Increasing participants in the industry has posed additional responsibility on the jobs of Credit Rating Agencies. Ratings issues by CRAs is considered to be public goods and has a greater influencing power. Despite the pervasive and influential power wielded by S&P, Moody’s and Fitch to shape markets and capital flows (granted by virtue of their exclusive oligopoly franchise which enables the three firms to control 94% of the industry) these firms have historically been able to escape regulation and oversight, including any degree of accountability for their ratings when such ratings are revealed as false. We have witnessed the lack of accountability and diligence of CRAs in case of Enron and WorldCom due to little regulations. Thus it is important to design a framework under which the system can work with better accountability and reliability. Regulation should not be considered as a hurdle as it will be just delegation of additional responsibilities of regulatory body to these CRAs. It will address the problem of due diligence, better mechanism and a more transparent system promoting larger number of market participants. However if I look on the other side then in some ways, governance of credit rating agencies or regulating them is a thornier problem than the governance of auditors. The only regulatory oversight of note for rating agencies is the NRSRO (nationally recognized statistical rating organization), status conferred by the SEC as a means to limit exposure to credit risk. Four credit rating agencies have NRSRO status - Moody's, Standard & Poor's, the Fitch Group and Dominion Bond Rating Service. If the issue is considered deeply, then the question arises that does designing standards that few can qualify will help the system in any means? Conferring the status to just four CRAs indicates that intentionally or unintentionally the event of regulation has been to create what is in effect a government-sponsored cartel. Even though S&P managers decline to accept that the regulatory body has helped their business in any ways as it creates barriers to entry and granting regulatory licenses. However, this issue can be taken care if the regulations promote entry of more CRAs and competition among them will force each of them for quality work and would address the issue of free riding.
The responsibility to choose among rating agencies and their services should be a decision of investors, financial advisors, issuers, creditors and other users of ratings—in short, to the market. A competitive market test, not a bureaucratic process, will then determine which rating agencies turn out to be widely accepted by the predominant users of ratings, and competition will provide its normal benefits. It will be a welcome decision as firms giving rating will have an opportunity to prove themselves with quality work rather than being subject to governmental shadow which will save them from any recourse. The alternative of having investors purchase the credit ratings arguably creates a superior incentive structure. Value of rating as well as of the firm will be dependent on the quality of work and its effect on market efficiency. This was the original historical model for the first 50 years of the rating agency business. If investors pay, it obviously removes the potential conflict of interest and any tendency toward a “race to the bottom” in ratings quality. I think this radical change will be a welcome change in the roles of agencies as it will not only address the issue of conflict of interest, current dual monopoly status of the top agencies but also redefine the system which will reflect more transparent methodology, better accountability and bigger participation in agency role.
Of course, a fully competitive rating agency market will not happen all at once and it will not be easy to grow business over a short span of time as there are significant natural (as well as the SEC’s artificial) barriers to entry in this sector, including the need to establish reputation, reliability, and integrity. Brand value of the rating agencies will be a determining factor when requesting for rating. Nevertheless, in time, innovation and better products can overcome such barriers, when not prevented by regulation and providing equal opportunities to all market participants. The desirable transition to a competitive rating agency sector would be evolutionary as I believe that the market will have a positive reaction to the fact that the agencies are no more ties to the regulatory regime and the opinion is issues not for the sake of marketing the bond but to give a picture of all the risks involved with it and its actual measure.
I recommend that a regulatory body be formed with a voluntary system to promote competition and fair play with all the advantages to customers that competition will bring, including better prices, more customer choice, more innovation, greater efficiency, and reduced potential conflicts of interest.
