Retirement Options

When dealing with option valuation, you should always remember is that an option always has value until it is exercised or expires. And, more importantly, an option can never have a negative value. COVID-19 lockdowns and the resulting economic uncertainty have affected many colleges and universities. In August, a top private university offered its faculty members over 70 a chance to accept a buyout if they retire by June 2021. In response, the faculty responded negatively to the buyout plan, essentially arguing against being offered something of value, the option to retire with a buyout, for nothing.

Dividend Payments Resuming

A recent Wall Street Journal article highlights part of the economic recovery from the COVID-19 shutdowns. In the spring, 42 S&P 500 companies announced dividend suspensions. To date, six of these companies have announced the resumption of dividends, and several others have announced a timeline for doing so. For example, Kohl's announced that it intends to resume dividends in the first half of 2021 after a smaller revenue drop compared to the previous quarter. Likewise, General Motors expects to resume dividend payments in mid-2021.

VC Hits Record

Even though economic shutdowns from COVID-19 have slowed the economy, it hasn't affected the venture capital market. Andreessen Horowitz closed two $4.5 billion funds, increasing the total venture capital raised in 2020 to $69.1 billion, surpassing the previous record of $67.8 billion raised in 2018. However, there were 589 VC funds started in 2018, but only 287 VC funds started in 2020. As the numbers show, there are fewer, but larger, VC funds started. 

McRib Investing

Although many people love the McRib, an even more important discovery has been made: You can make money investing in the stock market by investing in the McRib! Surely we jest, and we do. A recent article highlights the McRib effect, that is, the stock market as a whole has a higher return when the McRib is avialable. While this is a fact, as the article points out, there is an important distinction between causality and correlation. And while the McRib anomaly may tickle your ribs, it does highlight that many market analysts will tell you why the stock market rose or fell on a particular day. Most, if not all, are inferring causality when only correlation is present.

COVID-19 Stock Trading

In a positive announcement in the fight against COVID-19, on Monday, Pfizer announced a vaccine that is more than 90 percent effective. That day, Pfizer's stock rose about 10 percent. But a strange thing happened: Albert Bourla, the CEO of Pfizer, sold $5.6 million of the company's stock. The stock sale was part of a 10b5-1 plan. A 10b5-1 plan allows company executives to prearrange stock sales with a broker to avoid the appearance of insider trading. In Bourla's case, the 10b5-1 plan was put in place on August 19. However, some have scrutinized Bourla's plan as on August 20th, the company had a press release announcing new Phase 1 testing date. 

Goldman Fined And Claws Back Compensation

Goldman Sachs agreed to pay a $2.3 billion fine and disgorge $600 million in profits related to the Malaysian 1MDB scandal. Goldman employees bribed foreign officials and aided fund officials in misappropriating money from the fund. One Goldman banker has already pled guilty to criminal charges and another has his case still pending. Goldman has also clawed back $174 million in bonuses and reduced salaries from individuals involved in the scandal and their supervisors.

An Interview With Eugene Fama

Recently, an interview with Nobel laureate Eugene Fama, who laid the foundation for the efficient markets hypothesis, was published by The Market/NZZ. The wide-ranging interview covers topics from the problems with growing government debt, stock market bubbles, the efficient markets hypothesis versus behavioral investing, the reason for negative oil prices, and negative interest rates. Professor Fama also discusses his belief that the power of central banks is much more limited than many believe. The interview is definitely worth a read.

Big Bang Goes Off Smoothly

It appears that the "big bang" over the past weekend went relatively smoothly. The big bang was the transition from LIBOR to the Secured Overnight Funding Rate (SOFR) for exchange-traded swaps at the Chicago Mercantile Exchange. The LIBOR scandal in 2012 caused regulators and market participants alike to search for another reference interest rate that was less susceptible to manipulation. In the U.S., SOFR has become that reference interest rate.

Universities And Pensions Underperform

We recently discussed the underperformance of Harvard's endowment fund, but it appears that Harvard is not alone. A recent article shows that the endowment funds of major universities have underperformed the market by abut 1.6 percent per year. What is so interesting about that 1.6 percent? That is the average management fee paid by the endowment funds! In other words, the overall investment performance is the same as the market, but once fees are accounted for, performance lags the market. Of course, public pension funds have performed slightly better, only underperforming the market by about 1 percent.

