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SOME THINK FAST, SOME SLOW
JUST THINK!
SIC PRESENTATION, 9/12/2013
THREE IMPORTANT IDEAS
FRAMED INCORRECTLY
Size of the derivatives market
Disappearance on IPOs
Options expensing
OMG ??
EXAMPLE
• I own 5,000 shares of IBM, worth about $1,000,000.
• Hedge drop in price, long 50 put contracts, X = 170,
price of $0.27 per share (put contract = 100 shares)
• Long side, notional value $1,000,000
• Short side, notional value $1,000,000
• Short side was dealer putting a bigger deal together,
buys an offsetting put, X = 170, for $0.25 per share
• Long side, notional value $1,000,000
• Short side, notional value $1,000,000
• Short side is a PE firm with a short position on 50,000
shares sold @ $200 (ignoring rest of hedge).
EXAMPLE
• Finally, price of IBM drops to $185 a share. I sell my
5,000 shares of IBM, for $925,000. And to eliminate
my put, I entering into an offsetting put, price is now
$7.00 per share (netting me $35,000).
• Short side, notional value $925,000
• Long side, notional value $925,000
• Total derivatives outstanding (notional amount) is
$5,850,000. Note that $3,850,000 is perfectly
offsetting (no risk to system). Remaining short is
covered by short position (net no risk).
EXAMPLE
• 5,000 shares of IBM, worth $925,000.
• Total derivatives outstanding (notional amount) is
$5,850,000.
• Appears that derivatives market is 6.32 times the size
of the asset market.
• And none of this has anything to do with GDP!
THE ASSET APPROACH
http://www.zerohedge.com/news/2013-03-07/us-households-have-never-been-more-reliant-stock-market-their-net-worth
COMMERCIAL REAL ESTATE
GDP?
• Again, perspective is (partially) wrong.
• Treat world GDP as a perpetuity – an asset!
• $50 trillion / 10% = $500 trillion. That is was is at play,
not the annual nominal cash flows from that asset.
• Is it more correct to think of total derivatives
positions (especially repeats) as a stock or a flow?
Consumption GDP?
GDP?
• Again, perspective is (partially) wrong.
• Treat world GDP as a perpetuity – an asset! Not
entirely correct, but not entirely wrong either.
• $50 trillion / 10% = $500 trillion. That is was is at play,
not the annual nominal cash flows from that asset.
• Is it more correct to think of total derivatives
positions (especially repeats) as a stock or a flow?
Consumption GDP?
HOW DOES GDP PLAY?
MLB postseason chances
•
http://mlb.mlb.com/mlb/standings/probability.jsp
WHERE HAVE IPOS GONE?
CAUSES
• Popular view: drop in public market valuations of
tech companies, heavy-handed regulation such as
Sarbanes-Oxley (SOX), and a drop in analyst
coverage of small companies
• Jay’s view: declining profitability of small firms
IMPLICATIONS?
• Popular view: 10m – 20m “lost” jobs
• Jay’s view: (research) assume(s) that thousands of
companies that didn’t go public would have grown
as fast as companies such as Google if they had!
This assumption, which I would tend to categorize
as completely ridiculous …
IMPLICATIONS?
• Popular view: fix SEC, Wall Street, etc.
• Jay’s view: fewer investor protections can
potentially result in more fraud
• Eg., S. 1791 “Democratizing Access to Capital Act of 2011”
and S. 1970 “Capital Raising Online While Deterring Fraud
and Unethical Non-Disclosure Act of 2011”
OPTIONS EXPENSING
• Short video
“Stock options should be charged to earnings.”
OPTIONS EXPENSING
• Think about Cisco example
• $2.6 billion profit cut in half. Implications for the firm?
• Does this “expense” smell right?
• What do all other expenses have in common?
• Do options?
OPTIONS EXPENSING
• Scenario A: Whiz computer programmer leaves IBM
for a start-up. Was making $300K (assume this is
“fair”). Offered $100K plus deferred options
package. B-S puts package at $500K.
• Scenario B: Whiz computer programmer leaves IBM
for a start-up. Was making $300K (assume this is
“fair”). Offered $300K . Has right at end of year to
buy same options package as Scenario A.
ACCOUNTING
Scenario A
Salary Exp
Cash
Scenario B
$100,000
$100,000
Opt Expense $500,000
Cont Eq
$500,000
Salary Exp
Cash
Cash
$300,000
$300,000
$200,000
Opt Revenue
$200,000
Cont Cash
$XX
Cont Equity
$XX
“Fair value” is NOT a finance question. It is an HR question! And
even if you disagree with that point, still ignoring Revenue!
IMPORTANT QUESTION
• How messed up are financial statements for firms
that were forced to expense options?
• How can we profit from this?