A tryst with insanity!

Wordpress

2007-09-05T03:35:00.000-04:00

I also happen to have this very same blog at the following address:

http://nilanjanmishra.wordpress.com/

Eventually I will use the one that most appeals to whoever goes through my insane blog. Apparently a lot do - hint look at the 'hits' counter here on blogspot (under the yahoo finance screen).

So do leave me comments here or at wordpress or email me - and let me know which one works best for your browser/reading habits.

Ciao!

The deal from Falkirk.

2007-09-04T01:24:00.000-04:00

William Wallace. Yes we all know him - Braveheart fame. Great movie - enchanting music. And the movie talks about the Battle of Falkirk. So why do I want to talk about it?

Highly Leveraged!

Yes my dear friends William Wallace's army was leveraged more than he could handle - and he did not anticipate the market (or in his case - his allies) to turn on him.

What was that? Step back a little? OK so let's see if I make any sense at all.

What is 'Leverage'?

In a very general sense 'Leverage' means - to reinvest debt for a greater return than the cost of borrowing.

So how was Wallace highly leveraged? He depended on allies (borrowed forces), which he wanted to reinvest in the battle against King Edward I (Longshanks). If he won he would have achieved a greater return than the what he invested in having allies swear allegiance to him.

Oh but the mind is a 'tabula rasa' - "Et Tu Locke!" - Wallace must have muttered for I would chance to believe he did not know anything about empiricism. I digress - What I meant was that Wallace was 'blank' (tabula rasa = blank slate or with no experience - coined by Locke) to the experience whatsoever of working with leveraged positions.

Wallace's newly befriended allies kicked his behind and instead swore allegiance to King Edward I in return for nobility. Inevitably, Wallace lost the battle of Falkirk. In being dependent - or in our language - leveraged - he was exposed to:
1. His allies giving him the middle-finger salute.
2. His own men/forces being outnumbered and outflanked by Edward's army - and eventually slaughtered.

So let me try to make sense of this in terms that are closer home for us finance junkies.

I'm talking about positions where firms like LTCM (my recent obsession) were highly leveraged. LTCM used debt/loans/credit extensions to finance their strategies around derivatives/emerging markets/IR swaps/volatility etc. Their exposure in leveraged positions was twofold:
a) Exposure to risk in the investment/arbitrage opportunity itself.
b) Exposure to risk in the investment/arbitrage positions and having to repay loans after they booked losses on their positions.

This is but the simplest explanation and 'leverage' is not the criminal here - nor the crime. In fact, leverage is important for market participants to trade actively. However, keeping in mind the Credit Exposure and mark-to-market principles - a highly leveraged position may be extremely risky in case of a very volatile market or even a loss of liquidity in the market.

I have a very skewed perception of analogy. Inspite of the insanity and almost incoherent post above - I hope I have been able to manifest William Wallace and the Battle of Falkirk into the rabid and complex world of debt/leverage and most importantly - structured finance - which I will delve into soon after I get some sleep and someone to make me breakfast in the morning. Goodnight you princes of loans, you kings of subprime.

I can't wait for all you warriors out there to leave me hate-comments for this post.

An aside: I can't believe the Tigers beat Seminoles! "Riverboat Gambler" - when will you catch up with Joe Paterno? I believe in you. Go Noles!

When Genius Failed

2007-08-30T11:32:00.000-04:00

Maxrum - Again, thanks for the comments and yes I have read 'When Genius Failed' by Roger Lowenstein.
Roger Lowenstein is mostly recognized for his work - writing about big-dick-swinging people in the world of Finance as well as a bunch of very interesting articles on the NY Times Magazine. 'When Genius Failed' is more of a description of the people involved - John Meriwether, Robert Merton, Myron Scholes than a description of the actual trading strategies which caused LTCM to collapse. But it is still a very good read. Roger also wrote "Buffet:The Making of an American Capitalist" which is also a great read.

However, if you are really interested in the strategies LTCM was involved in you should pick up the book titled "Inventing Money" by Nicholas Dunbar.

As for me, I work in Structured Finance, in the big-bad world of 'subprime'.

Having said that, let me reiterate that all the views and opinions expressed in this blog are my own and have nothing to do with my employer.

Moving on, I had an interesting albeit insane experience last night and for once I will try and put it across as it was. As Thomas Aquinas puts it in his work - Summa Theologica - "God is perfect. HE is different from all other beings in being perfect". Of course that is but a translation of sorts and those might not be the exact words he used. But, my point is that I think we all are. We all are perfect.

So in the next couple of days I will post a new thought inspired by last night's incidents and Aquinas and a little bit of insanity.

Cheers! and have a great weekend.

Answers to comments

2007-08-29T16:06:00.000-04:00

I am so impressed with the responses that I thought it best to reply to comments in the space of a new post.

Indeed - maxrum - Scholes' first name is not Martin - it is Myron. Thanks for pointing that out to me. Hopefully, I will get more hits now. (37 and counting within the first 24 hours)

Now onto the first remark you made - Yes, LTCM did collapse in 1998 but the wheels had started turning in 1997. After the Asian financial crisis. The fact that the whole world essentially assumed that there was no risk at all eventually led to the Russian default and hence the LTCM collapse.

