Efficient Market Hypothesis - EMH

EMH is a cornerstone of modern financial theory. EMH asserts that financial markets are "informationally efficient". That is, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information publicly available at the time the investment is made.

But what if there is one big stakeholder who has enough stake to manipulate the market in the direction he wants.

The Wall Street Journal has just reported that in the copper market "a single trader has reported it owns 80% to 90% of the copper sitting in London Metal Exchange warehouses, equal to about half of the world's exchange-registered copper stockpile and worth about $3 billion."

The following reading in the context of above news report and EMH is interesting.

Copper soared to a new record of $4.2705 per pound on Tuesday in New York, and is up 28.3% this year. The LME's three-month copper contract closed at $9,353.50 a metric ton, up 1.6% on the day, a new record.

J.P. Morgan Chase & Co. recently had a large position in copper, though it is unclear whether the U.S. bank increased its holdings, or whether a new player has taken dominant position.

"Regardless of who owns it, the only thing of note here is that we are being told that one person has a substantial position," said David Threlkeld, president of Resolved Inc., a metals consultancy.

While commodities exchanges scrutinize all holdings to ensure a single player isn't trying to corner the market, and many of the positions are owned by big firms on behalf of clients, the large holdings do result in a concentration of ownership that could skew prices.

Please keep the bolded text in mind, as you read the following description of the idiocy spewed on TV tonight, via the Street:

"Everything that goes up is not a bubble," Jim Cramer told the viewers of his "Mad Money" TV show Tuesday, as he reminded viewers that the laws of supply and demand have not been replaced by the law of gravity.

Cramer said he's had enough with the skeptics keeping investors from making real money in stocks, and especially in commodities. He said it's OK to be skeptical sometimes, but being skeptical about everything will only hurt your portfolio.
Case in point, the commodities. Cramer said the last big rally in commodities like copper and oil was indeed driven by a hedge fund frenzy, but this time is different.This time, he said, commodities are being driven higher by real demand, by the fact that the world is growing, and there's an inability to find new raw materials fast enough.

In other words: per Cramer, the story broken by the WSJ is just fabulation and JPM's 90% lock of the copper market is as indication of proper supply/demand dynamics. Because, in some parallel universe, JP Morgan controlling 90% of the market is real demand...

You read that right.

Here is another twist to the financial theory.

Here's yet another diabolic cycle for ordinary Americans, engineered by the grifter class. A Pennsylvanian like Robert Lukens sees his business decline thanks to soaring oil prices that have been jacked up by a handful of banks that paid off a few politicians to hand them the right to manipulate the market. Lukens has no say in this; he pays what he has to pay. Some of that money of his goes into the pockets of the banks that disenfranchise him politically, and the rest of it goes increasingly into the pockets of Middle Eastern oil companies. And since he's making less money now, Lukens is paying less in taxes to the state of Pennsylvania, leaving the state in a budget shortfall. Next thing you know, Governor Ed Rendell is traveling to the Middle East, trying to sell the Pennsylvania Turnpike to the same oil states who've been pocketing Bob Lukens's gas dollars. It's an almost frictionless machine for stripping wealth out of the heart of the country, one that perfectly encapsulates where we are as a nation.
When you're trying to sell a highway that was once considered one of your nation's great engineering marvels — 532 miles of hard-built road that required tons of dynamite, wood, and steel and the labor of thousands to bore seven mighty tunnels through the Allegheny Mountains — when you're offering that up to petro-despots just so you can fight off a single-year budget shortfall, just so you can keep the lights on in the state house into the next fiscal year, you've entered a new stage in your societal development.

You know how you used to have a job, and a house, and a car, and a wife and a family, and there was food in the fridge — and now you're six months into a drug habit and you're carrying toasters and TVs out the front door every morning just to raise the cash to make it through that day? That's where we are. While a lot of this book is about how American banks used bubble schemes to strip the last meat off the bones of America's postwar golden years, the cruelest joke is that American banks now don't even have the buying power needed to finish the job of stripping the country completely clean.

So, it is high time that all the assumptions underlying modern financial theory like Banking, Stock Markets, Corporatization, Securitization etc. should be re-visited by honest academics, practitioners.

Is Doing PhD Worthless?

The Economist has published an article “The disposable academic – Why doing a PhD is often a waste of time”.

From reading the full article one gets that first things should always be first – first get a reasonable degree required by job market, land at a good job and then pursue your interest to become a PhD.

Following excerpts from the article are worth reading.

But universities have discovered that PhD students are cheap, highly motivated and disposable labour. With more PhD students they can do more research, and in some countries more teaching, with less money. A graduate assistant at Yale might earn $20,000 a year for nine months of teaching. The average pay of full professors in America was $109,000 in 2009—higher than the average for judges and magistrates.

Indeed, the production of PhDs has far outstripped demand for university lecturers. In a recent book, Andrew Hacker and Claudia Dreifus, an academic and a journalist, report that America produced more than 100,000 doctoral degrees between 2005 and 2009. In the same period there were just 16,000 new professorships. Using PhD students to do much of the undergraduate teaching cuts the number of full-time jobs. Even in Canada, where the output of PhD graduates has grown relatively modestly, universities conferred 4,800 doctorate degrees in 2007 but hired just 2,616 new full-time professors. Only a few fast-developing countries, such as Brazil and China, now seem short of PhDs.

