http://www.gurufocus.com/news/159099/interview--jpmorgan-ceo-jamie-dimon-on-regulation-volcker-rule-some-of-the-global-regulations-are-unamerican
When Obama first became president, he always asked Dimon for advice. Eventually, Dimon made more and more criticism against Obama's economic policies, and Obama stopped calling him for help. What were they that Dimon didn't agree on?
The biggest disagreement comes from Volcker Rule. The article referenced above records an interview with Jamie Dimon in January, 2012.
1. He says that while he agrees with no prop trading rule, although that was not even the biggest reason for the financial crisis.
- Why not? Weren't banks taking more and more risks with subprime mortgages with it?)
2. He thinks that Basel III requirements are too harsh for American banks, because 1) American banks to add more equity cushions to their balance sheet, and 2) no foreign banks will follow it because they are too strict.
- That may be true for European banks, Fed published an article this month about how Asian banks are well-capitalized because their governments made all these strict requirements similar to Basel III. http://www.frbsf.org/banking/asia-program/pacific-exchange-blog/why-asian-banks-are-well-positioned-for-basel-iii/
What I want to research on is, what are the major products banks can sell if capital requirement eases up?
Monday, December 5, 2016
Saturday, November 12, 2016
RSU vs RSA
One thing I struggled to understand during the internship is how to calculate Fully Diluted Shares Outstanding. Treasury Stock Method and If-Converted Method all made sense to me, but for some reason it didn't seem to make sense why we don't include RSA.
To begin with, once RSU becomes vested, the owner has to pay tax for it, whether the owner exercises or not. Typically, the owner has an option to eventually receive the number of corresponding shares - number of shares equivalent to the amount of tax payable, or to simply pay the tax in cash. The tax here is income tax for the total amount of value, not the long-term capital gain (which applies to stock options).
If RSU is not vested, it should be treated using TSM. However, there are three kinds of RSU:
1. time-based: RSU becomes vested according to the predetermined timeline
2. time-accelerated: time based, but if certain metrics are met, it will become vested
3. service-based: based on stock price, EPS, etc.
None of these methods give an exercise price. Therefore, when adding RSU, you use an exercise price of $0. Or, this is equivalent to not using TSM at all but just adding the number of RSU's unvested instead.
RSA, however, is slightly different because the stocks have already been issued, and they are already part of the basic shares outstanding. Unvested RSA just means that while stocks have already been issued, they just can't be sold to anyone. Also, both vested and unvested are entitled to dividends. So when the company discloses the amount of unvested RSA, there is no need to apply TSM because it's already included in BSO.
Another major difference between RSA and RSU is the timing of tax. RSU is always taxed at the time of vesting. However, RSA has an option to be taxed at the time of grant, should the owner choose to elect section 83b. Because of this, there is no way to find whether unvested RSA already paid for its income tax or not (I think).
To begin with, once RSU becomes vested, the owner has to pay tax for it, whether the owner exercises or not. Typically, the owner has an option to eventually receive the number of corresponding shares - number of shares equivalent to the amount of tax payable, or to simply pay the tax in cash. The tax here is income tax for the total amount of value, not the long-term capital gain (which applies to stock options).
If RSU is not vested, it should be treated using TSM. However, there are three kinds of RSU:
1. time-based: RSU becomes vested according to the predetermined timeline
2. time-accelerated: time based, but if certain metrics are met, it will become vested
3. service-based: based on stock price, EPS, etc.
None of these methods give an exercise price. Therefore, when adding RSU, you use an exercise price of $0. Or, this is equivalent to not using TSM at all but just adding the number of RSU's unvested instead.
RSA, however, is slightly different because the stocks have already been issued, and they are already part of the basic shares outstanding. Unvested RSA just means that while stocks have already been issued, they just can't be sold to anyone. Also, both vested and unvested are entitled to dividends. So when the company discloses the amount of unvested RSA, there is no need to apply TSM because it's already included in BSO.
Another major difference between RSA and RSU is the timing of tax. RSU is always taxed at the time of vesting. However, RSA has an option to be taxed at the time of grant, should the owner choose to elect section 83b. Because of this, there is no way to find whether unvested RSA already paid for its income tax or not (I think).