In 1997 when problems from thailand started hitting the shores of South Korea, the leaders of the US markets decided to get together on a cold wintry night on the eve of christmas to bail out South Korea - their comrades with a geopolitical advantage. World Bank, IMf and The US Treasury formed a so-called global consortium to reschedule South Korea's debt in the face of an impending downslide of the complete Korean economy.

Of course it was not all capitalism, it was the fear of a spillover effect. Not surprising, because although Thailand, Malaysia, Indonesia and the sorts don't have much of an macroeconomic influence over each other's economy they did have quite a bit of an influence with more links to developed countries than amongst themselves. In the same space - a spillover was not foreseen when the problem started with the Thai economy, but the disease spread fast and I mean real fast. Eventually when Korea was hit, the US came out guns blazing and rescheduled Korea's debt.

The world sat-back and watched and rightly assumed that the super-developed countries will bail them out in the face of an economical disaster. We entered a no-risk safe haven. LTCM buried their claws in deep. Russia - the superpower of yesterday was not going to go down - with all their missile reserves and some of the best vodka and caviar in the world! No way sir!

It did! Russia defaulted on their debt. Capitalism won and took the blow. IMF had tried to help Russia, but it did not work. The Russian currency devalued massively and all those no-risk angels with degrees from MIT and Harvard and PHDs from the moon - panicked. There was suddenly a huge risk in everything. Let's buy US Treasuries because USA is still a superpower! The on-the-run rates for 30 year US Treasuries fell because of this hurried buying by every economy that had become very very risk-averse. Money was pulled out from Russia, Brazil, Japan, etc. LTCM could not even unwind their trades effectively because there was no participant in that market - no buyer. This eventually led to the collapse of LTCM and which is why I had mentioned 1997 in my earlier blog, although, technically LTCM did collapse in 1998.

So thanks for reading my blog - maxrum and all the others - and hopefully we will have much much more interesting conversations. I look forward to more comments from you.

In the current Credit Crunch that the US and global markets are experiencing the situation is a little different albeit noteworthy might be the fact that this time the US is saying - Mea Culpa! Mea Maximus Culpa!

Frodo Baggins

2007-08-29T13:58:00.000-04:00

That last post was an interesting way to spend my time but I had to justify the title of my blog:

So I was thinking of some recent episodes in my life and was wondering if I could give it a deeper thought.

Disclaimer: These are but ramblings and musings of a much developed and insane mind so bear with me.

Frodo Baggins:
A halfling, a hobbit not more than 4 feet tall saves middle earth from the ultimate evil - Sauron. I was always interested in trying to understand why Tolkien chose such a weak character as the protagonist (of sorts) in his epic fantasy trilogy.

Powerful and magical characters exist in this fantastical journey -
Aragorn a numenorean lord, Boromir & Faramir -sons of the steward of Gondor (the seat of the numenorean kings) - protectors of Minas Tirith.
Gandalf greymane - a maiar and wizard and one who also wears one of the three magical and powerful elven rings - Narya.
Galadriel - lady of Lothlorien - lady of the wood-elves who also wears one of the three magical elven rings- Nenya.
Elrond - The lord of the noldor - the lord of rivendell who fought beside Isildur when Isildur cut off 'The one ring' from Sauron's hand with Narsil his sword. Elrond carries the most powerful of all three elven rings - Vilya.
And then we have Frodo - a 4 feet tall hobbit, grandson of Bilbo Baggins (who found the ring). And also three other hobbits who seem to be a bunch of misfits. The comic relief is duly provided by the 4 hobbits, but also there is an air of acceptance around these halflings. And a very natural sense of comraderie.

The difference I did notice in all characters was that only Frodo, out of all the plot's main characters, accepted his destiny from the very beginning. He was going to die. How and when and where he did not know, but he did accept it as unwittingly as possible.

Was Tolkien trying to tell us something? "The meek shall inherit the earth" Or maybe I am reading between the lines too much.

From the beginnning of the story - Frodo takes on the task of carrying the burden of the 'one' ring. He learns of it's temptations along the way. The shire taught him a thing or two about hunting but never before was he hunted. The temptations of the ring would have to be paid with blood if he fell for it, as he learns when he almost turns into a wraith when stabbed by the nazgul leader (the witch king of angmar) with a morgul blade.

Throughout his journey to Morgul, where he must throw the ring into the fires of Mt. Doom, Frodo experiences numerous sides of magic and treachery and comraderie. He brushes them all aside, as he trudges along the dangerous path that lies before him. He reflects every now and then, and talks about bag-end and the shire (home).

Just a few chapters before I finished the book for the umpteenth time I was impressed with the character of Frodo. He had no magical powers, no physical-towering advantage. He did have the gritty power of resisting temptation in the face of it. Yet, with all the tests and experiences frodo has throughout his journey - at the end of it all he falls for the ring. He does not want to let go of it. And as we all know (those of us who have read the book or seen the Peter Jackson movies), it was in fact gollum who steals the ring from Frodo and loses his balance and falls into the depths and fires of Mt. Doom.