In research the story is similar. PhD students and contract staff known as “postdocs”, described by one student as “the ugly underbelly of academia”, do much of the research these days. There is a glut of postdocs too. Dr Freeman concluded from pre-2000 data that if American faculty jobs in the life sciences were increasing at 5% a year, just 20% of students would land one. In Canada 80% of postdocs earn $38,600 or less per year before tax—the average salary of a construction worker. The rise of the postdoc has created another obstacle on the way to an academic post. In some areas five years as a postdoc is now a prerequisite for landing a secure full-time job.

These armies of low-paid PhD researchers and postdocs boost universities’, and therefore countries’, research capacity. Yet that is not always a good thing. Brilliant, well-trained minds can go to waste when fashions change. The post-Sputnik era drove the rapid growth in PhD physicists that came to an abrupt halt as the Vietnam war drained the science budget. Brian Schwartz, a professor of physics at the City University of New York, says that in the 1970s as many as 5,000 physicists had to find jobs in other areas.

PhD graduates do at least earn more than those with a bachelor’s degree. A study in the Journal of Higher Education Policy and Management by Bernard Casey shows that British men with a bachelor’s degree earn 14% more than those who could have gone to university but chose not to. The earnings premium for a PhD is 26%. But the premium for a master’s degree, which can be accomplished in as little as one year, is almost as high, at 23%. In some subjects the premium for a PhD vanishes entirely. PhDs in maths and computing, social sciences and languages earn no more than those with master’s degrees. The premium for a PhD is actually smaller than for a master’s degree in engineering and technology, architecture and education. Only in medicine, other sciences, and business and financial studies is it high enough to be worthwhile. Over all subjects, a PhD commands only a 3% premium over a master’s degree.

Why Blogs (Still) Aren't Dead.......

Why Blogs (Still) Aren't Dead.......No Matter What You 've Heard

A very good article on the state of blogosphere and also how one can lie with empirical research based on statistics.

سچی خوشی

ہماری زندگیوں میں جو باتیں اہم ہیں وہ ہیں ایک دوسرے کےساتھ وقت گزرانا، قریبی دوستوں کے ساتھ گپ شپ اور خوبصورت کتابیں پڑھنا اور ہم خوش قسمت ہیں کہ ہمارے پاس رہنے کے لیے جگہ ہے اور ارد گرد اتنی ثقافتی سرگرمیاں جاری رہتی ہیں جو ہمیں متحرک رکھتی ہیں۔ اس سب کچھ کے بعد آپ کیا کسی اور چیز کا مطالبہ کریں گے۔

'

یہ ہیں خیالات متوسط طبقے سے تعلق رکھنے والے ایک برطانوی نوجوان ٹوبی اورد کے جنہوں نے اپنی زندگی بھر کی کمائی ان لوگوں کے لیے

وقف کر دی ہے جن کے پاس ان کی ضرورت سے کم ہے۔

اکتیس سالہ اورد نےجو آکسفورڈ یونیورسٹی میں محقق ہیں اپنی زندگی میں دس لاکھ پاؤنڈ ضرورت مند افراد کو دینے کا عہد کیا ہے۔ اس مشن کی تکمیل کے لیے اورد نے فیصلہ کیا ہے کہ وہ سالانہ بیس ہزار پاؤنڈ سے زیادہ جتنا کمائیں گے ضرورت مندوں میں تقسیم کر دیں گے اور ان کی اہلیہ ڈاکٹر بیرنادیت ینگ نے اپنے لیے پچیس ہزار ہاؤنڈ کا ہدف رکھا ہے۔

وہ کرائے کے ایک کمرے کے خوبصورت فلیٹ میں رہتے ہیں جس میں صرف ضرورت کی بنیادی چیزیں رکھی ہیں۔ ان کے پاس ٹی وی نہیں لیکن اس کی وجہ پیسے کی کمی نہیں بلکہ ان کی خواہش ہے۔ وہ دو ہفتے میں ایک بار باہر کھانا کھاتے ہیں، ہفتے میں ایک بار کافی پیتے ہیں۔

اورد نے بی بی سی سے بات کرتے ہوئے کہا کہ جب وہ طالب علم تھے اور سالانہ چودہ ہزار پاؤنڈ کماتے تھے اس وقت وہ دنیا کے امیر ترین چار فیصد لوگوں میں سے ایک تھے۔ 'میں نے سوچا کہ اگر میں اس آمدن کا دس فیصد کسی کودے دوں تو میں پھر بھی دنیا کے امیرترین پانچ فیصد لوگوں میں شامل ہوںگا۔'

اب اورد تنہا نہیں۔ ان کی دیکھا دیکھی چونسٹھ لوگ ان کی تحریک

'Giving What We Can'(اپنی حیثیت کے مطابق دے دینا) میں شامل ہو چکے ہیں۔

Fallacies of Research

Researchers tend to generalize theories based on their observations and experiments. Sometimes these generalisations are too general, seeing things from the very high and assuming a dream world to be of any help in solving the real world phenomena and sometimes these generalisations are based on limited data that make these research meaningless in our day to day life. Take the case of Capital Structure theories in Finance, there is no link to real world and interaction of human beings who are not so rational and the markets are not so efficient.