Saturday, September 13, 2008
Subprime Mortgage Crisis -situation analysis
Situation Analysis:
Following the history of the housing market it seems apparent that its growth is dependent on the macro economy such as interest rates and buying power. However, financial engineering has lubricated the market in the last few years which has lead to a phenomenal growth in the industry. Its growth was no more effected by the interest rates because subprime loans tend to be less responsive to changing interest rates. I do not find a reason that subprime mortgage crisis would not have survived the swing of interest rates if mortgage generation was not affected by moral hazards. The situation is more complex than it seems as there were frequent use of use of financial engineering such as securitization, what is called “originate-to-distribute”. This business model became a success story and begets a new form of financial intermediation. This system allowed lenders to ward off or disperse their credit risks of underlying assets over investors via markets. This market soon became favorites not only to the investors who had better returns but also to the realtors and home buyers as they were getting a better deal. But then the incentive to pass on the risk was getting bigger and no one realized that the trap they were designing will fall back on them. Stats for foreclosures are frightening but it is the cost that these house owners were paying for being greedy and speculating that the housing market will be a better investment or rising housing prices will help them to refinance their house even though they do not have enough equity to buy a house. But they never realized that all speculations have downside risk. On the other hand Investors were tempted for better returns and they miscalculated the risk involved in the MBS as the reason they had to suffer huge capital loss. Thus the complete vicious cycle was free flowing as funds keep flowing from one end to another.
Key issues:
1. Risk information of securities has been inadequately distributed between all stakeholders such as lenders, middleman arranging securitization, CRAs and investors.
2. Roles of the credit rating agencies, as there seem to be conflicts of interest as they tend to disclose inadequate information on their evaluation criteria and its validity.
3. Financial institutions and investors have failed to design a robust risk managements and disclosure procedures.
4. Moral issue related to the generation of mortgage. Little due diligence while issuing loans.
Analysis of Alternatives:
Reviewing the above mentioned issues states that the issue is not only due to the agency problems arising out of sub-prime loan generation but also due to inadequate risk management by investors. The market would not have experienced this growth if the risk evaluation was priced in the securities. Based on current situation there can be short term alternative or a long term alternative which will be useful to resolve the credit crisis in the mortgage market.
The short-term alternative of this plan is to temporary freeze the resets of mortgage rates as it will allow home owner to deal with the decline in the housing prices and at the same time it will help to arrest the numbers of foreclosures due to the higher ARM. This is nothing more than a temporary measure as it cannot be designed into the system for a longer period as it will be affected by the lending rates in the other market and sooner or later that difference in the lending rates will be priced in.
The long-term alternative is in essence, an agency re-organization scheme. Design a robust organizational level incentive schemes to minimize moral hazard which will not only check the current issue but also will ensure not to encourage similar irresponsible behavior in the future. I think that if the loans were issued with strict credit check and only those borrowers receive loans who can manage to pay their dues in time, then the issue would have never taken such a shape. Since the loan originator was concerned with the volume of the business and not with the risk involved of non-payment and this agency conflict has added fuel to the crisis.
Following the history of the housing market it seems apparent that its growth is dependent on the macro economy such as interest rates and buying power. However, financial engineering has lubricated the market in the last few years which has lead to a phenomenal growth in the industry. Its growth was no more effected by the interest rates because subprime loans tend to be less responsive to changing interest rates. I do not find a reason that subprime mortgage crisis would not have survived the swing of interest rates if mortgage generation was not affected by moral hazards. The situation is more complex than it seems as there were frequent use of use of financial engineering such as securitization, what is called “originate-to-distribute”. This business model became a success story and begets a new form of financial intermediation. This system allowed lenders to ward off or disperse their credit risks of underlying assets over investors via markets. This market soon became favorites not only to the investors who had better returns but also to the realtors and home buyers as they were getting a better deal. But then the incentive to pass on the risk was getting bigger and no one realized that the trap they were designing will fall back on them. Stats for foreclosures are frightening but it is the cost that these house owners were paying for being greedy and speculating that the housing market will be a better investment or rising housing prices will help them to refinance their house even though they do not have enough equity to buy a house. But they never realized that all speculations have downside risk. On the other hand Investors were tempted for better returns and they miscalculated the risk involved in the MBS as the reason they had to suffer huge capital loss. Thus the complete vicious cycle was free flowing as funds keep flowing from one end to another.
Key issues:
1. Risk information of securities has been inadequately distributed between all stakeholders such as lenders, middleman arranging securitization, CRAs and investors.
2. Roles of the credit rating agencies, as there seem to be conflicts of interest as they tend to disclose inadequate information on their evaluation criteria and its validity.
3. Financial institutions and investors have failed to design a robust risk managements and disclosure procedures.
4. Moral issue related to the generation of mortgage. Little due diligence while issuing loans.
Analysis of Alternatives:
Reviewing the above mentioned issues states that the issue is not only due to the agency problems arising out of sub-prime loan generation but also due to inadequate risk management by investors. The market would not have experienced this growth if the risk evaluation was priced in the securities. Based on current situation there can be short term alternative or a long term alternative which will be useful to resolve the credit crisis in the mortgage market.