Friday, November 4, 2016
CMA, MMF, MMDA
One of the biggest M&A in Korean financial services industries is about to close: Mirae Asset and Daewoo. The combined company will have shareholder's equity of $7b. Some of the hurdles would have to be overcome in order for this deal to be accretive, such as some of the biggest shareholders exercising appraisal rights, which could increase the deal size by $400m or more.
Not knowing much about the market, I looked into Daewoo Securities. It turns out that their CMA is considered one of the most underrated product. What is CMA? For customers, it's just like any other checking account. For a typical checking account, a bank uses the deposit to make loans and pocket the spread. However, with CMA accounts, the deposits are used to invest in safest investment products, like money market fund.
Because you are making investments with the deposits, banks are not allowed to make CMA accounts, which is why you can find CMA accounts only from security-trading firms. It was first started by Merrill Lynch in 70's as an effort to increase their AUM and attract more clients by offering low-risk, low-return products. Because it invests in some of the highest-quality securities, it's nearly impossible to lose money. For security firms, they lock in interest rate paid to the depositors (or "cost of deposit") and then pocket the rest. That cost of deposit is still higher than a regular checking or savings account.
CMA is typically FDIC-insured, but there are two other alternatives: Money Market Mutual Fund (MMF) and Money Market Deposit Account (MMDA). MMF is like a mutual fund that only invests in short-term fixed-income investments. It can make higher or lower returns as it carries more risk, but it also carries expenses and is not FDIC-insured. MMDA, however, is FDIC-insured and allows you to withdraw and deposit money at the same time. It is even safer than CMA, but it has lower rates it invests ONLY in money market.
Not knowing much about the market, I looked into Daewoo Securities. It turns out that their CMA is considered one of the most underrated product. What is CMA? For customers, it's just like any other checking account. For a typical checking account, a bank uses the deposit to make loans and pocket the spread. However, with CMA accounts, the deposits are used to invest in safest investment products, like money market fund.
Because you are making investments with the deposits, banks are not allowed to make CMA accounts, which is why you can find CMA accounts only from security-trading firms. It was first started by Merrill Lynch in 70's as an effort to increase their AUM and attract more clients by offering low-risk, low-return products. Because it invests in some of the highest-quality securities, it's nearly impossible to lose money. For security firms, they lock in interest rate paid to the depositors (or "cost of deposit") and then pocket the rest. That cost of deposit is still higher than a regular checking or savings account.
CMA is typically FDIC-insured, but there are two other alternatives: Money Market Mutual Fund (MMF) and Money Market Deposit Account (MMDA). MMF is like a mutual fund that only invests in short-term fixed-income investments. It can make higher or lower returns as it carries more risk, but it also carries expenses and is not FDIC-insured. MMDA, however, is FDIC-insured and allows you to withdraw and deposit money at the same time. It is even safer than CMA, but it has lower rates it invests ONLY in money market.
source:
http://www.wealthmanagement.com/practice-management/cma-promise
https://www.depositaccounts.com/blog/understanding-the-differences-between-a-money-market-deposit-account-and-a-money-market-mutual-fund.html
http://economystory.tistory.com/71 (it's in korean)
Monday, October 3, 2016
Why are banks purchasing more government bonds?
On October 14, money market funds and other institutions will face a tougher regulation on their capital requirement. In anticipating the change, institutions are putting their excess cash into Repo Markets, or Reverse Repo Markets to be more precise, to increase their equity buffer.
To illustrate this point, let's look at Common Equity Tier 1 (CET1) capital ratio. The current Basel-III states that institutions are required to hold CET1 of 4.5% + 2.5% additional buffer. It means that at least 7% of their Risk-Weighted Assets (RWA) must be CET1-qualifiable equity. In order to increase this rate, there are basically two ways to achieve it: increase CET1-qulifiable equity or lower RWA. What is qualifiable for CET1 is less important here, so I'll jump straight to the next point.
How do we lower RWA? First, you have to look at how RWA is calculated. The fundamental definition of RWA is that it re-values the book value of assets based on their riskiness. For example, if a company has assets of $100 with $50 cash and $50 investment securities, RWA is $50, assuming that cash has 0% riskiness and investment securities 100%. Now, whenever institutions have excess cash, they typically make loans to finance securities dealers as well as their hedge fund clients and other leveraged investors. These loans are risky and therefore added to RWA. If RWA increases, CET1 ratio decreases, and that's bad for institutions.