SRI Hits Oil Companies

It appears that socially responsible investing (SRI) is affecting at least some oil companies. Five of the largest six banks have decided that they will no longer finance drilling projects in the Artic. As renewable energy becomes more widely used, oil and gas reserves may become less valuable. At the same time, since bank financing appears to be drying up, financing for the industry becomes more difficult to obtain.

Market Trounces Harvard

So how hard is it to beat the market? From 1993 to 2008, the portfolio managers of Harvard’s endowment fund beat the S&P 500 by almost five percent per year. A major contributor to that performance was a hugely successful investment in timber. Since then, things have not been so rosy (or even Crimson). Using the analysis in the article, the Harvard endowment fund has underperformed a blended portfolio of stocks and bonds by one percent per year over the past 20 years. Based on the current endowment value of $42 billion, this means the endowment potentially lost out on $420 million in growth per year, or roughly $8.4 billion dollars of growth over this period. It is tough for the best and brightest to beat the market.

Austria's 100-Year Bonds

In 2017, Austria issued 100-year bonds with a paltry yield of 2.112 percent. But recently, the country issued more 100-year bonds with the unbelievably low yield of .88 percent! And the issue was four times oversubscribed, meaning investors were willing to buy four times the amount of bonds than were being offered. Given the ultra-low interest rate environment, investors appear to be taking risks too attain any positive yield. For example, half of the German government debt has a negative yield, and the yields on Austrian government debt with less than 20 years to maturity are negative as well. 

Thiel In Control

Palantir Industries, the data-mining company owned by billionaire Peter Thiel, went public this week. But take note, if you buy stock in the company you will have virtually no say in the company's operations. Thanks to super-voting shares, Thiel and two other co-founders will retain voting control in perpetuity. Other Silicon Valley companies like Alphabet, Facebook, and Snap have similar voting structures. As Ohio State professor Michael Weisbach notes, "They  set it up so Peter Thiel can still sort of run it like a private company and still have the advantage of being public." The three co-founders will retain 49.99 percent of the voting power in the company regardless of the number of shares owned.    

Harley-Davidson Abondons India

Harley-Davidson announced that it was discontinuing manufacturing and sales in India, effectively abandoning the world's largest motorcycle market. Harley-Davidson joins the list of foreign manufacturers that have not been able to enter the Indian market, including General Motors, which stopped sales in India in 2017, and Ford, which entered a joint venture to scale back its Indian operations. These companies all exercised the option to abandon.

Dividend Comeback

Dividends took a major hit during the early part of the COVID lockdown, with numerous companies cutting or eliminating dividends. Now it appears that dividends are making a comeback. In August, 13 S&P 500 companies announced dividend increases, but only two companies announced a dividend cut. Remember, a company will generally only increase dividends if it believes that it can maintain that dividend in the future. Overall, this appears to be an indication that these companies believe the worst of the economic crisis may be over.

Loyalty Backed Bonds

Delta announced that it would issue $6.5 billion worth of new bonds. What is particularly interesting is that the bonds will be backed by the company's SkyMiles loyalty program. Although Delta did not disclose the value of SkyMiles in the announcement, United Airlines issued debt in June backed by that company's MileagePlus program, which it valued at $20 billion.

NPR Goes Junk

 A recent podcast from Planet Money on NPR details the purchase of a junk bond issued by Hornbeck Offshore. Hopefully, the initial purchase was designed for the podcast, not as an investment. For example, the bond was purchased because it had the lowest price, which means the bond had the highest yield to maturity because it was likely the closest to bankruptcy. If you listen to the podcast, you will find out that the company did eventually go through a bankruptcy reorganization. One of the most perceptive comments made after the bond was initially purchased was that it would not likely make it to maturity. The podcast is worth a listen since it is an interesting journey of the purchase of a junk bond through the bankruptcy process.

BMW's Operating Leverage

 A recent Wall Street Journal article highlights the operating leverage for several auto manufacturers. For example, BMW lost €666 million ($784.1 million) during the most recent quarter. A large part of the loss was due to the company's operating leverage. BMW loses $.43 for every dollar of lost sales, which of course means that the company gains $.43 for every increased dollar of sales. By way of comparison, Fiat Chrysler's operating leverage is about 18%, GM's is about 20%, and Ford's is about 25%. As a result, we would expect BMW's earnings to be more volatile when compared to other auto companies.

