WHAT HAPPENED ON WALL STREET?

By, Adhvith Dhuddu

Shock and awe ravaged through the minds of millions from Wall Street to the Great Wall this week as tremors in the financial sector bought down industry giants Lehman, Merrill and AIG. An unfortunate convergence of ugly factors contributed to this saddening collapse leaving thousands jobless and millions a bit poorer. These are undoubtedly historic times with no precedent leaving many jittery about the future, which is why an elemental breakdown of the major factors that contributed to this crisis is vital.

The leverage factor: Investment Banks (IB's) over extended themselves with this luxury that many financial institutions used conservatively. The Bear Stearns collapse exposed the super leveraged nature of IB's where they could borrow $30-$35 for every $1 of collateral (1:35 leverage). This is primarily what IB's were armed with to maximize profitability and dampen the losses. Fearful of similar consequences Lehman frantically deleveraged their highly leveraged balance sheet by selling assets and raising capital impacting their profitability. It's important to remember that the new capital raised to decrease leverage could have been used as collateral for more capital which Lehman could have used to generate revenue.

Recapitalization and mark to market accounting: In addition to raising capital to deleverage balance sheets, Lehman and Merrill had to continue their daily activities which require large amounts of capital. Complex financial trades performed by IBs require them to put up and receive massive amounts of money (tens of billions) on a day to day basis, making them heavily cash dependent.

Because mark to market accounting forces investment banks to value assets at market prices rather than perceived or book value, it exacerbates the pain by damaging the balance sheet. These accounting practices are being heavily criticized and blamed for the crisis because they cloud the real values of assets, the balance sheets of these institutions and hence the value of these companies. This massive and unending need for cash to recapitalize and deleverage coupled with the high cost for credit literally strained these institutions to the last penny.

Access to Fed funds: Unlike commercial banks, IB's don't have direct access to federal funds. Their primary sources of capital are commercial banks for short and long term lending and cash infusions from customers, hedge funds and private equity firms. This again handicapped many IB's as the cost of borrowing surged, credit markets froze and their credit rating was slashed. For this specific reason, the existence of IB’s with the independent broker-dealer model is being questioned.

Failure of counterparty surveillance and "Self Regulation": Regulating IB's and hedge funds are complicated. The quantitative and mathematical nature of their operations require them to trade equities, bonds, debt, forex, futures and options in massive quantities at lightning speed. The positions on their balance sheet change literally everyday making the risky and highly leveraged nature of their positions tricky for regulation. Although the Federal Reserve knew of the threats posed by this due to their closely intertwined nature to the financial system, they never saw the need to regulate because of the high level of counterparty surveillance and, "self regulation" at IB's and hedge funds. Laissez-faire economists often hailed this development of, "self regulation," as something unparalleled. The unfortunate consequences of not regulating these IB's are what we now face and there sure is nothing unparalleled about the present crisis.

Credit rating agencies: The Moody's, S&P's and Fitch's of the world which are expected to be proactive and offer leading indicators were disastrously late to the party, reacting to the crisis by issuing warnings when it was no news to the financial community. These agencies share a massive portion of the blame simply because they failed to perform their fundamental duty: to accurately assess the quality of credit. A lot of pain could have been salvaged if these agencies were forthright in their assessments and exposed toxic balance sheets of troubled IB's.

Freddie, Fannie, and the underlying factor: The fall in real estate prices triggered this chain reaction, which is about half way through. Outlook in the real estate market doesn't look very sanguine either, which means this crisis could be painful and prolonged. A weak US dollar was an incentive for many overseas investors to explore real estate investments here and provide the much needed boost. But a steady strengthening of the dollar and apprehensions about the overall economy is now keeping these investors away. Local investment in real estate is not sky rocketing anytime soon as Americans are concerned more about wealth preservation than wealth creation for now.

Freddie and Fannie were taken over the by the government which could either be a boon or a bane in this situation. These two institutions are the primary sources of home mortgages underwriting a huge portion of them. If the federal government preoccupies itself in the takeover and transformation process and allows business as usual to continue at Fannie and Freddie, the required stimulant in the housing market will be absent. But if the feds recognize the need for a boost in the real estate market, ease regulations and churn out more affordable and flexible mortgages into the market this will undoubtedly attract buyers and spur the real estate market.