Frodo does not really ask for forgiveness from the fact that he fell for the ring at the last minute - for a moment it feels like he revels in it. And yet we, the readers, do not crucify him. Is it only because we know of the times he did not get tempted? Or is it because we believed that eventually the ring will consume frodo too? Or maybe it is because we did not really care about Frodo and just wanted the ring to not get into Sauron's hands? Or, was it just the journey we held on to?

Frodo Baggins' character and his journey presents a lot of questions (and some answers) to me in my life at this time. Yes, I have journeyed through life and have learnt from my experiences - good and bad alike. Yet, with all that knowledge and acceptance of what lies beyond and the fact that I might eventually be burnt at the stake, it is the journey, I believe, that helps me or rather gives me the power to fall for temptation. Yet again! Yet again I choose to fall for a temptation as magical as the 'one ring' itself, not to rejoice in it's nefarious sentiment to rule the world but to revel in it's grandeur.

How will you take this journey?

The answer is 2.

2007-08-28T12:20:00.000-04:00

Lehman is uncertain. Merrill is uncertain. Morgan is uncertain. Goldman is uncertain. And of course how could I miss out Bear Stearns!

Where is Wall St. headed?

The financial markets, they say, move in circles. The rally and frenzied selling are intrinsic parts of it. Have we seen this type of a movement in the market?
The answer is - Yes, at least 2 of them.
The most recent one being in 1997 when LTCM lost their foothold even with the behemoths of Quantitative finance backing the structural construct of complex fixed-income arbitrage trades. Convergence trades as they are known were the most common.

Let's start with the basic concept of Convergence. The word by itself means - The act, condition, quality, or fact of converging. In Mathematics it means - The property or manner of approaching a limit, such as a point, line, function, or value.

A convergence trade with respect to the fixed-income market was based on the idea that long-term bonds issued around the same time would eventually 'converge' to the same price/value. The rate at which they converged would be different depending on their liquidity. An on-the-run bond is always more liquid than a off-the-run bond. The convergence would take place as new bonds would come on the run. (That's funny 'come on the run' - but let's not digress).

Thats a unique bond-arbitrage position. Buy off-the-run bonds at a cheaper price and short-sell on-the-run bonds. So where is the catch? The trick (or should we call it the downfall of LTCM) was highly leveraged positions. Since the differences in the values of these bonds were really small, the positions had to be highly leveraged in order to make a decent buck.

Did the leveraged positions define the downturn? -no, but they were a major factor in defining the effect it had on LTCM. Causality is but a post-action study. What did define the downturn was the loss of liquidity and a spike in the volatility in the market. After the Asian Market crisis (1997)and the Russian financial crisis (1998) the Global markets lost a ton of liquidity, prompting the investors and banks alike to run for cover under the umbrella of US Treasuries. The so called zero-default-risk bonds. As the demand went up so did the prices and instead of converging they 'diverged'. To unwind these positions meant huge losses for LTCM and eventually their assets were wiped out.

LTCM's impact was felt all across the US as almost all of the big banks and investment firms pooled in to contribute money to LTCM to cover their asses!(sic) Without significant contributions, LTCM would have had to liquidate a lot of it's securities to cover it's debt which would lower prices and in turn other companies would offload their debt creating a complete downward slide in the debt/credit market. That of course did not happen since LTCM was bailed out.

So how is this related to the markets now and where is Wall St. headed?

We see the same trend - Low liquidity - High volatility and more risk-averse investors. Let's talk about that in the next post. I also want to talk about:
1. Black-Scholes (since Martin Scholes was part and parcel of the quantitative trading strategy development team at LTCM)
2. Martingale (probability and betting theory)
3. Game theory.

The last one being my favorite (cos it teaches you how to get to the blonde without being rejected!)

LTCM stands for Long Term Capital Management.

The reflection and the rules.

2007-08-28T10:10:00.000-04:00

So that last blog was funny. Last night I decided to blog and used my real name as my blog address - and what do I write? A bunch of probably very unrealistic and much-maligned questions. If anyone has read it so far (before i deleted it) - I feel sorry for you and apologize for wasting your time.

Moving on - I used google to search for 'nilanjan mishra' and the first link is this blog. Surprising, because personally I do not feel like it should be so. No, but I will not question it. Who doesn't like an audience? So if someone is going to read my blogs - I will lay down a few rules:
1. I do not believe in punctuation.
2. This is my blog and the opinions are strictly my own.
3. Based on 2. above I will be writing about whatever the hell I feel like.
4. Based on 2. and 3. above I would really appreciate if someone left their comments/opinions out here. You can also issue 'fatwas' against me.
5. I will read your opinions and most assuredly will try my best to answer you.

Reflect on the title for a bit. This is what my posts are going to be about. I do not claim to be a philosopher or writer with uncanny skills over words or mastery of the english language. But I do tend to think a lot about nothing in general and that is what I am going to jot down here.