Currency Fluctuations Damage Earnings

In its latest report, Kyriba estimates that North America companies earnings fell by $10.77 billion due to currency fluctuations last quarter. The most common currencies affecting earnings were the Brazilian real, the euro, and the Mexican peso. The industry that was most affected was Healthcare Equipment & Supply. In contrast, European companies had a negative earnings impact of $1.44 billion.

Amazon Acqui-Hires Zoox

Amazon offered $1.3 billion to buy Zoox last month. So what are you buying when you buy a tech company? Since there are often limited fixed assets, generally, you are seeking to get the employees. In this case, two Zoox senior engineers had already accepted offers from other companies. So Amazon upped the offer by $100 million to compensate the employees who stay after the acquisition. The new condition of the acquisition is that all of the employees on a "key list" must stay and at least 19 employees on a second list must stay. Finally, three schedules of other employees was created. 90 percent of the employees on the first two schedules must stay and 88 percent on the lowest schedule must stay, otherwise, Amazon can walk away from the deal.

Kia's Home Run

When Kia debuted the Telluride, the company set production capacity at 60,000 units. Demand was so high that the company upped production to 100,000 units, but one couple has already waited 9 months for their SUV and they were told to expect another 5-6 month wait. A production shutdown due to COVID-19 has slowed delivery and once production restarted, a parts shortage still limited manufacturing. Obviously, sales of the Telluride is a best-case scenario for Kia, although production difficulties means the best-case has been limited to date. One other thing we want you to note is terminology. The article states that the turn rate was 11 days for most of the year, but it is currently at 0 days. The turn rate is the same as the days' sales in inventory ratio we discussed in the textbook.

Total Cost To Reward And Retain Employees

As we mentioned in the textbook, there are numerous other ratios that can be calculated and analyzed. The American Productivity & Control Center (APQC) is advocating a new ratio, the total cost to reward and retain employees (TCRRE). This ratio is calculated by summing costs for compensation, benefits, payroll processing, award/incentive administration, and employee assistance, divided by sales. In using this ratio, APQC argues that a low TCRRE ratio may indicate that a company may be spending too little on employees, which can result in lower morale or employee satisfaction. However, as with most other ratios, there is no absolute measure for this ratio. In this case, the ratio is determined in large part due to the company's size, culture, internal reward, and retention practices.

It's Bobby Bonilla Day!

It is a New York holiday (at least until 2035) that you may not be aware of, Bobby Bonilla Day. What is Bobby Bonilla Day? In 2000, the New York Mets owed Bonilla $5.9 million to buy out his contract. Rather than pay the lump sum, Bonilla and the Mets agreed to a payment of about $1,193,248.20 every July 1st for 25 years, starting on July 1, 2011. The agreed upon interest rate was 8 percent. So, the former Mets slugger will be receiving payments until 2035, when he turns 72, 36 years after he last played for the team.

Fintech

So what is Fintech? Fintech is a broad term, covering direct money transfers, crowdfunding, and direct to consumer lending. But an important part of fintech is embedding financial products in everyday consumer and business products. For example, Amazon offers free credit on every purchase, although it is often better to use an Amazon credit card for a 5 percent discount, assuming that you pay your credit card bill every month. Of course the Amazon credit card and the Apple credit card are actually fintech services as well. But Amazon went even further, partnering with Goldman Sachs to offer small business loans of up to $1 million to its merchants. Shopify has also rolled out loans to its customer base, loaning out over $750 million to date. A big advantage for existing companies in offering financial products to existing customers is a built-in client base, as well as knowledge of what financial services a customer may need.

Wirecard Turmoils

Creditors of German digital payment processor Wirecard, which advertised "Beyond Payments," may find that the company's debts are beyond payment. Wirecard also proved that accounting fraud is unfortunately worldwide when it filed for bankruptcy yesterday. The company said that €1.9 billion ($2.1 billion) in cash that was on its balance sheet probably never existed in the first place. Now, things have gotten bad for the company's auditors as the German shareholder association SdK announced that it had filed a criminal complaint against the company's auditor Ernst & Young (EY). SoftBank, a major investor, also announced that it planned to file against EY. In its defense, EY stated there were "clear indications that this was an elaborate and sophisticated fraud, involving multiple parties around the world at different institutions, with a deliberate aim of deception" and that "even the most robust and extended audit procedures" were not enough to uncover the fraud.