The short-term alternative of this plan is to temporary freeze the resets of mortgage rates as it will allow home owner to deal with the decline in the housing prices and at the same time it will help to arrest the numbers of foreclosures due to the higher ARM. This is nothing more than a temporary measure as it cannot be designed into the system for a longer period as it will be affected by the lending rates in the other market and sooner or later that difference in the lending rates will be priced in.
The long-term alternative is in essence, an agency re-organization scheme. Design a robust organizational level incentive schemes to minimize moral hazard which will not only check the current issue but also will ensure not to encourage similar irresponsible behavior in the future. I think that if the loans were issued with strict credit check and only those borrowers receive loans who can manage to pay their dues in time, then the issue would have never taken such a shape. Since the loan originator was concerned with the volume of the business and not with the risk involved of non-payment and this agency conflict has added fuel to the crisis.
Tuesday, September 2, 2008
Ready for finance job ?
Interviewing tips and practice questions.
Recruiting Practices & Strategy:
1) Opening for summer internships begin in October. Generally in financial sector recruitment is earlier than the other industry. It is important to get an early start.
2) Jobs are not readily available. Thus it is important that you understand the significance of networking in this challenging environment. You should meet with alumni, individuals that you meet at company presentations, current students, etc.
3) A good resume is essential to landing an interview. Take full advantage of resume workshops, second-year resume reviews, alumni reviews and consult career director/peer advisors to polish your resume.
4) Your resume should be set up so that it clearly highlights your achievements/abilities in the context of the Skills & Requirement sections above.
5) For most finance positions, informational interviews (as recommended for investment banking) are not the norm, but however, are beneficial.
6) In interviews, be prepared to discuss how you have demonstrated leadership, your quantitative skills, industry interest, why the company interests you and your strengths and weaknesses.
7) Not everyone will get a finance internship through campus recruiting. Each company will look to hire a handful of individuals so you must apply to many companies. You will have to follow-up with companies that meet your interests.
Interviewing Tips:
1. Know your resume well. Be prepared to discuss any item on your resume
2. Prepare your elevator speech (should be concise and relevant)
3. Be sure to know the difference between the different firms in the industry or functions
4. Review the company’s annual report/10-K and glance at its financial statements beforehand so you know the different sources of each component of revenues.
5. It is highly recommended that you make a concerted effort to meet people from the different firms through the presentations and through alumni contacts. In this reference try to use internal resource like career director and student advisor to get contacts.
6. It is probably a good idea to cast your net wide and try to interview with many companies, although you should act focused when meeting the respective companies.
7. It might be an idea to give each other mock interviews and to critique each other.
8. Be prepared for technical and non technical questions:
Sample Interview Questions:
General Questions:
1) Walk me through your resume.
2) What three things would your colleagues say about you?
3) Why did you decide to pursue an MBA? Why Atkinson?
4) Describe your experience with your study group. What role do you generally hold when completing projects? What would they say about you?
5) What has been your most challenging class first semester at Atkinson?
6) You are involved in a lot of things. Which is most important to you?
7) Tell me about an experience where your ethics or values were questioned and what you did.
8) Describe an obstacle you faced at work and how you overcame it.
9) Tell me about your biggest failure.
Finance Specific Questions:
1) Why do you want to work in this industry?
2) Why do you want to work at our particular firm?
3) What are the major issues facing this industry?
4) Tell me about a complex model that you built? How did you approach the situation?
5) How would you value a company?
6) Walk me through how to do a Free Cash Flow Valuation.
7) Describe WACC and how it applies to Discounted Cash Flow valuation.
8) If I can give you 2 out of the 3 financial statements from a company (Balance Sheet, Income Statement, Statement of Cash Flows) and ask you to pick 2 to reconstruct the 3rd statement, which would you choose?
10) What do you think about the flattening yield curve? Tell me about the ABC-XYZ merger?
11) Where do you see yourself in 5 years?
When you are given time to ask questions about the firm, use it well. Intelligent and relevant questions demonstrate your interest in the firm. If you do enough research on the firm beforehand, you are better positions to asked key questions. Advice: show real interest in the company.