Financial models, illiquid markets and over the counter trading: Many of the troublesome assets that contributed to Lehman's decline were the toxic credit derivative swaps, and similar products. Most or all of these products had very illiquid markets forcing IB's to come up with complex mathematical models to price these securities. With no credible regulatory institution in place there was absolutely no accountability which led to pricing at will and pricing based on trust. The illiquidity in the secondary market only aggravated this as insufficient buyers and sellers led to a non-market math modeled and misleading pricing.

This recent implosion indicates a lot more than the dampened mood on Wall Street. This fallout clearly showed how financial engineering and innovation outpaced the federal financial market regulators who were caught off guard, desperately trying to save face and avert a lock down of the financial system in the country (and around the world).

Back to the basics: The last few decades saw the rise of a new type of bank: the investment bank. Well common sense now prevails and has proven that there is in fact only one type of bank: the normal bank where individuals park their savings which the bank then lends out at rate. Many wondered how the investment banking business model is sustainable, where short term loans are leveraged 1:30 and used in long term investments with no direct access to federal money. There was no credible regulator and the IB's had no oversight of any kind. Any venture capitalist would debunk these flaws in the investment banking business model if no IB ever existed and an ambitious entrepreneur draws up such a plan. There is talk about the new normal, because Wall Street's landscape has changed dramatically in the last six months. There will be a new normal: we will get back to the basics and have just one type of bank, the commercial bank.

The Future: Of the five major IB's which operated using the independent broker-dealer model, only two, Morgan Stanley and Goldman Sachs remain. It's very unlikely that Morgan could survive this crisis and the future looks uncertain even for Goldman in this fragile market environment. Leverage that was built up over years is hard to undo in a weeks or months. The deleveraging process will be nasty and unfortunate because the losses will be socialized and divided amongst taxpayers but profits will be privatized.

History has proven that our economy is one of the most resilient and nimble structures around the world. It has braved diverse problems from accounting scandals to bank failures and continued to roar forward. This is largely attributable to the strong foundations of America, competent regulatory institutions and the grit of the American worker. Although this down phase is looking ominously different, one can be sure that when the bad times pass, investment opportunities will open up.

Online link to Article: Click Here

BEGINNING OF EXTENDED VERSION (ON BLOG):

The right remedies: Understanding the intricacies of the US and world financial system would take years. But here are some measures that the Fed and Treasury could have taken to diminish the volatility and lessen the panic.

1. The cost of credit for all the companies in question surged dramatically around rumors that credit rating agencies were exploring the option of downgrading their credit ratings. If some internal financial levers were pulled to stop these credit rating agencies from downgrading, this would have bought companies time, and saved billions of dollars of taxpayer money because credit could've been generated easily.

2. Mark to market accounting wrongly portrayed the balance sheets and hence the value of companies, which resulted in credit rate agencies downgrading debt and increasing the cost of borrowing. Practicing mark to market accounting when there is no market for securities is fundamentally flawed and this rule has to be scrutinized and reviewed.

3. Prevent hedge funds and investors from opening up naked Credit Default Swap positions that gamble on company's defaulting (i.e. no one should be allowed to purchase a credit default swap if the buyer of the CDS has no underlying asset to protect)

Financial or economic crisis: What started out as a financial crisis isolated to credit derivatives and the debt markets could soon transform to an economic crisis. The unfolding of events in this crisis has terrified normal folks and experts on Wall Street. For the first time in the history of Wall Street, brokers and bankers were actually asking for regulation and begging for intervention. These events have dented the confidence and questioned the sustainability our borrow-and-spend economy, which might result in a weaker US currency and the emergence of a multi-currency reserve system. In a consumer driven economy where prices of fuel, gas and food are on the rise, a simultaneous increase in the cost of borrowing will only intensify the pains on Main Street.

Large and small businesses depend on short term credit for their everyday transactions, and the dangerous freeze in the credit markets is harming the lifeline of corporate America as they operate with a broken backbone which is an illiquid credit market. Ordinary folks often use the stock market as a barometer of the economy which could be misleading sometimes. In this case especially, while the stock market recouped major losses by the end of the week, credit markets remained frozen and inaccessible which was scary and abnormal.