Behavioural Finance has come to rectify this anomaly. But it also have its limitations. Here is an excerpt from an article that shows what these are

The behavioural revolution in economics and psychology has successfully identified and named close to three dozen biases (my favourite behavioural folk song defines them in verse).  I had thought that these biases transcended issues of culture.  Indeed, both neoclassical and behavioural economists were united in a belief that cultural variables were of secondary importance when it came to the deep drivers of behaviour.  But a series of experiments now has me thinking that the underlying heuristics are less universal.

The article, “The Weirdest People in the World” (ungated working paper), has the startling thesis that social scientists in trying to investigate basic psychology may have erred by oversampling outlier populations.  The “Weirdest People” of the title are Western, Educated, Industrialized, Rich, and Democratic.  (The cuteness of the title is not one of the article’s strengths.)  But the idea that “we” are the exotics usefully jars one from complacency.

The heart of the review is a catalogue of experiments where the results differ markedly across different societies.

Take, for example, the Müller-Lyer illusion, which I would have bet dollars to doughnuts would be a universal trick of the eye:

Turns out not only that different societies display different degrees of illusion bias, but the U.S. subjects (represented here by subjects in Evanston, Illinois) are outliers when researchers tested for the prevalence of the illusion across more than a dozen societies throughout the world.  The WEIRD subjects, as expected, require “segment a” to be on average 20 percent longer than “segment b” before they subjectively assess the two to be the same length.  But other cultures exhibit markedly less bias.  Indeed, the “San foragers of the Kalahari seem to be virtually unaffected by the illusion”:

MM Theorem and Reality

MM proposition 1 says that value of a firm is independent from its financial structure. If this is the case then the ideal financial structure is 100% debt.
But fortunately this is not the case otherwise everything on the earth might be held by banks as collateral. The reasons for the current scenario is different than advocated by MM are
1. Arbitrage mechanism has its limits.
2. Interest rate on personal debt is different from corporate debt because of underlying collateral, size of debt and remaining borrowing capacity.
3. Borrowing capacity of corporations as well as its shareholders is limited because there is a real cost of bankruptcy.
4. Capital markets are not perfect, there is asymmetry of information between corporations and its capital providers.
5. Interest rate varies with the leverage because of risk of default.
6. There is no “equivalent return” class because the underlying risk is different from firm to firm, which is accumulation of numbers of factors.
7. Firms within the same industry post very different operating income because of difference in strategy pursued.
8. Securities of all firms in the world are not traded on capital markets.

Sure Win Turnaround Formula

One of the reason for a turnaround of Ford Motors is slashing of debt and reducing interest cost. This is another evidence that debt exert unbearable pressure on companies and bring them down. Here is an excerpt from an article from Economist

That turnaround is impressive (see chart 1). Despite the sluggish recovery in the North American market, in the third quarter Ford’s automotive businesses made an operating profit of $2.1 billion, twice as much as a year before and the fifth quarterly surplus in a row, on revenue of $29 billion. Its net income was a quarterly record of $1.7 billion. Analysts at Morgan Stanley, an investment bank, expect the company to make a profit of $10.5 billion in 2010. In 2009 it made one third of that. Ford has also slashed $12.8 billion off the automotive debt of $33 billion it had at the start of the year. By late November the company reckoned it had lowered its annualised interest costs by nearly $1 billion.

Markets can be manipulated

Here is an excerpt from an article which throws some light on the causes of bubbles in finance. Clever people take advantage of human brain flaw and succeed in creating bubbles and bubble are destined to burst, which is as sure as daylight.

Why are bubbles such a persistent feature of financial history? Economists argue that these speculative frenzies are caused in part by market failures like too much liquidity or lax regulation. Cognitive psychologists, meanwhile, see bubbles as a case of pattern recognition gone awry, as people extrapolate the past into the future. In recent years, neuroscientists also have become interested in bubbles, if only because the financial manias seem to take advantage of deep-seated human flaws; the market fails only because the brain fails first. Read Montague, at Baylor College of Medicine, has spent the last few years trying to decipher the bits of brain behind our irrational exuberance. It’s microeconomics at its most microscopic.

At first, Montague’s data confirmed the obvious: our brains crave reward. He watched as a cluster of neurons acted like greedy information processors, firing rapidly as the subjects tried to maximize their profits during the early phases of the bubble. When share prices kept going up, these brain cells poured dopamine into the caudate nucleus, which increased the subjects’ excitement and led them to pour more money into the market. The bubble was building.

But then Montague discovered something strange. As the market continued to rise, these same neurons significantly reduced their rate of firing. “It’s as if the cells were getting anxious,” Montague says. “They knew something wasn’t right.” And then, just before the bubble burst, these neurons typically stopped firing altogether. In many respects, these dopamine neurons seem to be acting like an internal thermostat, shutting off when the market starts to overheat. Unfortunately, the rest of the brain is too captivated by the profits to care: instead of heeding the warning, the brain obeys the urges of so-called higher regions, like the prefrontal cortex, which are busy coming up with all sorts of reasons that the market will never decline. In other words, our primal emotions are acting rationally, while those rational circuits are contributing to the mass irrationality.