So instead of making these more-profitable-but-riskier loans, institutions are purchasing more government bonds, which have 0% risk weight. This allows institutions reduce, or not to be forced to increase, RWA. Maintaining a higher level of CET1 is important for institutions right now because they are uncertain of what the new regulation is going to be. Whether the new rules are going to be much stricter or not, they want to lessen the impact.
So how are the institutions purchasing government bonds? Right now they are purchasing through Reverse Repo Markets (or RRP). Through this program, institutions deposit money into central banks in exchange for government bonds. They are required to sell back these bonds to central banks, while collecting a nominal interest rate of 0.25% on the deposits. This arrangement can last up to 65 days, though it is rare to go over 14 days.
Source:
WSJ article "Fed 'Repo' Program Swells"on 10/3/2016
NY Fed article "Repurchase and Reverse Repurchase Transactions": https://www.newyorkfed.org/aboutthefed/fedpoint/fed04.html
To illustrate this point, let's look at Common Equity Tier 1 (CET1) capital ratio. The current Basel-III states that institutions are required to hold CET1 of 4.5% + 2.5% additional buffer. It means that at least 7% of their Risk-Weighted Assets (RWA) must be CET1-qualifiable equity. In order to increase this rate, there are basically two ways to achieve it: increase CET1-qulifiable equity or lower RWA. What is qualifiable for CET1 is less important here, so I'll jump straight to the next point.
How do we lower RWA? First, you have to look at how RWA is calculated. The fundamental definition of RWA is that it re-values the book value of assets based on their riskiness. For example, if a company has assets of $100 with $50 cash and $50 investment securities, RWA is $50, assuming that cash has 0% riskiness and investment securities 100%. Now, whenever institutions have excess cash, they typically make loans to finance securities dealers as well as their hedge fund clients and other leveraged investors. These loans are risky and therefore added to RWA. If RWA increases, CET1 ratio decreases, and that's bad for institutions.
So instead of making these more-profitable-but-riskier loans, institutions are purchasing more government bonds, which have 0% risk weight. This allows institutions reduce, or not to be forced to increase, RWA. Maintaining a higher level of CET1 is important for institutions right now because they are uncertain of what the new regulation is going to be. Whether the new rules are going to be much stricter or not, they want to lessen the impact.
So how are the institutions purchasing government bonds? Right now they are purchasing through Reverse Repo Markets (or RRP). Through this program, institutions deposit money into central banks in exchange for government bonds. They are required to sell back these bonds to central banks, while collecting a nominal interest rate of 0.25% on the deposits. This arrangement can last up to 65 days, though it is rare to go over 14 days.
Source:
WSJ article "Fed 'Repo' Program Swells"on 10/3/2016
NY Fed article "Repurchase and Reverse Repurchase Transactions": https://www.newyorkfed.org/aboutthefed/fedpoint/fed04.html
Monday, September 19, 2016
Alternatives to CAPM
At one superday I attended, I was asked this question:
"If we can't calculate CAPM, how can we calculate cost of equity?"
Though it has been almost a year, it lingered on my mind and kept asking myself if I answered it correctly.
So, what are the alternatives to CAPM? The book called Valuation by Mckinsey shows a couple different methods. But in order to understand these methods, you first have to understand that CAPM is really a one-variable prediction model. It basically looks like
y= a+ bx
where
y = cost of equity
a = risk-free rate
b = beta
x = market risk premium
By market risk premium, what we really mean is the historical market excess return with regards to the risk-free rate, which usually is 10-year US Treasury yield.
What this model tells us is that by plugging in the historical excess return, we can estimate cost of equity. Flip it around, it means that cost of equity can be predicted by the historical excess return of the equity market (It's excess because it's calculated as market return - risk-free rate).
What other model points out is that historical return alone can't be the only contributor (or variable) to predicting cost of equity. The question, then, becomes: what other variables are there?
First, you have Fama-French model. It basically takes account into a company size (smaller ones outperform bigger ones) and a P/BV ratio (lower ratios outperform high ratios.)
How do you calculate the variables and coefficients? I decided not to spend too much time on this because 1) you can get these numbers from professional data providers, and 2) it's still not considered a perfect model.
