Do Buybacks Create Value?

There are several reasons a company would buy back its stock. A buyback could be used in lieu of a dividend, the company could be altering its debt-equity ratio, or the company could feel that its stock is the best investment possible. So do buybacks increase shareholder value? In a recent interview, Greg Milano, CEO of Fortuna Advisors, argues that buybacks result in a temporary stock price pop when the buyback is announced, but over the long-term, companies that buy back more stock tend to perform worse than other stocks. Further, the bigger the increase in the EPS due to buybacks, the lower the PE ratio falls.

NYSE No More

The Intercontinental Exchange (ICE) announced that it would purchase the NYSE for $33.12, a 38 percent premium over its market value. ICE, which operates Commodities and derivatives markets around the world, was formed in 2000 yet has a larger market value than the NYSE. ICE intends to spin off many of the European operations into a separate company. Although the particulars of the spin off were not announced, it appears that much of the spin off will include assets acquired in the Euronext acquisition made by the NYSE only five years ago. NYSE shareholders will own 36 percent of the combined company after the acquisition.

LIBOR Arrests

The recent LIBOR scandal has resulted in three arrests. British police arrested three men after searching their homes. LIBOR affects an estimated $300 trillion in derivatives and about $10 trillion in loans worldwide are tied to LIBOR.

Convertible Bond Issuance Near Record

New convertible bond bond issues have a chance to reach last year's record of $20.7 billion, while at the same there has been more than $1 trillion in high-grade bonds issued during 2012. One downside of convertible bond issuance is evidence that the announcement of a convertible bond generally has a negative effect on the stock price. When electronics company Sony announced its recent convertible issue, the stock price dropped 10 percent. And anecdotal evidence suggests that some stockholders sold stock and purchased the bonds even though the bonds were zero coupon bonds.

The 2012 Stock Market: Early Returns

Year-to-date, the S&P 500 is up around 12 percent, an average return for the market since 1926. Both the Nikkei Index in Japan and Euro Stoxx 600 are up around 13 percent. Given the problems in Greece and other European countries' sovereign debt and the recent threat of a fiscal cliff, an average market return seems pretty good. Surprisingly, the VIX, a measure of stock market volatility, is also down by 40 percent since the beginning of the year. 

Does Apple Really Have $121 Billion In Cash?

At the end of September, Apple reported a cash balance of $121.25 billion. But does Apple really have a savings account with that balance? Yes and no. While Apple's worldwide cash balance is $121.25 billion, the company only has $38.65 billion in the U.S. For the 600 U.S. multinationals that report cash balances held overseas, about 60 percent of the cash is overseas. Johnson and Johnson reported a cash balance of $24.5 billion, but the company holds essentially no cash in the U.S. The reason companies have not repatriated overseas earnings is that these funds would be subject to a 35 percent tax rate. The effect is to reduce a company's liquidity and ability to pay dividends or repurchase shares. For example, Emerson Electric recently borrowed money in order to pay dividends, repurchase shares, and make debt payments and pension contributions in spite of the fact that the company reported a cash balance of $2 billion.

The Average Investor

Even with our discussion of the Efficient Markets Hypothesis (EMH), we often get the feeling that many students still believe that when they leave our class they will become superstar investors and greatly outperform the market. So, how have investors done on average? In the chart of the week at BlackRock, it appears that the answer is poorly. Over the past 20 years, oil has averaged 8.6 percent, stocks have averaged 7.8 percent, and bonds 6.6 percent. Inflation has been a relatively mild 2.6 percent. Yet, over this period, the average investor has returned only 2.1 percent per year! The reason given by BlackRock is that the average investor allows emotion to rule their decisions, moving into and out of different investment classes at the most inopportune times.

Inflation As Measured By The CPI

The Consumer Price Index (CPI) is  a common measure of inflation, however a more interesting CPI is the Christmas Price Index, calculated each year by PNC Bank. This CPI calculates the cost of all of the gifts mentioned in the Twelve Days of Christmas, from a partridge in a pear tree to 12 drummers drumming. This year, uncovering the cost of the CPI requires you to take a virtual journey around the world. Over the past year, the CPI increased 4.8 percent to $25,431.18, a fairly expensive Christmas! The biggest price jump was the 29.6 percent increase in the six geese-a-laying. Six items remained unchanged, including the partridge, turtle doves, and lords-a-leaping. And for the really interested individual, the website has prices for each of the items back to 1986, the beginning of the CPI.