Unfortunately this tendency is exacerbated by other people. Montague has also found, for instance, that subjects in the investment game are extremely vulnerable to what he calls “the country-club effect,” which occurs when we try to make more money than someone else. “This is what happens when you’re sitting around with your friends at the country club or watching cable TV, and everybody is talking about their huge profits,” he says. “Those conversations are going to change the way you think about risk.” Men seem especially vulnerable to this foible: When they competed against strangers, they were much more likely to get swept away by the financial speculation.

Efficient Market Hypothesis

Efficient Market Hypothesis (EMH) - An hypothesis which states that the price of a security is a reflection of all available information about it and thus represents its true value. It states also that the current price of a security is the most appropriate measure of future returns. 


But in real world there is no such thing. Investment bankers, brokers, vested interests all use all the weapons including academia to ensure that people believe in the EMH. Here is an excerpt from an article that makes the point clear.


" We already know that Lehman and other firms used fake accounting to hide liabilities and inflate assets; that lenders and securitizers frequently knew that the loans they sold and packaged were fraudulent or defective; and, of course, we also now know that Goldman Sachs and other investment banks sold securities they knew to be defective (they were often sold to pension funds for low-paid government employees, by the way) -- and that they designed many of these securities so that they could profit by betting against them after they were sold."

Another "Inside Job" Revelation

Business news followers will already be familiar with much of the film's main turf. And, of course, we all now know Alan Greenspan's heinous role in the whole mess. Even close readers may be surprised, however, at some of Ferguson's revelations. I was particularly struck by the complicity of the academic world in providing the intellectual underpinnings for the theories that led us off a cliff (for example: "It's a good idea to deregulate derivatives!")--for money. Larry Summers, Harvard's Martin Feldstein, and Columbia'sGlenn Hubbard come across as particularly culpable.

Intellectual Conflict of Interest

Here is an excerpt from an article by the director of "Inside Job" that throws some light that not all research is done objectively there may be compromises.

Over the past 30 years, the economics discipline has been systematically subverted, in much the same way as American politics - by money, especially from the financial services industry. Many of the most prominent economists in America are now paid to testify in Congress, to serve on boards of directors, testify in antitrust cases and regulatory proceedings, and to give speeches to the companies and industries they study and write about with supposed objectivity. This is not a marginal activity; it is now an industry, run by a half dozen large companies.

Some prominent academics have close ties to financial services yet neither their university employers nor the journals in which they publish require them to disclose their conflicts of interest, their financial positions, or the relationship between their financial interests and the policy positions they take.

It is time to end this. At a minimum, federal law should require public disclosure of all outside income that is in any way related to professors’ publishing and policy advocacy. It may be desirable to go even further, and to limit the total size of outside income that potentially generates conflicts of interest.

the justice is “half baked at best,”

An excerpt from Break the Banks

During the last two decades, major U.S. and European banks have paid fines to settle charges of, among other things, accounting fraud (Fannie Mae, Freddie Mac), assisting Enron’s fraud (Citigroup, J.P. Morgan), assisting people in tax evasion (UBS), using bribery to sell financial products (J.P. Morgan), money laundering (Citicorp), and fraudulently recommending stocks in exchange for business (10 investment banks in the dotcom era). In paying the fines, none of these banks acknowledged wrongdoing.

Now we’re witnessing another round of this shameful routine. President Obama and Attorney General Eric Holder Jr. have said they would hold Wall Street accountable for the crash, warning “unscrupulous executives,” in Holder’s words, that “we will investigate you, we will prosecute you, and we will incarcerate you.” But despite fraud on a scale possibly unmatched in history, the Justice Department has not charged a single executive or firm. The Securities and Exchange Commission, meanwhile, has extracted only fines from a handful of big banks. Three of the federal judges who oversaw these cases—none of which included an acknowledgment of guilt—protested from the bench, saying the fines are “not enough to deter anyone from doing anything,” the justice is “half baked at best,” and the banks are getting “a free ride.” (Holder has defended his financial-fraud task force, stressing “the totality” of its efforts, including cases against mortgage fraud and insider trading; SEC chairwoman Mary Schapiro has noted that the bulk of its investigations are “not necessarily” done.) 

BCG Growth - Share Matrix

An excerpt from Nudge Blog

How would a behavioral economist look at the BCG growth-share matrix? She might start by redrawing the axes and isolating the analysis to business units (or business unit workforce, perhaps). And what axes could be most appropriate? Procrastination and status quo bias.

The dog and star boxes should make sense to readers. In the cash cow category are high status quo bias and low procrastination. In other words, the business unit is working diligently and productively on its key product, while remaining oblivious to forward-thinking innovations. As long as the status quo is working in the marketplace, the unit will survive just fine. Then there is the unit that is not wedded to any status quo, but is stuck in a cycle of “tomorrow we’ll deliver.” Will that delivery ever arrive? Indeed, that’s a question mark.

Khan Academy

A statement from Khan Academy website.

The Khan Academy is a not-for-profit 501(c)(3) with the mission of providing a world-class education to anyone, anywhere.

We are complementing Salman's ever-growing library with user-paced exercises--developed as an open source project--allowing the Khan Academy to become the free classroom for the World.

Sal Khan: Bill Gates' favorite teacher - Aug. 24, 2010

Warren Buffet

Change Agent Bumper Stickers

Here are seven "Bumper Stickers" from Rosabeth Moss Kanter, change agent must be aware of these.