Day Trading For Profit?

In our opinion, a negative financial outcome of the COVID-19 pandemic is the rise of day trading. Dave Portnoy, the CEO of Barstool Sports, has named himself "Davey Day Trader" and helped popularize day trading. And although not all are day trading accounts, Robinhood added 3 million accounts during the first quarter of 2020. One new investor, a 20-year old from Nebraska, tragically committed suicide after his account balance showed a loss of over $700,000. In fact, his account balance may have only been temporary until trades settled. It is important to note that short-term investors tend to do worse than longer term investors, and for day traders, the success rate is less than 10 percent, with only 1 percent or so who really make money. We do believe that investing is worthwhile, but do your research, diversify, and make longer term decisions.

Hertz SEO

We had previously discussed the Hertz bankruptcy filing. In an indication that the current economic conditions caused by the COVID-19 lockdown are unique, Hertz is planning a secondary stock offering while in bankruptcy. An SEO in the middle of a bankruptcy filing has never been attempted before. The company has warned prospective shareholders that it is unlikely that they will receive anything in bankruptcy, and barring a rapid improvement in the company's prospects, will almost certainly be wiped out. Based on the current stock price, Hertz hopes to raise $500 million. Hertz currently owes about $2.3 billion. This is certainly an SEO we are not trying to jump in line to buy.

Misunderstood Dividends

As we have stressed in the textbook, an investor should be indifferent between dividends and capital gains. And, in a world with higher taxes on dividends than on capital gains, investors should prefer capital gains. A recent WSJ article discusses the fact that many investors prefer dividends. In fact, the British Investment Association, which represents investment managers in the UK, argued that companies should not reduce dividends. It is surprising that professional investment managers would have such a strong view on high dividends. The preference for high dividends also appears to affect corporate finance as well. One survey mentioned in the article finds that about two-thirds of CFOs admit they would forego profitable projects if undertaking these projects would result in a dividend cut.

Book Value Versus Market Value

Rental car giant Hertz recently filed for bankruptcy. The bankruptcy is for the rental car company, while Hertz Vehicle Financing, which owns and finances the purchases of vehicles, is not included in the bankruptcy. While we will discuss bankruptcy later in the text, this filing does allow us to show the difference between book values and market values, a concept that can cause confusion for students. The 6th full paragraph of an article about the bankruptcy states:  

"A major factor in the timing of the bankruptcy filing was the $389.5 million monthly lease payment that included an additional $135 million "true-up" payment for difference between the depreciated value compared to the book depreciated value."

If you read this carefully, the timing of the bankruptcy was chosen because Hertz car rental could not make the additional payment of $135 million to account for the difference between the book value and market value of the cars it leased from Hertz Vehicle Financing. In other words, the combined market value of the cars leased by Hertz car rental was $135 million less than book value. 

Warner Music's IPO

Warner Music Group has announced that it will continue with its IPO. The company plans to offer 70 million shares at a price of $23 to $26 per share, which would raise about $12.5 billion. An interesting part of the IPO is that all of the funds raised in the IPO will go to current shareholders and the company will receive no cash. Additionally, Access Industries, the current majority shareholder, will retain more than more 99 percent of the voting rights.

Good News For Student Borrowers

If you have a student loan, there is good news. The interest rate on new undergraduate student loans has fallen from 4.53 percent to a record low of 2.75 percent. This means that the monthly payment on a $10,000 loan repaid over 10 years will fall from $103.78 per month to $95.41 per month. For graduate students, the interest rate has fallen from 6.08 percent to 4.3 percent, which will drop the monthly payments on the same $10,000 loan from $111.42 to $102.68.

U.S. Dollar Rises

With the economic turmoil from the COVID-19 virus, the U.S. dollar rose again. During economic uncertainty, the dollar gains value as investors seek stability, and the U.S. dollar is generally regarded as one of the safest, if not the safest, currencies in the world. For the week, the dollar is up about 3 percent against a basket of other currencies. Surprisingly, the dollar is also up against the Japanese yen, which is also regarded as a safe haven currency.