The Money Trail: Lots of hedge funds made massive profits in this financial crisis. Having mastered the system, there is a possibility that some firms legitimately exploited the loopholes for huge profits. With this basic understanding of CDS’s let me illustrate one instance of how this is possible.

CREDIT DEFAULT SWAPS (CDS) SIMPLIFIED
BUYER OF A CREDIT DEFAULT SWAP (or insurance): Hedge fund, investment bank or an accredited investor.	SELLER OF A CREDIT DEFAULT SWAP (or insurance): An investment bank, hedge funds and insurance companies.
Buyer purchases a CDS (or insurance) for an underlying asset (the underlying asset could be a loan, a bond, or any type of obligation). There is no requirement that the buyer of the CDS be the owner/holder of the underlying asset.	The CDS seller is selling the insurance for the underlying asset for which the seller will receive regular payments like insurance premiums.
The CDS buyer makes regular payments to the seller of the CDS, like insurance premium. So if XYZ hedge fund buys a CDS for Lehman Brothers debt from Morgan Stanley, XYZ hedge fund will make regular payments to Morgan Stanley, who in this case acts as the insurer for Lehman’s debt.	The CDS seller pockets the regular premium paid by the buyer and promises insurance in exchange. So in this case Morgan Stanley would have priced the CDS on Lehman’s debt based on complex models and sold that insurance to XYZ hedge fund. Morgan Stanley in turn receives and keeps the premiums.
XYZ hedge fund (the buyer of the CDS) is in effect, buying insurance and transferring the risk on Lehman’s debt to the seller of the insurance.	The seller of the CDS, Morgan Stanley, is in effect taking on the risk of the buyer’s underlying asset, Lehman’s debt, and is insuring it. So CDS buyer has transferred the risk to the CDS seller.
In the case of a credit event, the buyer of the CDS (XYZ hedge fund) gets a massive payout from the seller (Morgan Stanley), because the underlying asset has defaulted (i.e. Lehman’s debt defaulted).The payout can be a cash or a physical settlement based on the contract terms.	In the case of a, “credit event,” (i.e. bankruptcy, bond or credit default, obligation default, etc.) because the CDS seller has been collecting premiums and assumed the risk of the underlying asset, they are obligated to compensate the buyer for that. So Morgan Stanley compensates XYZ hedge fund proportionally.

Taking the same example used in the CDS illustration, where XYZ hedge fund buys a CDS for Lehman debt from Morgan Stanley, where the hedge fund in this case does not own or has no exposure to Lehman in any way, and it’s just a speculative play. When any bank, hedge fund or private equity firm buy a CDS on corporate bonds, on company short term or long term debt, this in turn lowers the price and value of these bonds.

Once XYZ hedge fund buys loads of CDS on Lehman’s debt, it is a good thing for this hedge fund if Lehman defaults on its debt. XYZ hedge fund can now short the stock (which was extremely easy to do before the present rules took effect, hedge funds and institutional players could short the stock naked, i.e. short massive amounts of the stock without actually owning it). Observing a rising short interest in the stock, other market players add to the downward momentum and drive down the stock price to depressed levels.

Depressed stock prices forces credit rating agencies to step in and downgrade the company’s debt, which could result in a bankruptcy filing (if sufficient capital cannot be raised for new collateral levels) or a default on their credit. Now, XYZ hedge fund, the buyer of the Credit Default Swap makes enormous profits because Lehman defaulted and Morgan Stanley, the seller of the CDS has to deliver a huge paycheck to XYZ hedge fund. Many suspect these practices could have been rampant in the last few months. One expert described this as, buying (or owning) your neighbors insurance and running his house over with your truck.

Online link to this article: Click Here

THE NEXT THREAT: INFLATION

The demise of Bear Stearns, failure of IndyMac Bank, troubles at US mortgage giants Fannie and Freddie and the housing debacle coupled with the nasty deleveraging process saw our markets and economy on tenterhooks. Each time we escaped with minor setbacks, clearly reflective of the resilient and agile nature of our financial structure. But something more ominous is gaining momentum which could potentially rattle the economy if kept unchecked: Inflation.