1. Change is a threat when done to me, but an opportunity when done by me.
2. A journey of a thousand miles starts with a single step.
3. If you don't know where you're going, any road will take you there.
4. Change is a campaign, not a decision.
5. When you come to a fork in the road, take it.
6. Everything can look like a failure in the middle.
7. Be the change you seek to make in the world.

Seven Truths about Change to Lead By and Live By - Rosabeth Moss Kanter - Harvard Business Review

Wealth and Happiness

Here is an excerpt from an article that provided an evidence that money can't bring happiness. It is an illusion. These thoughts are akin to Quranic teachings

Fair in the eyes of men is the love of things they covet: women and sons; heaped-up hoards of gold and silver; horses branded (for blood and excellence); and (wealth of) cattle and well-tilled land. Such are the possessions of this world's life; but in nearness to Allah is the best of the goals (to return to). Say: shall I give you glad tidings of things far better than those? For the righteous are gardens in nearness to their Lord with rivers flowing beneath; therein is their eternal home; with companions pure (and holy) and the good pleasure of Allah. For in Allah's sight are (all) His servants. (Ayat 14-15, Sura Al-i'Imran)

Say: "In the Bounty of Allah and in His Mercy in that let them rejoice": that is better than the (wealth) they hoard. (Aya 58, Sura Yunus)

 

It's a mystery why money doesn't make us happy, because it feels like it damn well should. With money we can buy whatever we want, go wherever we want, even be whoever we want. Surely that should make us happy? 

And yet study after study shows that in affluent societies money might bring satisfaction, but it doesn't bring much happiness.

Deficit Terrorist at work again

Here is a reproduction of a news item from DAWN

ISLAMABAD, July 12: While the rest of the country was fixated on the face-off between the media and the PML-N, Prime Minister Yousuf Raza Gilani was provided a reality check last week about the precarious economic situation in the country. He was warned by the finance ministry that with the fiscal deficit touching 6.2 per cent of GDP (Rs925 billion) last year, the government ran the risk of IMF backing out unless it earned Rs500 billion through additional revenue or reduce its expenditures drastically during the current fiscal year. More serious still, he was informed that the only way of controlling expenditures was to ask the provinces not to exercise their powers to raise additional funds under the new NFC award. This was the gist of the message hammered home during a presentation by Finance Minister Dr Abdul Hafeez Shaikh and his team to the prime minister during his visit to the ministry. A major headache in this regard, Dawn has learnt, is the overall fiscal situation which can deteriorate because of inter-corporation circular debt. This, according to the finance ministry’s estimates, will take a 25-30 per cent hike in electricity tariff during the current financial year to breakeven on this count. However, what makes this crisis unpredictable is that an increase in international oil prices or Pakistan’s failure to produce estimated amount of gas and hydel energy (which would mean more thermal energy and hence more oil) can push these numbers higher. No wonder then that the World Bank and the IMF, sources told Dawn, had estimated a 49 per cent increase in electricity rates. As a result, the government has no choice but to check its spending and improve revenue collection. The prime minister was informed that the government had exhibited little fiscal responsibility and failed to limit debt for the third year running because of financial indiscipline by the provincial governments. Hafeez Sheikh and his team pointed out that the provincial governments, which were expected to provide a surplus of about 0.6 per cent of GDP during the last financial year, ended up with deficits. The Punjab government closed its accounts with a Rs38 billion deficit, followed by Sindh at Rs27 billion and Balochistan Rs7 billion. As a result, the provincial governments together contributed about one per cent to the overall fiscal deficit of 6.2 per cent instead of helping to meet the 5.1 per cent target agreed with the IMF. The prime minister was also informed that Federal Board of Revenue had missed the revenue collection target by about Rs70 billion, excluding over Rs50 billion of refunds. The total revenue shortfall, therefore, remained in excess of Rs120 billion. If the refunds were also excluded, the fiscal deficit could be close to Rs1,000 billion. MORE BAD NEWS: The bad news for the prime minis ter did not end here. He was informed that the economic situation could further worsen because of the strong parliamentary opposition to the value-added tax (VAT). The reformed general sales tax could also face practical and administrative hiccups in case the Sindh government did not drop it insistence on collecting the tax on services. And if the government fails to introduce the uniform reformed GST across the country, it should stop counting on the IMF programme under which more than $2 billion is still to be transferred to Pakistan. As a consequence, the country will not be able to get bilateral and multilateral financial support, increasing the chances of a default. Mr Gilani was told that if the government wanted to avoid this situation it would have to persuade the provincial governments to check expenditures and prepare themselves for additional revenue generation. The problem the government may face is that the finance ministry cannot rein in the provinces and force them to spend less or to reduce their federal transfers in view of a consensus NFC award. Therefore, the prime minister had been requested to persuade the provinces to limit their spending to the last year’s level, notwithstanding additional shares they had thanks to the new NFC award to generate a surplus of at least 1.5 per cent of GDP (which translates to about Rs170 billion), the sources said. According to the sources, the prime minister assured the finance ministry officials that he would raise the matter with chief ministers on Tuesday.