COVID-19 To Hit Bonds

We're sure by now that you have seen the dramatic volatility in the stock market, along with the precipitous drop. But the recent economic slowdown caused by COVID-19 will officially hit the bond market soon. Moody's announced that it was undertaking a global review of bond ratings, with a mass of downgrade or downgrade warnings coming in the next several weeks. The review of airlines, cruise ship companies, and oil companies has already begun. About 9 percent of the companies Moody's reviews in Europe have significant exposure, and another 54 percent have moderate exposure. About 16 percent of the North American companies rated are at high risk of a ratings downgrade.

Smart Money Versus Dumb Money

The growth of passive investing, that is, investing in index funds, has arisen in large part due to the growing popularity of the efficient market hypothesis. In short, it seems that outperforming the stock market is a difficult, if not impossible, task. As a result, retail investors, sometimes referred to as dumb money, have flocked to index funds. A common belief on Wall Street is that in a severe market downturn, retail investors would flee the market. The 30 percent drop in the market over the past month has been a severe downturn. But, when fund flows, which is the amount of money put into or pulled out of an investment, is examined, the two S&P 500 Index ETFs favored by individuals showed net buying, while the ETF preferred by professionals showed net selling. In other words, the professionals ran and mom and pop actually bought more. With the market up about 5 percent for today, maybe dumb money does know a little more than previously believed.

Free Connect Offer From McGraw-Hill

For all those students and Professors impacted by the COVID-19 virus and moving to online instruction, McGraw-Hill is offering free access to Connect for the remainder of the spring semester. The access includes all questions and problems in Connect, as well as the ability to record and upload video lectures to the website. For Professors, you can even download a report that details which videos were watched by which students and the time spent watching videos. McGraw-Hill is offering support and webinars for those wishing to take advantage of this offer. You can find more information here.

Yield Curve Inverts

In the textbook, we discussed a normal, or upward sloping, term structure, and an inverted, or downward sloping, term structure. The U.S. Treasury yield curve inverted again on Monday, after inverting at the end of January and in March 2019. An inverted yield curve has preceded the last seven U.S. recessions. However, several analysts are not convinced a recession will result from this inversion. U.S. Treasuries are regarded as a safe haven investment. Given economic issues around the world, the low 10-year yield may be driven by the demand for this bond, not U.S. economic conditions. Here is a question for you: Notice in the first sentence (and in the textbook), we discuss the term structure, but then change to the yield curve. What is the difference between the term structure and a yield curve?

Cash Balances Increase

The old expression "cash is king" is often followed by corporate treasurers, especially when the economic outlook is uncertain. In the 2019 Cash Management Survey, 42 percent of companies increased cash balances, while only 22 percent reduced cash. Additionally, 62 percent of companies are net investors, with only 38 percent are net borrowers, another indication of a fight to cash. One significant issue found in the survey was that more companies experienced a decrease in operating cash flow during 2019 compared to 2018, an indication of why corporate treasurers are becoming more conservative.

FX Hurts North American Profits

According to a recent report, currency exchange fluctuations reduced North American corporate profits by $11.55 billion in the third quarter of 2019. The loss amounts to an average reduction of $.03 in EPS. The euro was the currency which caused the most losses, affecting about 46 percent of companies. The British pound, Argentine peso, the Australian dollar, and Chinese yuan were next on the list of most impactful currencies.

IPOs Get Direct

Spotify and Slack have recently gone public using a direct listing. In a direct listing, the firm arranges for its stock to be listed directly on an exchange without the help of underwriters. One downside to a direct listing for the company is that it cannot sell new shares in the listing. Now, the NYSE and NASDAQ are proposing new rules that not only would allow more companies to use a direct listing. The proposals would allow also companies to raise capital in a direct listing. Both exchanges are proposing methods to allow a company to sell new shares in a direct listing, although the mechanics have not yet been decided. Additionally, a drawback of the current direct listing process is that a company must have at least 400 shareholders who own at least 100 shares each before the listing. NASDAQ is proposing to allow a 90 period after the listing for a company to meet this requirement.