leading indicator as to the demand for labor shifts much before an actual change in the business cycle. If the demand for goods is anticipated to increase the supervisors may ask for a greater labor supply indicating a positive sign for the economy. A change in demand for labor will also impact other dependent sectors like transportation and retail.

Building permits

Building permit numbers are published monthly by the U.S. census which tells us in advance about the expected spending on construction-related projects. We all know the importance of the real estate sector on the economy from the subprime mortgage crisis in 2008.

Unemployment claims

The weekly claims for unemployment insurance help the government calculate the total layoffs and publish a report. This report is an indication of the changes in unemployment levels, business activities, and their impact on consumer income.

Manufacturing new orders

The Manufacturing New Orders Index published by the Institute of Supply Management (ISM) is calculated from the survey of purchasing manufacturers of hundreds of manufacturing firms. It indicates the change (increase or decrease) of orders of manufactured goods.

Consumer expectations

Consumer expectations is a survey conducted to gain insights from the end-users themselves. The surveyors ask the consumers about their opinions regarding jobs, income, and overall business conditions. They try to gauge the consumer sentiment for the next 6 to 12 months.

Leading Credit Index

This component is derived from six other financial indicators. All these financial indicators are forward looking such as 2 years swap spreads, security repurchases, investor’s sentiments, etc.

Lagging indicators

Lagging indicators are those economic indicators that lag the economic performance of a geographic region. Therefore, these indicators are not useful to predict the future health of the economy but to assess and confirm a pattern after a large movement in an underlying economic variable of interest like the unemployment rate. Since these indicators trail the shifts in the underlying variable, they are useful to analyze long-term trends in the economy. They are further categorized into economic, technical, and business indicators as per their use.

Composite index of lagging indicators

As discussed in the blog Economic Indicators, the Composite Index of Lagging Indicators is published monthly by the Conference Board. This Index includes the following seven components which help assess and confirm the economic situation of the U.S.

Average duration of unemployment

The Bureau of Labor Statistics computes the average number of weeks an individual has been unemployed. During a recession, long-term unemployment rises and vice versa.

Ratio, manufacturing, and trade inventories to sales

The Bureau of economic analysis computes the ratio of inventories to sales to understand the business conditions of both the individual firm and the industry. The inventory and sales data related to the manufacturing, wholesale, and retail is provided by the Bureau of the Census. When sales targets are not reached due to a weak economy, the inventories tend to shoot up and the ratio reaches its cyclical peak in the middle of a recession.

Change in labor cost per unit of output, manufacturing

The Conference Board computes the rate at which the labor costs per unit rise with respect to the cost of production per unit. During a weakening state of the economy, the production declines at a much higher rate than the labor costs even with layoffs of the laborers. This series is calculated over six months as monthly data can tend to be inconsistent.

Average prime rate charged by banks

The prime rate is the benchmark rate which banks use to estimate their interest rates for various types of loans. The change in this rate usually tends to lag the general economic performance. During periods of a strengthening economy, banks tend to resist reducing the interest rates, while during times of a weak economy, banks tend to resist increasing the interest rates.

Commercial and industrial loans outstanding

The total volume of outstanding business loans held by both banks and non-financial companies is computed by The Conference Board from the data compiled by the Board of Governors of the Federal Reserve System. When the revenues or profits decline in a business due to the weakening of the economy, banks start to take out more loans to cover their costs. Similarly, an improvement in the economy will result in liquidity and the demand for short-term credit may fall if the deflation sets in.

Ratio, consumer installment credit outstanding to personal income

This is the ratio of consumer debt to personal income. This ratio is a measurement of the indebtedness relative to income. This ratio tends to increase during times of expansion when the consumers are confident enough to pay off their debts in the future. Similarly, they tend to hold off borrowing even until after the months of recession due to skepticism and uncertainty.

Change in Consumer Price Index for services

The Bureau of Labor Statistics computes the rate of change in the services component of the Consumer Price Index (CPI). This is a lagging indicator as the services sector may raise prices well in advance in anticipation of a recession. The rise in prices may be due to market rigidities and recognition lag. Even with the recovery, firms in the services sector may keep cutting the prices. This is because they might not recognize when the recession is over.

Related posts on the SimTrade blog

   ▶ Bijal GANDHI Economic indicators

   ▶ Bijal GANDHI Gross Domestic Product (GDP)

Useful resources

US Department of Treasury

United States Census Bureau

Labor Statistics

About the author

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

Economist – Job description

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Economist – Job Description

Akshit Gupta

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

Introduction

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

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

Duties of an economist

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

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

Whom does an economist work with?

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

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

How much does an economist earn?

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

What training do you need to become an economist?

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

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

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

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

Example of an economist’s report – BNP Paribas

BNP Paribas – Economic Research Report

Related posts on the SimTrade blog

   ▶ Akshit GUPTA Remuneration in the finance industry

   ▶ Akshit GUPTA Trader: Job Description

   ▶ Akshit GUPTA Financial Analyst: Job Description

Useful Resources

All About Careers

Relevance to the SimTrade certificate

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

About theory

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

Take SimTrade courses

About practice

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

Take SimTrade courses

About the author

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