TOP

It seems that these terrorists are developing their arguments for the total surrender of our autonomy, whatsoever is left, to IMF. To me this deficit and its consequences can be taken as a blessing in disguise as we, the masses, shall not be taking another burden of $2 billion that the IMF has yet to disburse. We all including the so called Servants of the country have to face the stark reality of living within our means so there would be automatic cut in expenditures, no need to worry about increasing trend in expenditures. As the saying goes " Necessity is the mother of invention", when there will be acute shortage of electricity on numbers of accounts, people will find a way to out of this seemingly impossible obstacle. And this necessity shall not be only in electricity but shall be everywhere and when you put the brains of some 200 million people on innovation, then everything and anything is possible. Moreover, we, the masses, shall be relieved of the rampant corruption as Muslims we have faith in Allah (SWT) that He is the One who has all answers to our miseries and as we have shown time and again that in adversity we turn toward Him for help and we then behave or try to behave as closely as possible as Allah (SWT) has ordained.

So, default and save the country from the plunderers.

Capital Structure and Its Determinants

Harris, M. and A. Raviv (1991) in their paper "The Theory of Capital Structure" identified four categories of factors that are responsible for determination of capital structure of a firm. These factors or as they put it "desires" are

• ameliorate conflicts of interest among various groups with claims to  the firm's resources,  including managers (the agency approach), 
• convey private  information  to capital markets or mitigate adverse selection effects  (the asymmetric  information approach), 
• influence  the  nature  of  products  or  competition  in  the  product/input market, or 
• affect the outcome of corporate control contests. 

The theories that it is to "ameliorate conflict of interest" and "affect the outcome of corporate control contests" have nothing to do with the basic purpose of the firm - to create value for stakeholders - and in all probability, these are satanic designs that ruin the firm in the end. If all the stakeholders are working according to the well defined norms of justice and fair play than why there is conflict of interest? The theory of Capital Structure to avoid agency costs that Jensen and Meckling identified lead the managers on the path of destruction since the managers are given incentives such as based on EVA etc. and managers when faced with -ve results try to manipulate the earnings in order to achieve the target and earn incentives, the examples are "Enron", "Worldcom", etc. Debt provides incentive to engage in suboptimal investment because  in debt  contract  there is an implicit provision  that  if  an  investment  yields  large returns, well  above  the face value of the debt, equityholders capture most of the  gain.  If,  however,  the  investment  fails,  because  of  limited  liability, debtholders  bear  the  consequences in case liquidation is insufficient to cover the entire amount of debt. So clever managers who would like to hold on to power would go for the higher debt equity ratio and this is the strategy that comes to mind immediately there is any threat of take over. But that is a dangerous path to move on because debt has to be paid at some fixed time in future and that future is highly uncertain. Uncertainty coupled with fixed nature of debt commitment puts the managers under pressure for results and that is where the best laid out plans fall apart and lead the managers to play games.

The theory that capital structure decison is to convey inside / private information to market means it is used / can be used as a deception. Why can't we convey inside information in a straight forward manner without taking any steps that can lead the firm on the road to destruction? If the answer is no, then something is wrong that is being dragged under the rug. Information asymmetry between insiders and outsiders cause different value for the firms' assets and that may result in financing a new project / investment opportunity by existing owners / managers with debt if internal fund are insufficient - pecking order theory of capital structure. This pecking order begins when outsiders have some serious doubts about the information not available to them and that makes them suspicious. The question is why such asymmetry of information in the first place? Market, it seems always thinks of the information asymmetry that is why  "Noe shows that the average quality of  firms  issuing  debt  is  higher  in  equilibrium  than  that  of  firms  issuing equity.  Therefore,  like Myers-Majluf,  Noe's model  predicts  a  negative  stock market response to an announcement of an equity issue. Noe  also predicts a positive  market  response  to  an  announcement  of  a  debt  issue." There is always mistrust of managers by the market about firm's inside information. Why can't insiders speak the truth? Or why can't market take the words of insiders to be true on its face value unless otherwise proved? Is there lack of trust or lack of reputation? Because of lack of trust and distortion of communication between management and market, the market tends to heavily tilted towards the debt, which promises a fixed return irrespective of any reference to profit / (loss) - a figure that is highly questionable from the point of view of the outsiders for numbers of reasons but mainly on account of asymmetry of information. 

Leverage changes the behavior of the firm and its strategy because a levered firm assumes a sure commitment of periodic fixed payment to debtholders to remain in business. In the face of debt, it is very difficult to sustain high quality. Because quality can only be achieved through truth - speaking truth about its systems, products, people and speaking truth to its suppliers, customers, but when a firm has a debt to pay its ability to speak truth is highly undermined. This is even more true in case of an adverse forecast or less than expected results then the deviations from the straight path take start. All information asymmetries, conflicts of interests, contests for control of firm and competitive strategies move in different directions than the relevant theoretical models predict. 

Capital Structure Decision and Firm Value

According to famous MM proposition I, value of the firm is independent of its capital structure - firm value is invariant to its financial structure. They proved this proposition mathematically. Intuitively this proposition hold value. Valuation of a firm is a function of its expected earnings over time capitalized at an appropriate rate for its given risk class. Critics, however, are ready to point out that value of the firm can be increased by taking tax advantage of debt, which has been rejected by the MM by going over the investors' side and taking help from personal Income Tax. The value maximization criticism can't be overruled as a firm's net after tax cash inflow to firm increase with the addition of debt in the capital structure. 