Economist John Maynard Keynes once said, “Inflation is a form of taxation which the public find hardest to evade and even the weakest government can enforce when it can enforce nothing else.” Unfortunately, not much light is being shed on this issue and our Fed is under the illusion that inflation is under control. Something very significant is about to unfold because a variety of factors could converge to drive inflation to disturbing levels.

A post analysis of the most vicious inflationary periods in recent history has shown that inflation primarily finds its roots when money supply increases dramatically. This creates a condition where more money chases the same goods and services, hence driving up price. But now, in addition to an oversupply of money, other factors like high commodity and agricultural prices, imported inflation, rising producer price index and a weak US currency will contribute to drive up inflation.

Money Supply Exploding: The Fed and the Treasury have our printing presses on overtime and money is being printed and pumped into the economy at an alarming rate. The sharp cuts in interest rates from 5.25 to 2 percent in a few months accelerated borrowing by banks and expanded money supply in the form of credit. Amidst all the turmoil, Congress approved a $150 billion stimulus package adding more money into the system now in the form of cash.

Lost in all this noise was a disturbing and vital piece of news which received no coverage. The Treasury/Fed decided to stop publicly releasing M3 money supply information. M3 is an extremely important number because it the broadest measure of money circulating in the economy which is tracked closely by economists. This number gives a clear picture of how much money is in the system. Having been publicly available for decades no rational explanation was given for this retraction. Although less accurate measures of money (like M1 and M2) are still available, it severely hinders the capability to quantify the amount of money in the system.

Imported Inflation: Textiles, electronics, furniture, toys and now even inflation is made in China. Many developing Asian economies which export heavily to the US are experiencing high levels of inflation. Central bankers and regulators in India and China are fighting vigorously to tame inflation, sometimes even at the cost of growth. But inflationary forces are still largely at bay in those economies and a significant portion of that inflation gets imported into the US through their exports.

This unfortunate phenomenon significantly affects our inflation rendering the US government helpless because this inflation is imported. This particular source of inflation is not about to drawdown anytime soon and has to be tackled.

Rising Agricultural/Commodity Prices and PPI: Significant price rises in commodities, agricultural and food products are inciting widespread agitation here and around the world. The producer price index (PPI) is widely considered a leading indicator of where consumer price inflation or CPI is headed. Measuring inflation in primary input articles for a wide array of manufacturers, the PPI reflects the rising cost of production and manufacturing which will eventually be passed on to consumers. Even this number has been on the rise, raising several red flags, which the Fed has chosen to ignore. There seems to be no reprieve for the PPI, which are disturbing signs going forward.

Misery Index: Many economists track the famous Misery Index (unemployment rate plus inflation) which is currently at 10.72 percent (unemployment at 5.7 percent and inflation at 5.02 percent). The appropriately worded indicator basically reflects the overall mood of the economy and the signs don’t look very sanguine going forward.

All these factors will converge and drive inflation to outrageous levels, so now is an appropriate time to look at your portfolio for asset re-allocation.

Your Money: Usually high-inflation periods result in super-low real returns when invested in the stock market (if stock market is up 15 percent, inflation is at 10 percent, your real return is 5 percent). This is primarily because of US Dollar devaluation and loss of purchasing power. Majority of local and dollar denominated investments will drastically underperform and here are some ideal avenues to park your funds in this situation.

1. Buying foreign currencies via ETN’s like CNY and INR or best, buying foreign currencies directly.

2. Investing in commodity rich country’s government bonds with high yields like Australia: Here you are positioned to gain from both currency appreciation and bond yields.

3. Shorting the US dollar via ETF’s like UDN.

4. Purchasing TIPS or Treasury Inflation-Protected Securities.

5. Purchasing significant quantities of gold, silver or other precious metals as a hedge.

6. Buying ETF’s, ETN’s and their options that track inflation.

7. Generally divesting from dollar-denominated assets.

Online link to this article:

http://centralpennbusiness.com/article.asp?aID=67795#

FKCCI ARTICLE: JUNE/JULY 2008 ISSUE

GOLD WILL CONTINUE TO GLITTER

By Adhvith Muralidhar Dhuddu, Regular Columnist

There’s been much hullabaloo about investing in gold and gold related companies in the last few months. Although gold has historically been a low yielding investment in the long run, it has run up spectacularly and more than doubled in the last few years. With the stock markets in India, China and the USA in shambles right now and other asset classes drastically underperforming, investors are exploring safe havens like gold, silver (and other precious metals and commodities) to park their funds. But let’s look at some basic drivers of supply and demand for gold to see if it will continue to shine.