Mazimize Shareholder Wealth

The goal of a corporation should be to maximize shareholder wealth. Why? Since shareholders have a residual claim, if they are happy, everyone in line before them such as creditors and employees have been financially rewarded. In a new book, Lynn Stout argues that increasing shareholder value is not the goal of a corporation. In fact, her argument extends to the notion that shareholders do not own a corporation, a strange argument from a law professor. She states "No human being can own a corporation-they are independent legal entities," which makes little sense since ownership of stock confers a legal ownership of a corporation. Our response is best summed up by Charles Elson: “What [Professor Stout] is saying is nothing new and is actually quite silly.”

Another argument we disagree with is that corporations sacrifice long-term goals for short-term profit. While we don't disagree that this happens, sacrificing long-term shareholder wealth maximization does not fit with the goal of maximizing shareholder wealth. Choosing short-term results over long-term results is an agency problem that needs correction if it occurs, but not at the expense of shareholder wealth maximization.

Finally, we would like to address the statement made by Professor Stout that companies "...drain out cash through stock repurchases and dividends - all for the purpose of pumping up the share price temporarily." The relevance of dividends and stock repurchases is discussed in the text, but if the company has no positive NPV investments, excess cash should be paid to shareholders. Additionally, given that the S&P 500 companies (excluding financials) have a near record level of cash, we would argue that if anything, companies have not paid out enough to shareholders in the form of dividends and share repurchases.

What Are The Odds?

With the Powerball jackpot reaching $500 million, lottery ticket sales are very brisk. So what are the odds of winning? 1 in 175 million. You would have a better chance of randomly predicting the name of a female in the United States (1 in 157 million). While the jackpot is announced at $500 million, it is actually paid over 30 payments with the first payment being made today. If the winner selects the cash option, they will receive "only" $327 million. So, with equal annual payments, what interest rate is being offered? Check for yourself that it is about 3.24 percent. 

HP Write-Off

HP announced an $8.8 billion write-off associated with the company's purchase of Autonomy, a British software company HP purchased for $11 billion last year. The reason for the write-off is that HP discovered Autonomy misrepresented not only its past performance but its prospects going forward. The fraud was evidently well hidden as the purchase was audited by Deloitte, which itself was audited by KPMG. HP has filed a complaint with the SEC as well as British securities regulators, with the hope that criminal charges will be filed. Civil charges against the officers of Autonomy also appear to be forthcoming.

A Christmas Present From Walmart

Walmart announced that it was moving its next dividend payment to December so that investors could enjoy the lower dividend tax rate of 15 percent, rather than face a tax rate of up to 43.4 percent (including the healthcare dividend tax) beginning in January. Walmart's total dividend payment is $1.34 billion, so investors will likely save millions of dollars in taxes, a nice package under the Christmas tree.

Twinkies Disappear

In a sad day for junk food lovers everywhere, Twinkies maker Hostess Brands has asked the bankruptcy court judge for permission to liquidate its assets. The company blamed a strike by the Bakery, Confectionary, Tobacco Workers and Grain Millers International Union (BCTGM). The company will continue to ship products until inventory runs out. Of course, Twinkies will likely make a comeback. It is likely that another bakery or private equity firm will purchase the Twinkie name in bankruptcy and bring back the familiar yellow treat.

Stock Certificates Damaged

The flooding in New York from Superstorm Sandy hit the vault of the Depository Trust & Clearing Corporation (DTCC). While the DTCC is relatively unknown, it holds $35.6 trillion in securities and settled nearly $1.66 quadrillion in trades during 2010. The DTCC is the primary clearinghouse for securities in the U.S. The job of the DTCC is to keep track of the trades made in stocks, bonds, and other securities and track who owns those securities after each trade. Many financial instruments, such as Treasury bonds, are book entry only. This means that ownership of a particular Treasury bond is electronically recorded, often at the DTCC. Physical stock and bond certificates have been rapidly declining in favor of the book entry system, although as the damage from this flooding shows, there are still a significant number of physical financial certificates.

Dividends Jump Before January?