Inherent in the discussion on capital structure decision is that EBIT of a firm is independent of its financing structure. Expected earnings are a function of assets' earning capacity and its productivity and this has nothing to do with how the assets are financed. But "DEBT is as powerful a drug as alcohol and nicotine. In boom times Western consumers used it to enhance their lifestyles,companies borrowed to expand their businesses and investors employed debt to enhance their returns." Can we say that inclusion of debt in capital structure is synonymous to introduction to a healthy person "drug and alcohol"? In the words of Hyman Minsky, an American economist "these debt crises were both inherent in the capitalist system and cyclical. Prosperous times encourage individuals and companies to take on more risk, meaning more debt. Initially such speculation is successful and encourages others to follow suit; eventually credit is extended to those who will be able to repay the debt only if asset prices keep rising (a succinct description of the subprime-lending boom). In the end the pyramid collapses." 

The problem with debt is that it needs to repay it. That is where the problem starts. The need to repay something in future and future is a t the very best is a mere guess - uncertain. This compulsory payment in future coupled with uncertainty about future is the root cause of the problem that needs to be probed into and analysed thoroughly. A firm which has future obligations for payment must meet the minimum necessary to honor its commitments. In the words of Merton H. Miller "The firm pays  its debts not just  because the  law says it must, but because the value of  the stock to  its shareholders is  greater  to  them  if  the  firm  pays  the  debts  than  if  it  doesn't." So  to remain on the same level of value before inclusion of debt in the capital structure, a firm has to honor its commitment to pay the debt obligation and has to earn a minimum to honor that commitment. This compulsory or mandatory nature of target puts some kind of an extra pressure on the levered firm as compared to unlevered firm. Because of that extra pressure, the EBIT of a levered firm may be different than an unlevered firm keeping everything else same.

Too Big To Fail is a New Way to Fraud

Here is a reproduction of a blog entry that shows the ugly face of capitalism.

As prospects before BP get darker by the day, and the likelihood of bankruptcy grows, the TBTF propaganda begins. Evidence A - Bloomberg headline: "BP Demise Would Threaten U.S. Energy Security, Industry." Just as the failure of bankrupt banks was supposed to lead to the destruction of capitalism, so the bankruptcy of BP plc is now supposed to lead to the degeneration of US energy independence. And who in their mind would force the Chapter 11 of a systemically important company? Once again, free market capitalism is about to walk out through the back door...

So now that we know BP is the new AIG, and the new media campaign is to paint it as this year's TBTF, the only question we need to ask is how many billions in CDS has Goldman sold that reference the BP, and/or how many billions in counterparty risk the firm has outstanding with BP? Surely the answer is "lots", and a simple and elegant solution that would prevent the domino effect that bring take down Goldman and its peers, is the taxpayer funded bailout of the energy giant, which has quietly morphed into another too big to fail company. The opportunity cost, of course, is a ten million march of all soon to be terminally unemployed, and very agnry, gulf workers headed toward D.C. and 200 West.

Deficit Terrorists

The financial sector, which controls the money supply and can easily capture the media, cajoles the populace into compliance by selling its agenda as a “balanced budget,” “fiscal responsibility,” and saving future generations from a massive debt burden by suffering austerity measures now. Bill Mitchell, Professor of Economics at the University of New Castle in Australia, calls this “deficit terrorism.” Bank-created debt becomes more important than schools, medical care or infrastructure. Rather than “providing for the general welfare,” the purpose of government becomes to maintain the value of the investments of the government’s creditors.

England’s new coalition government has just bought into this agenda, imposing on itself the sort of fiscal austerity that the International Monetary Fund (IMF) has long imposed on Third World countries, and has more recently imposed on European countries, including Latvia, Iceland, Ireland and Greece. Where those countries were forced into compliance by their creditors, however, England has tightened the screws voluntarily, having succumbed to the argument that it must pay down its debts to maintain the market for its bonds.

Deficit hawks point ominously to Greece, which has been virtually squeezed out of the private bond market because nobody wants its bonds. Greece has been forced to borrow from the IMF and the European Monetary Union (EMU), which have imposed draconian austerity measures as conditions for the loans.

DEFICIT TERRORISTS STRIKE IN THE UK - USA NEXT?

Balancing Task-Focus with Goal-Focus

"So establish weight with justice and fall not short in the balance." Aya 9 of Sura Ar-Rahman


Recent psychological research suggests one of the keys to getting big projects done is balancing up individual tasks against the grand vision. It's all about knowing when to flip the frame of reference from looking closely at the details of individual components of a project, and when to look up and see the project's grand sweep.


How we react to failure along the way is a clear predictor of ultimate success (or otherwise). That's why Houser-Marko & Sheldon (2008) set up an experiment to see how people reacted to failure depending on whether they were thinking about the individual task or their overall goal.


What they found was that being told they were doing badly made participants feel bad and lowered their motivation. No surprise there. But what they were really interested in was whether their level of focus - either on the individual task or the overall goal - affected their motivation. They found that it did: those told they were doing badly but only on the specific task didn't feel as bad, and didn't expect to do so badly in the future, as those who were focusing on their primary goal. So it seems that when doing badly on a task it's better to keep focusing on the individual task rather than start contemplating the ultimate goal.