1. Inflation and Gold as a safe haven: Inflationary periods are detrimental to any economy and if high inflation persists for long, it consistently erodes the value of a country’s currency. Going back to the basics of money, we recognize that the primary function of money is: (a) to preserve value, (b) to be a medium of exchange and facilitate easy transactions, (c) to be a unit of account to help measure the value of an economy. The second and third function can be taken for granted as this is fulfilled irrespective of the type of currency or money used. But the most important function of money is to preserve and store value. If Rs.10 could buy you 5 tomatoes a few years ago, but can only buy you two tomatoes now, clearly the purchasing power of the currency has declined and it has failed to preserve value. Governments and central banks use politically appropriate verbiage and label this inflation.

When this phenomenon unfolds there is a rush to accrue assets that don’t decline in value and historically gold has been that safe haven. Gold is traditionally identified as a safe haven investment that preserves capital and increases in value gradually. But what is unfolding now is monumental because not only are emerging economies experiencing high inflation, slowly the US and the European economies will face inflationary problems. When this occurs, the rush to accumulate gold will drastically drive up the price with an increase in demand.

2. Gold investments via ETFs, ETN’s and increased access to retail investors: The only access individual investors had to invest in gold was jewelry and coins making it an illiquid and untradeable asset. But this is rapidly changing. Now, investors can buy, sell and trade gold with ease with the introduction of Exchange Traded Funds (ETF’s) and Exchange Traded Notes (ETN’s).

The boxed portion of the gold supply demand table below clearly reflects the rise in demand for gold by retail investors via ETF’s and other similar products. This is poised to increase tremendously as the demand to invest and trade gold continuously increases. The rise in popularity of these ETF’s and ETN’s is evident in the US markets and as other emerging countries’ financial markets mature to provide these instruments, the demand and popularity for them will increase. Another vital factor is that gold is considered a safe haven not just by US investors or households in India, but every individual, bank, and fund manager knows that gold is a safe haven investment and as access, liquidity and tradability increases, there will undoubtedly be more demand.

3. Role of Central Banks, Sovereign Wealth Funds and Foreign Exchange Reserves: As more wealth is created in third world and emerging economies and as foreign exchange reserves of export oriented countries continue to swell the demand for gold will continue to rise. The US Dollar’s recent decline has hurt the value of foreign exchange reserves forcing policymakers to identify another stable currency or any other form of capital preserving asset. And many central banks are slowly transitioning portions of their funds to gold, silver and other precious metals. Not only is gold turning out to be a safe haven for retail investors, even central banks and sovereign wealth funds want to park their funds in gold.

Nobel Prize economist Joseph Stiglitz clearly delineated in his book, “Making Globalization Work”, the flawed single currency reserve system. Many of the fears he outlined are slowly unfolding with the US dollar becoming a less favorable reserve currency. Allocators of forex reserves are prudently diversifying their funds by exploring other currency options like the Euro and Yen and safe haven commodities like gold and silver.

4. The Dollar Factor: The weakening of the US dollar has significantly affected the price of gold. Like crude oil, gold is a dollar denominated asset and its relative price has risen with the fall in the value of the US dollar. At least 15 to 20 percent of the price rise in gold can be attributed to the weakening of the US dollar.

Although the US Dollar/Indian Rupee relationship has been choppy, the overall strength of the US dollar (measured best using the US Dollar Index), which compiles the US Dollar exchange rates with the Yen, Euro, Pound, Swiss Franc and other major currencies has significantly declined. So the USD’s comprehensive weakness in the last few years helped inflate the price of gold, silver, steel, copper, crude oil, natural gas and many other US Dollar denominated commodities. Hence, going forward, the movements of the US Dollar will considerably impact the price of gold.

5. Universal demand and supply: Given below is a table outlining the worldwide supply and demand for gold in the last ten years. A comfortable balance can be observed in the supply less demand column which fails to explain why the price of gold has increased so much. What’s important now is not what the historical relationship was, but what will the supply demand relationship will look like going forward.