Recruiting Practices & Strategy:
1) Opening for summer internships begin in October. Generally in financial sector recruitment is earlier than the other industry. It is important to get an early start.
2) Jobs are not readily available. Thus it is important that you understand the significance of networking in this challenging environment. You should meet with alumni, individuals that you meet at company presentations, current students, etc.
3) A good resume is essential to landing an interview. Take full advantage of resume workshops, second-year resume reviews, alumni reviews and consult career director/peer advisors to polish your resume.
4) Your resume should be set up so that it clearly highlights your achievements/abilities in the context of the Skills & Requirement sections above.
5) For most finance positions, informational interviews (as recommended for investment banking) are not the norm, but however, are beneficial.
6) In interviews, be prepared to discuss how you have demonstrated leadership, your quantitative skills, industry interest, why the company interests you and your strengths and weaknesses.
7) Not everyone will get a finance internship through campus recruiting. Each company will look to hire a handful of individuals so you must apply to many companies. You will have to follow-up with companies that meet your interests.
Interviewing Tips:
1. Know your resume well. Be prepared to discuss any item on your resume
2. Prepare your elevator speech (should be concise and relevant)
3. Be sure to know the difference between the different firms in the industry or functions
4. Review the company’s annual report/10-K and glance at its financial statements beforehand so you know the different sources of each component of revenues.
5. It is highly recommended that you make a concerted effort to meet people from the different firms through the presentations and through alumni contacts. In this reference try to use internal resource like career director and student advisor to get contacts.
6. It is probably a good idea to cast your net wide and try to interview with many companies, although you should act focused when meeting the respective companies.
7. It might be an idea to give each other mock interviews and to critique each other.
8. Be prepared for technical and non technical questions:
Sample Interview Questions:
General Questions:
1) Walk me through your resume.
2) What three things would your colleagues say about you?
3) Why did you decide to pursue an MBA? Why Atkinson?
4) Describe your experience with your study group. What role do you generally hold when completing projects? What would they say about you?
5) What has been your most challenging class first semester at Atkinson?
6) You are involved in a lot of things. Which is most important to you?
7) Tell me about an experience where your ethics or values were questioned and what you did.
8) Describe an obstacle you faced at work and how you overcame it.
9) Tell me about your biggest failure.
Finance Specific Questions:
1) Why do you want to work in this industry?
2) Why do you want to work at our particular firm?
3) What are the major issues facing this industry?
4) Tell me about a complex model that you built? How did you approach the situation?
5) How would you value a company?
6) Walk me through how to do a Free Cash Flow Valuation.
7) Describe WACC and how it applies to Discounted Cash Flow valuation.
8) If I can give you 2 out of the 3 financial statements from a company (Balance Sheet, Income Statement, Statement of Cash Flows) and ask you to pick 2 to reconstruct the 3rd statement, which would you choose?
10) What do you think about the flattening yield curve? Tell me about the ABC-XYZ merger?
11) Where do you see yourself in 5 years?
When you are given time to ask questions about the firm, use it well. Intelligent and relevant questions demonstrate your interest in the firm. If you do enough research on the firm beforehand, you are better positions to asked key questions. Advice: show real interest in the company.
Finance Industry Snapshot
Trends
The finance industry has changed significantly over the decades. Innovations and competitions shape the industry for a new and more sophisticated future. The globalization of the economy and the increased sophistication of companies have led to an expansion in the type of finance careers available. While areas such as structured finance and strategic planning have shown growth in the past couple of years, there is a current trend towards risk management and corporate restructuring. Today the positions at offerings are in wide arrays. Hiring of MBA graduated with little or no experience is at associate or analyst positions.
Lifestyle
It is said that individuals are panicked twice, once when they have money and second when they don’t have money। Thus the learning is that in the financial industry life is not smooth as it is job of higher responsibility involving millions and billions. However, lifestyle varies significantly based on your function, the culture of the company and the current trends in the industry. Positions at investment will have the greater number of hours (ranges from 10 – 16 hour days). Positions involving capital budgeting and strategic initiatives (M&A, Structure Finance) within a corporation tend to have better hours than banks but will fluctuate based on the current projects of the company (i.e. acquisitions, IPO’s, debt offerings, etc.) Traditional finance paths such as treasury, risk management, etc. will have hours closer to a 40-hour workweek.
