Samples of Financial Writing
Omega Capital Advisors, LLC
Exceptional asset-management capabilities in the service of high-net-worth families and individuals
Omega will design a portfolio-management strategy that addresses your goals, wishes and concerns. We will offer you investment advice within the context of a fiduciary relationship. We will recommend the asset allocations we believe best can protect your wealth, grow your wealth and preserve its purchasing power. For security selection, we will rely upon fund managers of proven ability. We can control and minimize your capital-gains taxes. MORE
Option Pricing—
Black-Scholes Made Easy
A few years ago, a senior strategist at one of the world's leading investment firms told me something quite profound.
"Many people," he said, "gain some understanding of the stock market. Then they apply that way of thinking to the options market. Usually these people do not fare very well."
"A much smaller group of people gain a sophisticated understanding of options-pricing theory. They then apply this way of thinking to the options market and to the stock market. These people have a superior understanding of both markets. They tend to fare extremely well."
In 1997, the Nobel Prize in Economics was awarded for the work that led to Black-Scholes Options-Pricing Theory. Black-Scholes has become the fundamental way of understanding the relationships among options prices, stock forecasts and expected stock-market volatility. MORE
History is just one damn disintermediation after another
For decades, financial institutions have witnessed successive waves and different forms of disintermediation. Mutual funds and IRAs sucked savings out of banks. Commercial paper cut banks out of a lot of corporate borrowing. Electronic settlement left the DTC and a few specialized institutions with most of the securities clearing business. For many individual investors, index funds did away with the need for an asset manager.
Now the Internet promises to link consumers and businesses more and more directly to the computers where financial assets and liabilities live and where transactions take place. Firms may not necessarily get disintermediated, but more and more traditional bank jobs are becoming superfluous. The Internet may prove to be the greatest disintermediator of all. MORE
Price Convergence Strategy
At the Poseidon Fund, we see the opportunity for sophisticated investors to profit handsomely from a chain of events that occur over and over. Participants in the world's major financial markets frequently overreact to political, economic, and financial news. When they do, they bid prices of some stocks and bonds below or above their economic values. MORE
Pension Benefit Guaranty Corporation's risk model calculates
1-in-20 chance that in 2011 the corporation's financial position will be $22 billion or more in deficit
Established by the U.S. government in 1974, the Pension Benefit Guaranty Corporation currently guarantees pension benefits to about 44 million workers in slightly more than 35,000 defined-benefit pension plans. When plan sponsors are unable to meet pension obligations, PBGC steps in.
With so many potential claimants, PBGC is vulnerable to large losses that may have low probabilities. Future claims are sensitive to changes in interest rates and stock returns, overall economic conditions, underfunding in large plans, success or failure of sponsors in particular industries, and rates of bankruptcy of plan sponsors. Failure of a few large sponsors can generate large dollar amounts of claims. Future courses of these factors are uncertain.
To evaluate its risk exposures, PBGC uses a stochastic model- the Pension Insurance Modeling System (PIMS). Into the model PBGC feeds measures of historical behavior (including volatilities, autocorrelations and intercorrelations) of stock returns, interest rates, bankruptcy rates of defined benefit plan sponsors, and relationships between bankruptcy rates to financial ratios, employment counts, and pension data. PBGC also feeds in detailed data on the current state of a set of actual pension plans, which they weight to represent the PBGC-insured, single-employer universe, and data on the current financial health of plan sponsors. MORE
Allocating Pension Assets to Mortgage-Backed Securities
Win: An ancient Chinese curse says, “May you live in interesting times.” A number of factors make these times especially interesting for you who are responsible for your companies' pension funds.
High returns over the past five years or so in both the stock and bond markets lowered the effective costs of funding pension liabilities. In many cases these high returns generated cash surpluses in pension funds.
Many companies tapped their surpluses and plowed the cash back into operations.
But, just as some of your CEO's were getting used to funding pension liabilities cheaply and even finding the pension fund to be a source of cash, high prices in the stock and bond markets have lowered yields and expected returns. The lower yields and expected returns have eroded surpluses. Some companies are worried that their surpluses may disappear.