The increase in demand for gold going forward cannot be denied. Going forward, demand for gold to use in electronics, dentistry, and other industrial applications will only increase. But the supply picture for gold does not look very bright. Gold supply has increased at an average rate of 2-3 percent historically and this number is not about to change any time soon. One has to remember that the supply of gold is limited to how much gold is mined which limits the availability of this commodity.

6. Extreme Cases: Some economists have boldly predicted that the days of fiat currencies are numbered and the world will return to the gold standard. This could unfold if a major currency like the Dollar, Euro or Yen completely collapses or if inflation in developed economies like US reaches the stratosphere rendering paper money to be completely valueless. Although these are extreme cases nothing can be ruled out. In this case, the value of gold will also reach the stratosphere trading at eight to ten times of its current price.

Clearly, the current dire economic scenarios around the world, and other favorable factors outlined will send the price of gold higher. One should explore to see how they can diversify to include gold in their portfolio.

Money WhizDom: Corn flakes, coffee and the changing world of commodities

Adhvith Dhuddu, CT Regular Columnist

Wednesday, November 28; 12:00 AM

The commodity market boom coupled with spiraling inflation is taking more out of our pockets for everyday purchases such as coffee, corn flakes and crude oil (gasoline) than ever before.

This extended Bull run initiated at the turn of the millennium is expected to last at least another decade. Though these elevated prices are here to stay, it's not too late to explore opportunities to put your money to work in the commodity arena.

The explosion in commodity prices (e.g. raw materials, natural resources, precious metals, etc.) closely resembles the buoyant stock markets from the late '90s. The only difference is that these lofty prices are sustainable over the long term. This is because of the tremendous imbalance in the supply/demand relationship in the next few decades, attributable to the rise of Southeast Asian economies (more demand) and fast-deteriorating supplies.

It's imperative to be well-informed about commodities as they — unlike stocks, bonds and real estate — are a part of our lives everyday. Your breakfast includes corn and milk; your Starbucks mocha contains sugar, cocoa and coffee; your lunch and dinner include wheat, rice, beans and pork; and the car you drive is made of steel, aluminum and rubber. Each day, you encounter commodities that are traded on a 24-hour basis around the world, and each day, the demand for these consumables is outpacing the supply.

Sugar, for example, has been experiencing a rise in prices for the last few years. Reasons include an increasing number of sugar beet processing plants shutting down since the mid '90s and higher demand for sugar from China (China has increased its sugar imports by 20 percent year-over-year for the past six years). Brazil (one of the largest sugar producers) has also contrib-uted to the price jump through smarter use of its home grown sugar for local consumption and ethanol use that have reduced its capacity to export.

Lead is a metal with wide-ranging applications in electric power systems, lead-acid batteries, ceramics, roofing, forklifts, television, computer monitors, etc., and its demand is expected to swell in the next two decades. If supply remains either constant or deteriorates, lead's price will inevitably increase.

The central bank of any country has the power to warm up the printing presses and create more money out of thin air if there is a need. But it's impossible to similarly create tangibles, such as foodstuffs, precious metals and raw materials. It will take 10 to 15 years for these highly demanded commodities to meet the supply.

It is cumbersome to invest directly in commodities such as sugar, lead or coffee, but more direct methods like investing in a commodity index (which tracks a bunch of commodities) or an ETF tracking commodity index solves the problem. Some internationally acclaimed indices such as the Rogers International Commodities Index and the Dow Jones AIG Commodity Index are up many-fold in the past few years.

Other alternatives include investing in companies that produce commodities. Behemoths like Arcelor-Mittal (which produces steel), Alcoa (which produces aluminum), Phelps Dodge (which produces copper), Rio Tinto (a mining giant), etc., are sure to rope in record profits in the next decade and a half with rising commodity prices. In fact, most of these stocks are up 300 to 500 percent in the last few years and still appear undervalued.

It is also very safe to invest in countries that produce commodities. Natural resource rich countries such as Australia, New Zealand, Canada, Bolivia and Chile will experience good economic times in the next few years.

One book, "Hot Commodities," written by legendary commodity investor Jim Rogers, explains why the next decade and a half will see an unprecedented boom in prices of all types of commodities, be it precious metals, energy, cereals or food. Being the first to foresee the commodity boom in 1998, he commands immense international respect.