Corporate Finance Functions and Career Paths
Job Functions:
These job functions are basic format that most of the companies follows. They may vary based upon the industry and size of the company.
Some examples of finance careers include:
· Banking Analyst
· Trust Officer
· Stockbroker
· Treasurer
· Securities Analyst
· Financial Reporter
· Portfolio Analyst
· Investment Counselor
· Bank Officer
· Corporate Reporter
· Capital Budgeting Manager
· Mortgage Broker
· Consultant
· Loan Officer
· Financial Analyst
· Financial Planner
· Institutional Broker
· Mortgage Banker
· Pension fund Manager
· Bank Officer
· Real Estate Appraiser
· Underwriter
· Insurance Agent
· Options Trader
· Floor Trader
· Real Estate Lender
· Risk Manager
· Cash Manager
· Chief Financial Officer
· Mutual Fund Manager
· Investment Banker
· Credit Manager
Careers in corporate finance include funding a business, growing a business, acquiring new assets, and planning for the financial future of the business. You might work for a large multinational company or a smaller player with high growth.
Skills and Requirements for Success
· Problem solving
· Strong quantitative and analytical background
· Strong knowledge of spreadsheet and word processing applications
· Leadership distinction
· Academic excellence
· Client relationship expertise
· Superior interpersonal skills
· Demonstrated work ethic
The finance industry has changed significantly over the decades. Innovations and competitions shape the industry for a new and more sophisticated future. The globalization of the economy and the increased sophistication of companies have led to an expansion in the type of finance careers available. While areas such as structured finance and strategic planning have shown growth in the past couple of years, there is a current trend towards risk management and corporate restructuring. Today the positions at offerings are in wide arrays. Hiring of MBA graduated with little or no experience is at associate or analyst positions.
Lifestyle
It is said that individuals are panicked twice, once when they have money and second when they don’t have money। Thus the learning is that in the financial industry life is not smooth as it is job of higher responsibility involving millions and billions. However, lifestyle varies significantly based on your function, the culture of the company and the current trends in the industry. Positions at investment will have the greater number of hours (ranges from 10 – 16 hour days). Positions involving capital budgeting and strategic initiatives (M&A, Structure Finance) within a corporation tend to have better hours than banks but will fluctuate based on the current projects of the company (i.e. acquisitions, IPO’s, debt offerings, etc.) Traditional finance paths such as treasury, risk management, etc. will have hours closer to a 40-hour workweek.
Corporate Finance Functions and Career Paths
Job Functions:
These job functions are basic format that most of the companies follows. They may vary based upon the industry and size of the company.
Some examples of finance careers include:
· Banking Analyst
· Trust Officer
· Stockbroker
· Treasurer
· Securities Analyst
· Financial Reporter
· Portfolio Analyst
· Investment Counselor
· Bank Officer
· Corporate Reporter
· Capital Budgeting Manager
· Mortgage Broker
· Consultant
· Loan Officer
· Financial Analyst
· Financial Planner
· Institutional Broker
· Mortgage Banker
· Pension fund Manager
· Bank Officer
· Real Estate Appraiser
· Underwriter
· Insurance Agent
· Options Trader
· Floor Trader
· Real Estate Lender
· Risk Manager
· Cash Manager
· Chief Financial Officer
· Mutual Fund Manager
· Investment Banker
· Credit Manager
Careers in corporate finance include funding a business, growing a business, acquiring new assets, and planning for the financial future of the business. You might work for a large multinational company or a smaller player with high growth.
Skills and Requirements for Success
· Problem solving
· Strong quantitative and analytical background
· Strong knowledge of spreadsheet and word processing applications
· Leadership distinction
· Academic excellence
· Client relationship expertise
· Superior interpersonal skills
· Demonstrated work ethic
Saturday, March 8, 2008
Sky is falling...
Sky is falling has become a cliché. Everyone is doomed by the fact that US economy is heading towards recession. It seems that there is a consensus in this regards. Now the question is-- Is this recession going to be deep and long or short and shallow. No one has the answer. Taking cue from the economic indicators it seems that the slowdown is going to continue until US government is able to find a resolution to some of the risk of the near term US economic outlook. These risks to the near term US economic outlook are mentioned below.