Second, you have Arbitrage Pricing Theory. All that it means is that you basically add all possible variables that affects cost of equity. It's perfect in theory, but the practical issue is 'how do you determine all those variables and how do you measure them?'
Now, I think there can be another way to calculate cost of equity, but it would work best for banks. The bottom line is that you take the average of ROE for the industry. The underlying assumption is same as Dividend Discount Model, where the company pays out all excess earnings as dividends.
"If we can't calculate CAPM, how can we calculate cost of equity?"
Though it has been almost a year, it lingered on my mind and kept asking myself if I answered it correctly.
So, what are the alternatives to CAPM? The book called Valuation by Mckinsey shows a couple different methods. But in order to understand these methods, you first have to understand that CAPM is really a one-variable prediction model. It basically looks like
y= a+ bx
where
y = cost of equity
a = risk-free rate
b = beta
x = market risk premium
By market risk premium, what we really mean is the historical market excess return with regards to the risk-free rate, which usually is 10-year US Treasury yield.
What this model tells us is that by plugging in the historical excess return, we can estimate cost of equity. Flip it around, it means that cost of equity can be predicted by the historical excess return of the equity market (It's excess because it's calculated as market return - risk-free rate).
What other model points out is that historical return alone can't be the only contributor (or variable) to predicting cost of equity. The question, then, becomes: what other variables are there?
First, you have Fama-French model. It basically takes account into a company size (smaller ones outperform bigger ones) and a P/BV ratio (lower ratios outperform high ratios.)
How do you calculate the variables and coefficients? I decided not to spend too much time on this because 1) you can get these numbers from professional data providers, and 2) it's still not considered a perfect model.
Second, you have Arbitrage Pricing Theory. All that it means is that you basically add all possible variables that affects cost of equity. It's perfect in theory, but the practical issue is 'how do you determine all those variables and how do you measure them?'
Now, I think there can be another way to calculate cost of equity, but it would work best for banks. The bottom line is that you take the average of ROE for the industry. The underlying assumption is same as Dividend Discount Model, where the company pays out all excess earnings as dividends.
Saturday, September 17, 2016
Money Market
One thing that had never been clear to me was how Fed's control over the interest rate actually works. I have always wondered which interest rate they were talking about, and how they actually execute a change in the interest rate.
First of all, "interest rate" here refers to Fed Funds Market interest rate. It is basically an interbank interest rate within Fed, where financial institutions are required to deposit a reserve. It is similar to LIBOR, but the major difference is that Fed Funds Rate is targeted by a government entity Fed (specifically Federal Open Market Committee), whereas LIBOR is determined by the free market of supply-demand.
Why is this rate important? To begin with, there are several ways a bank can borrow money from the government; fed funds market and treasury bills, which account for "government loans to banks" with the duration of less than one year. While this treasury bills are sold through an auction (some through non-competitive bids, but mostly competitive bids), their demand and its corresponding yield will be influenced, or determined, by fed funds rate. Subsequently, as the treasury bills rate changes, the yield for treasury notes and bonds changes accordingly, based on the yield curve.
How is this yield curve determined? I remember learning this in an Econ class, but I have to revisit and fully understand the mechanics of it. One thing to note is that this would probably have an indirect impact on a bank's own yield curve model, and therefore Net Interest Margin and earnings.
First of all, "interest rate" here refers to Fed Funds Market interest rate. It is basically an interbank interest rate within Fed, where financial institutions are required to deposit a reserve. It is similar to LIBOR, but the major difference is that Fed Funds Rate is targeted by a government entity Fed (specifically Federal Open Market Committee), whereas LIBOR is determined by the free market of supply-demand.
Why is this rate important? To begin with, there are several ways a bank can borrow money from the government; fed funds market and treasury bills, which account for "government loans to banks" with the duration of less than one year. While this treasury bills are sold through an auction (some through non-competitive bids, but mostly competitive bids), their demand and its corresponding yield will be influenced, or determined, by fed funds rate. Subsequently, as the treasury bills rate changes, the yield for treasury notes and bonds changes accordingly, based on the yield curve.
How is this yield curve determined? I remember learning this in an Econ class, but I have to revisit and fully understand the mechanics of it. One thing to note is that this would probably have an indirect impact on a bank's own yield curve model, and therefore Net Interest Margin and earnings.
Subscribe to:
Comments (Atom)