During the late 1970s commodity bull market, oil hit a record high of $101.30(inflation adjusted). The late 1970s was also when gold and silver hit record levels. Something very similar has been unfolding in the last few months and will continue to do so for some time. History might not repeat itself, but it definitely rhymes with the past.

Online link to this article:
http://www.collegiatetimes.com/stories/2007/11/28/corn_flakes__coffee_and_the_changing_world_of_commodities

Money WhizDom: Decode the world of investing with knowledge

Adhvith Dhuddu, Regular Columnist

Wednesday, November 7; 12:00 AM

Investing without sufficient knowledge is like driving your car blindfolded or entering a football field with no gear on. You are bound to get clobbered and will end up on wrong end of a fiscal beating sooner rather than later. With that said, it also wouldn't be appropriate if the investing world hung a sign like, "Enter at your own risk," because risk in investing can be eliminated.

The first step is to become educated and learn about the different investment vehicles the financial universe has to offer. Just understanding all the available options wins half the battle, and the next step is analyzing these to see which investment vehicle will suit you best and yield the highest returns.

Investment opportunities abound, everything from currencies and commodities to real estate and stocks offer a chance to grow money. But when we identify an opportunity, it often appears hard to exploit due to lack of funds or information. Diverse investment vehicles are present to tap these opportunities, but we as students can use two specific instruments called Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) because they don't require capital in the hundreds of thousands and are easy to decipher.

With emerging markets looking more attractive, real estate dilly-dallying, and the commodity market experiencing a boom similar to the stock market in the late 90s, these financial instruments are becoming popular among amateur investors with less cash. Anywhere from $500 to $1,000 is sufficient to get your foot into investing and trading commodities, currency, mutual funds, real estate, stocks and emerging market securities. Something like this would have never been possible just a few years ago.

ETFs and ETNs function a lot like stocks. They can be bought and sold with the click of a mouse, and they don't charge annual fees like mutual funds, or consulting fees if you directly purchase real estate, or handling fees if you trade in commodities. For example, after your finance class you feel that the real estate market has hit its bottom and will rebound soon. Instead of regretting the fact that you can't buy a house in this depressed market, you can cash in on your prediction by purchasing a real estate ETF, which tracks the real estate market as a whole. If you are right, the price of the ETF will increase, and you can take home a tidy profit.

Two famous real estate ETFs are DJ Wilshire REIT ETF (ticker — RWR) and Vanguard REIT Index ETF (ticker — VNQ). REIT stands for Real Estate Investment Trusts. Investing in REITs can also give you some tax benefits. Maybe you diagnose the American economy as treading on thin ice and want to invest in precious metals such as gold, silver and platinum as a safe haven. Rather than shelling out $800 to buy an ounce of gold and get a special locker to store it, you can buy the gold or silver ETF (ticker — GLD or SLV) and watch it move in tandem with the price of gold. GLD quotes 1/10th the actual price of gold; for example, if an ounce of gold costs $768.50, the gold ETF, GLD, can be bought for $76.85.

You have seen oil prices skyrocket in the recent months and foresee no reprieve. But it would be ridiculous to buy ten barrels of crude oil, stack them in your apartment and sell them later. A much easier approach is to purchase the United States Oil Fund ETF (ticker - USO) and watch it rise in price as crude oil prices go up. There are ETFs that track the stock market indices like the Dow and NASDAQ (ticker — DIA and QQQQ), but what if you think the stock markets are headed down? Amazingly there are ETFs that track the stock markets in reverse. For example, UltraShort QQQ (ticker — QID) tracks the NASDAQ in reverse direction times two, e.g., if the NASDAQ goes down 2 percent the QID increases by 4 percent, and if the Nasdaq goes up by one percent QID would go down by 2 percent.

Stock markets in Southeast Asia and Latin America have been buoyant, and this optimism will persist for some time to come. Again through ETFs, you can invest in countries such as China, Japan, Korea, India, Brazil and Russia without worrying about transferring money, exchanging currencies and setting up local investment accounts.