Here's what the research means in practical terms:

• To stick to a task, while carrying it out, keep the ultimate goal in mind. Self-control is increased by global processing, abstract thinking and high-level categorisation. Taking the first step on the long road to your goal may require a greater focus on the destination.
• When evaluating progress on hard tasks when the chance of failure is high, stay task-focused. At the start of your journey, when evaluating progress, it's often better to focus on the individual steps. Comparing recent failure with the ultimate goal destroys motivation - instead narrow focus to succeeding on the individual task.
• Once tasks are easier or the end is in sight, a goal focus is once again the psychological approach to choose. It increases positive emotion, decreases negative emotion and increases perceived performance.

Think of it like a 100 hundred metres runner. Moments before the race they look off into the distance, in the general direction of the finish line. Moments after the starting gun fires they stare down at the ground and their feet. Smoothly the head comes up, then, towards the end of the race, they have just one focus: the line.

Only most projects take a little longer than 9.69 seconds.

Halal Phenamenon

Here is an excerpt from an article on "Halal Branding"

THE world is slowly but surely realising the importance of the "halal" branding as major companies around the world move in to capture a global Muslim community, where the "ummah" brings together nearly 1.8 billion people around the world.

The majority of those people are in Asia, particularly South and East Asia. It's also a very young demographic - 52% are under 24. This means a trend-setting, ambitious, and internationally connected market is at hand here.

"Halal" according to Islam is very different than it is being projected as "the authenticity and cleanliness of the product".

"Halal (Arabic:حلال, ḥalāl; means lawful or legal) is a term designating any object or an action which is permissible to use or engage in, according to Islamic law."

We, the Muslims have no concern with anything other than it is permitted by Allah (SWT) or not. There is no such thing as "clean" or "Authentic" in any other sense. Any thing can be clean and authentic but if not permitted by Allah (SWT), it is not Halal.

He hath only forbidden you ...............................and that on which any other name hath been invoked besides that of Allah (Aya 173 of Sura Al-Baqara)

Behavioral Traps

Behavior means actions or reactions of a person or animal in response to external or internal stimuli. It is the mind that sends signal to different parts of the body to act or react to any exteral or internal reason for such an action. Normatively speaking everybody is rational unless otherwise proved. By being rational, we tend to behave rationally, means behaving logically, based on reason. That is where the danger lies.

Our minds set up many traps for us. Unless we're aware of them, these traps can seriously hinder our ability to think rationally, leading us to bad reasoning and making stupid decisions. Features of our minds that are meant to help us may, eventually, get us into trouble.

Here is a list of 10 such traps.

1. The Anchoring Trap: Over-Relying on First Thoughts - Your starting point can heavily bias your thinking: initial impressions, ideas, estimates or data "anchor" subsequent thoughts.
2. The Status Quo Trap: Keeping on Keeping On - We tend to repeat established behaviors, unless we are given the right incentives to entice us to change them. The status quo automatically has an advantage over every other alternative.
3. The Sunk Cost Trap: Protecting Earlier Choices - You pre-ordered a non-refundable ticket to a basketball game. On the night of the game, you're tired and there's a blizzard raging outside. You regret the fact that you bought the ticket because, frankly, you would prefer to stay at home, light up your fireplace and comfortably watch the game on TV. What would you do?

It may be hard to admit, but staying at home is the best choice here. The money for the ticket is already gone regardless of the alternative you choose: it's a sunk cost, and it shouldn't influence your decision.

4. The Confirmation Trap: Seeing What You Want to See - You feel the stock market will be going down and that now may be a good time to sell your stock. Just to be reassured of your hunch, you call a friend that has just sold all her stock to find out her reasons.

Congratulations, you have just fallen into the Confirmation Trap: looking for information that will most likely support your initial point of view - while conveniently avoiding information that challenges it.

This confirmation bias affects not only where you go to collect evidence, but also how you interpret the data: we are much less critical of arguments that support our initial ideas and much more resistant to arguments against them.

No matter how neutral we think we are when first tackling a decision, our brains always decide - intuitively - on an alternative right away, making us subject to this trap virtually at all times.

5. The Incomplete Information Trap: Review Your Assumptions - We keep mental images - simplifications of reality - that make we jump to conclusions before questioning assumptions or checking whether we have enough information.
6. The Conformity Trap: Everybody Else is Doing It - This "herd instinct" exists - to different degrees - in all of us. Even if we hate to admit it, other people's actions do heavily influence ours. We fear looking dumb: failing along with many people is frequently not considered a big deal, but when we fail alone we must take all the heat ourselves. There's always peer pressure to adopt the behaviors of the groups we're in.

7. The Illusion of Control Trap: Shooting in the Dark - Even in situations we clearly can't control, we still tend to irrationally believe that we can somehow influence results. We just love to feel in control.

8. The Coincidence Trap: We Suck at Probabilities - This means that the "miracle" is not only possible but - given enough attempts - its likelihood increases to a point of becoming almost inevitable.

9. The Recall Trap: Not All Memories Are Created Equal - What happens is we analyze information based on experience, on what we can remember from it. Because of that, we're overly influenced by events that stand out from others, such as those with highly dramatic impact or very recent ones. The more "special" an event is, the greater the potential to distort our thinking.

10. The Superiority Trap: The Average is Above Average - With few exceptions, people have much inflated views of themselves. They overestimate their skills and capabilities, leading to many errors in judgment.