The discounted-cash-flow calculations that determine pension liabilities generate higher liabilities in times of low interest rates.
Meanwhile, while you're trying to explain these interrelationships and their implications to your company's CEO and investment committee, more and more of the assets that you can invest in are derivative products--products that owe their existence to complex mathematical computations.
But what, you may ask, has all this got to do with mortgage-backed securities?
The factors that make your professional lives interesting--in the Chinese sense-- are risks, yields, interest rates, and mathematical complexity. This too happens to be what mortgage-backed securities are about: risks, yields, interest rates and mathematical complexity.
"So what?" you may say, "That's what all investments are about."
True enough, but for mortgage-backed securities, the interactions among these factors are different than they are for stocks and for other bonds.
To decide if there's a place in your pension portfolio for these unusual instruments, you might want to know how risks, yields, and interest rates interact for mortgage-backed securities. You might want to know some of the simple principles that lie behind the complex mathematics. MORE
Seminar Notes: How to Value Stock Options in Divorce Proceedings
In many divorces today, one spouse’s employee stock options account for a significant portion of the marital wealth to be divided. Even so, courts have yet to establish or recognize standard and reliable procedures with which to value these assets.
Valuing employee stock options in divorce proceedings presents a number of difficulties: In financial professions, Black-Scholes and risk-neutral methodologies are widely used and accepted for valuing market-traded stock options, but— as usually explained— these methodologies can be difficult for the non-mathematician to understand. Depending on the factual context of a particular set of employee stock options, these methodologies may be applicable, may not be applicable, or may be applicable only as a starting point for the valuation of the options.
To add to the potential for confusion, what are commonly referred to as option grants often— in two respects— do not in fact grant options: What the grants define as options may not conform with the definition of a market-traded option on which accepted valuation methodologies rely. Even what the grants themselves define as options they may not actually grant to the employee at the time of the so-called grant.
Interspersed with some words being used to mean things other than what they mean, other words may carry different implications within the legal and financial professions. In the legal realm, if an attorney successfully lambastes a financial prospect as speculative or as an expectancy, a court may be inclined to regard the prospect as being of zero dollar value. By contrast, in the financial realm, a speculator is defined as someone who expects to profit by taking on exposures to risk. In the financial realm, every forecast is a probability distribution. An expected return is defined as the probability-weighted average return of a given forecast. While speculative ventures and expectancies may get thrown out of court, without speculators and expected returns the financial markets might grind to a halt.
Of a perhaps more esoteric but nonetheless real concern is whether and how courts regard risk in their valuations of employee stock options. The essence of stock options is uncertainty about the future market price of the underlying stock on which the option is written. Valuing options requires moving uncertain values across time. Accordingly, under the standard valuation methodologies, the value of an option is a probability-weighted present value. In a sense, the probability-weighted present values used to value options ignore how risk averse an employee may be to having a substantial portion of his or her wealth concentrated in an asset of highly uncertain future value. Does a high likelihood that the employee spouse may reap no payoff from the options somehow— rationally or psychologically— diminish the legitimacy of a probabilistic approach to valuing them?
Even if a judge, the spouses’ attorneys and their respective expert witnesses were working collaboratively to arrive at a fair valuation of employee stock options, the task could be daunting. Thrown into the adversarial process, the task has the potential to prove maddening to all.
To make it easier for judges, attorneys, and divorce financial planners to arrive at fair valuations of employee stock options, I here offer a conceptual context for thinking about the fair value of options and a sequence of steps for calculating that value. To begin, we look at how the potential payoffs of market-traded options translate into option values. Then we look at ways to apply these principles to employee stock options. Our goal is to calculate values for employee stock options that are consistent with the values of market-traded options and that compensate the employee spouse for his or her continued exposure to uncertainty. MORE.
Jerry Marlow, MBA
Freelance Financial Writer
(917) 817-8659
jerrymarlow@jerrymarlow.com
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