There are lots of other ETFs and ETNs that track mutual funds, hedge funds, commodities, individual sectors, economic indicators, etc. So, exploring investing through ETFs and ETNs is a good way to start investing even if you lack sufficient funds or posses limited information.

Online link to this article:

http://www.collegiatetimes.com/stories/2007/11/07/column__decode_the_world_of_investing_with_knowledge

Money WhizDom: Learning stock market basics. (CT Column 1)

by Adhvith Dhuddu, Collegiate Times Regular Columnist 
Wednesday, August 29th, 2007

There is no better way to understand how the markets work than to open a trading account and dabble around with a few hundred dollars (not play money). The knowledge that one can gain by doing this is immense and will compound going forward. But to the novice, stocks, futures, options and commodity markets appear complicated and out of reach. Understanding basic aspects of how they function will greatly help in making a decision to start investing early. Starting early tremendously helps improve ones general knowledge about the economic and financial health of a country (or company) and also gives an exposure to how corporate America functions.

When a company wants to raise money there are three primary ways of doing it: borrow money from the bank, issue bonds in the bond market, or issue stock in the stock market. The company decides to issue stock and then approaches, say, Merill Lynch, and asks to help them out. Merill Lynch agrees and they are called the underwriters for the stock. Merill Lynch provides this company the $10 million they need (in exchange they get proportional control) and turns around, slices them up into two million shares of five dollars each and sells them to brokers, investors and other banks (the public). The stock of this company is officially in the public, has been listed as a public company in a stock exchange, and can be traded. This whole process is called the initial public offering or IPO.

As most people are aware, the main stock exchanges in America are the New York Stock Exchange (NYSE), National Association of Securities Dealers Automated Quotations (NASDAQ) and the American Stock Exchange (AMEX). Note that the Dow Jones is not a stock exchange, it's only an index. These are the exchanges where you can buy and sell your stocks through your broker (there are mainly two types of brokers the discount brokers and fully functional brokers). The reason you buy and sell through your broker is because he or she is a member of the exchange and you are not. To become a direct member of the exchange you should be willing to shell out a few million dollars.

Think of the stock market (or the futures, options and commodity markets) as an automobile. Your car has different parts (engine, tires, etc.) and runs on a fuel. Similarly, these markets have different parts (the exchanges, the companies listed, the brokers, the Securities and Exchange Commission, etc.) and run on a fuel called money. If the day money dries up on this planet, these markets will cease to exist.

But why and how does the stock price go up or down? In the business world, a year is referred to as a "financial year," and the financial year varies for different companies. For example, GAP's financial year starts May 1 and ends April 30 and ExxonMobil has its financial year lasting from Nov. 15 to Nov. 14 of the following year. Each financial year is divided into four quarters of three months each. Publicly listed companies release their earnings report for each quarter on a pre-specified date. Stocks experience extremely significant movements the day the earnings report is released. This is one event that moves the stock price considerably depending on the earnings report and the company's outlook in the coming quarters and financial years. Also, extremely heavy buying and selling of a particular stock by a mutual fund, pension fund (your 401(k) and IRA money) or a hedge fund can significantly impact the price of the stock.

One must understand that the primary driver in the movement of the stock price is the supply and demand relationship. If the stock has increased demand and less/constant supply (i.e. more people willing to buy a stock and lesser number of people willing to sell the stock) the price of the stock moves up. On the contrary, if there is less demand for the stock (i.e. less people want to buy the stock) and more/constant supply (i.e. more people willing to sell the stock), the price tends to go down. Therefore, when the above mentioned funds buy and sell stocks, a significant imbalance in the equilibrium of supply and demand is created (because these funds buy and sell in hundreds of millions of dollars) driving the stock price up or down.

You can sit in a class and learn about swimming all day, but when you dive into the water you pretty much forget everything you learned and start again. Similarly with the stock markets, taking the initial plunge is important and learning about investing/trading will follow. You drive your car and follow certain rules (stop on red, go on green, etc.), likewise, following rules while trading and investing will put you on track for financial success. Once you've understood basic concepts, opening an account is hassle-free. Online brokers like Scottrade, ShareBuiler and Zecco are extremely customer friendly and will help you along the way.

Online link to this article:
http://www.collegiatetimes.com/stories/2007/08/29/column__learning_stock_market_whizdom