1. If there is a free flow to interest rate cut then it will fuel inflation. Where is the cap to consider that the rates are too low and when will Fed consider that the inflation has reach its limit and consider the flip side and stop cutting interest rates.
2. Prices of homes continue to decline and it is evident that housing sector is already in recession. Is the houses already priced or we are to witness more decline is housing prices.
3. Exponential hike in oil prices has fueled inflation and seems to a never ending story. Will there be a pass through of high energy prices into consumer inflation?
4. US have funded its trade deficit by vendor financing and weakening dollar has made investment in US lucrative. It is a perennial issue until BOP is positive, which seems unlikely in near future. Will vendor financing continue forever?
5. One of the major indicators of economic indicator is unemployment data. Recent release unemployment data is not supportive of economic growth but looking forward the issue is, will it deteriorate or it has reached its bottom.
I think that these questions will give a better perspective of where the economic trends is heading and better analysis will help us to define and gauge economic trend of near future.
1. If there is a free flow to interest rate cut then it will fuel inflation. Where is the cap to consider that the rates are too low and when will Fed consider that the inflation has reach its limit and consider the flip side and stop cutting interest rates.
2. Prices of homes continue to decline and it is evident that housing sector is already in recession. Is the houses already priced or we are to witness more decline is housing prices.
3. Exponential hike in oil prices has fueled inflation and seems to a never ending story. Will there be a pass through of high energy prices into consumer inflation?
4. US have funded its trade deficit by vendor financing and weakening dollar has made investment in US lucrative. It is a perennial issue until BOP is positive, which seems unlikely in near future. Will vendor financing continue forever?
5. One of the major indicators of economic indicator is unemployment data. Recent release unemployment data is not supportive of economic growth but looking forward the issue is, will it deteriorate or it has reached its bottom.
I think that these questions will give a better perspective of where the economic trends is heading and better analysis will help us to define and gauge economic trend of near future.
Sunday, February 10, 2008
Rising India: is this how we know India? A country of billions with millions of occasion to celbrate. Number of festivals are more than the number of days. Now the question is, why do we care for one more festival which is not our own and imported from the west? Every festival has a purpose and its effects, so does Valentine. As we celebrate holi, diwali, christmas and many more festivals to develop a stronger community feeling and share joy and happiness. So where does the valentine fits in? Oh I forgot to mentioned that all relations owe their existence to the feeling of love that we have for our family, friends, neighbour and countrymen. But life does not ends here, we spend greater part of out life with our better half who cares for us, who is happy when we are happy, for whom we are ready to let go even the most important things in life. It means that she is more than life to us. Does she deserves a day when we can express our feelings for her, make her feel special, let her know how much we care for her. Yes, she does deserves it and it does answer my question that “where does the valentine fits in?” It is this day when you have to let her know what you feel for her, it is the opportunity not an occation when feeling are transformed into actions and words. If all these makes sense then it will make sense that if a rich culture like India is missing an important day to celebrate it should encourage such festival. But I, for one, don't have to worry about corrupting our great culture. Fortunately, or unfortunately, I don't have anyone to celebrate Valentine's day with.
I think there is no harm in change if it fot the benefits of all, because something that a lot of people in a society do and accept becomes culture. This is what has gained grounds in recents years and people have accepted it. So its time for all of you to stop reading and approach the only person who has defined your life and make her/him feel special.
I think there is no harm in change if it fot the benefits of all, because something that a lot of people in a society do and accept becomes culture. This is what has gained grounds in recents years and people have accepted it. So its time for all of you to stop reading and approach the only person who has defined your life and make her/him feel special.
Tuesday, February 5, 2008
US & and India...highly correlated...
India and United States are at the crossroads of international partnerships. In this regard, India and the United States could not be more alike. Although in economic terms India is only now experiencing faster economicgrowth, many of us are optimistic that this path will lead to the kind of vibrant and responsive economic structures that now support American markets. Alongside this economic parallel is the natural bond that flows from being the planet's largest democracies. India, like the United States has a conglomeration of several races and communities with different religions and creeds. But just as the United States has been welding this large concourse into a national entity, through the cultural unity of ages, the framework of a national Constitution, and the elements of an industrial structure, India is also a united nation today.
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