5 June 2018 FT — Articles to Read

5 June 2018

Announcement: Foundations of Real Estate Financial Modelling, 2nd Edition, Routledge, 2018, is officially published!!!  Global sales for the 1st Edition warranted a second edition.  This text will replace the standard Real Estate Finance textbooks covering Real Estate Finance basics as well as advanced concepts and modelling utilizing stochastic processes and optimization.  The text is first to publish Optimization for physical real estate products within a single asset and portfolio (Prof Note: Can you see my pride?!)

While I would love to take all the glory and the pride of my name on the cover is unending, this was a work of many!  The text is 70% larger than the first edition and includes problem sets as well as case studies written by graduate students.  Many tirelessly edited the text over months, accepting no payment, but committed to broadening the world of Real Estate Financial Modelling.

The major outgrowth of both editions is the development of the new financial metric, P(Gain).  This metric, utilizing a normal distribution, z-score, and efficiency, addresses the most fundamental question, and least addressed, in finance, i.e. “What is the probability of Return OF Capital?”.  From this a new company has been formed, P(Gain), LLC, and over the next few months this list-serve will be transitioned to a new email address, i.e. rstaiger@pgainllc.com.  Please note that the list-serve’s purpose, goals, and structure will not change.  The list-serve will continue to provide daily capital market summaries, employment opportunities from participants and readers, and will still be subject to my “Prof Note”, i.e. occasional rant! J)

 Question: What financial metric quantifies the probability of Return OF Capital?

Finance – Pg. 7

  • …$10tn market for credit default swaps
  • The credit default swap, a financial instrument intimately associated with the losses incurred by the banks during the US subprime mortgage crisis, is most commonly used to either hedge against a company falling into trouble and possibly not paying off its debts, or as a tool of outright speculation over whether a default will occur
  • It is the debt equivalent of a controlled explosion: offering a company favourable financing, such as low interest loans, to convince it to intentionally default in a way that will trigger payouts on CDS contracts, but without bringing down the whole company
  • When the India-born and Cambridge educated ….
  • But experts believe the damage to the market is already done, as the run of trades from GSO have exposed how easy it is for big players to alter outcomes in the very markets they are betting on

Commodities trading booms as new kind of strategy emerges – Pg. 19

  • A class of investors who have put tens of billions od dollars into commodities over the past few years do not care whether the prices of oil, wheat, cattle and the rest go up or down
  • Risk premia investing, a strategy borrowed from equities markets that weights factors other than price, has caused a boom in trading volumes on exchanges and resuscitated revenue for banks bleary from a sluggish decade in their commodities divisions
  • Risk premia strategies have attracted about $20bn to commodities markets over the past two years…
  • Instead of trying to predict whether commodities prices will rise or fall, risk premia investors systematically place bets based on so-called factors such as momentum, volatility and a pattern of prices for future delivery
  • This stands in contrast to traditional commodities investing, which involves tracking an index such as the S&P GSCI or placing money with hedge fund managers claiming expert knowledge of the commodities they trade
  • Risk premia attempts to isolate the factors responsible for outperformance and feed them into an algorithm that selects which commodities to buy or sell. In theory they are more transparent and cheaper than a hedge fund and at least somewhat insulated form indices’ pitfalls
  • The strategies differ from “enhanced” strategies, an earlier innovation built to deal with flaws in commodity index investing. Enhanced strategies hold bullish, or long, positions.  Risk premia strategies might instead have long and short positions
  • One simple risk premia strategy follows momentum: in a basket of commodity futures, the investor buys the ones that have performed better in the past year and shorts those that have done worse, based on the belief that markets digest new information gradually
  • Another might involve liquidity: by purchasing a corn contract for delivery next December and hedging it with the more actively traded spot month contract, a risk premia fund could be paid a premium for its willingness to own a thinly traded contract
  • A third might involve buying commodities where the spot price is highest relative to futures
  • Risk premia strategies do not rely on counting barrels or bushels, having privileged contacts among physical traders and processsors, or keeping up with geopolitical events – the stock in trade of traditional commodities funds
  • (Prof Note: This is precisely why I was/am blessed with an engineering background and finance graduate studies. Never did anyone express the power (read: financial opportunities in trading) of mathematics when I was an engineer.  It was only 10 years into my career when I realized, while MD for a Commodity division, the true blessing(s).  The ability to trade on developed relationships and profit is what makes Western Finance so great!  There are basically no barriers to entry.  With $300 one can open a brokerage account and start trading utilizing their mathematics skills!  We need to stress this in classrooms.  Regressions for the sake of regressions are boring (there, I said it!).  However, a simple univariate regression equation, personally developed in 2007, relating commercial and residential pricing changed my life!  Understanding these products, understanding the mathematics, understanding the markets and how to structure and execute is a blessing!  Math is SEXY!!!)

Answer: P(Gain)