With the impending dividend tax increase from 15 percent to 43 percent, at least some companies are paying special dividends before January 1, 2013 to allow shareholders to be taxed at the lower rate. For example, The Buckle announced a special dividend of $4.50, more than 10 percent of its stock price and Commerce Bancshares announced a $1.50 special dividend.

Eugene Fama Interview

Professor Eugene Fama from the University of Chicago is regarded as a financial leader, with some of the most cited research in Finance. In a recent interview, Fama discusses a wide range of financial topics, including the ability of portfolio managers to beat the stock market, the equity risk premium, CAPM, and a discussion of underfunded pensions, among other topics. As for the equity risk premium, Fama argues that because of an increase in PE ratios, the equity risk premium going forward is about 4 percent, significantly lower than the approximately 7.5 percent historic risk premium since 1926. In the discussion of underfunded pension liabilities, Fama argues that "The sponsor should be discounting the liabilities at the expected return implied by the risk of the liabilities, not the expected return of the assets." To show the link between different areas of Finance, consider that while the interview discusses capital markets, this statement is a fundamental tenant of capital budgeting, that is, the cost of capital depends on the use of funds, not the source of funds.  

Currency Risk

If your company has operations, sales, or production in different countries, hedging is a necessity. With the recent rise of the U.S. dollar, some companies have become complacent about hedging. While U.S. companies can benefit from a rise in the dollar, it is difficult to predict future exchange rate movements. Hedging should be an ongoing process, even if the company feels exchange rate moves might be favorable. As the article notes, the business of most companies is not to take currency risk, but rather buy or sell a product. Unfortunately, some CFOs try to use currency markets to generate additional revenue. And while this may sound appealing, as with any investment, it is very hard to beat the currency market.

Which EPS?

One problem with using financial ratios is that the calculation of these numbers is done differently by different people. You would think that EPS would be calculated the same all over, but in fact there are two common EPS numbers, the basic EPS and the diluted EPS. The basic EPS is calculated as we have done in the textbook, that is, net income divided by shares outstanding. The diluted EPS is the net income divided by the total potential shares outstanding. Many companies use stock options to motivate employees, especially upper management. If there are a large number of employee stock options issued by the company and not yet exercised by employees the number of shares outstanding could grow rather quickly if the options are exercised. The diluted EPS uses the number of shares as if all employee stock options were exercised. This gives a lower EPS, which is a more conservative estimate of the company's EPS.

Luck Or Skill?

The efficient markets hypothesis may be the most bitterly debated topics in Finance. Portfolio managers believe that the market is not semistrong form efficient, otherwise their contribution is negligible. However, many proponents argue that beating the market is nearly impossible. Michael Mauboussin, the chief investment strategist at Legg Mason Capital Management, argues that on the skill/luck continuum, stock picking requires just abount as much luck as roulette or slot machines. In part, he argues that the number of intelligent people in the investment industry means that the distinction between the best and the worst narrows. And, as people become more skillful, luck becomes a more important component of performance.

A Prospectus Is Meant To Be Read

One cause that some have given for the recent financial problems is that the underwriters and sellers of the securities misled investors. With the discussion of various financial regulations, and passage of others, the government agrees. While we have no stance on whether investors were misled in verbal communications, it appears that these claims may be overstated. For example, in the famous Abacus CDO prospectus, Goldman Sachs stated they "..shall not have a fiduciary relationship with any investor," and that the firm "may have conflicts of interest." Even more directly in another deal, Citigroup and Credit Suisse stated that the firms may have conflicts, but also that the firms’ “actions may be inconsistent with or adverse to the interests of the Noteholders.” As an investor, you must remember that just because the SEC approves a prospectus does not mean that the SEC feels the investment is a good idea, but rather that all relevant information is disclosed. It is up to the individual to research the investment and decide for themselves.

Apple Cannabilization

One key consideration in calculating the cash flows from a new project is side effects, including cannibalization, or erosion, of existing product sales. When Apple announced its new iPad Mini, one of the key considerations for Apple should have been the potential cannibalization of sales of the regular iPad. However, as the article points out, not all of the cannibalization is relevant. If Apple hadn't cannibalized some of its iPad sales, Amazon or Google would have taken these sales from Apple with their smaller tablets.

Using Time Value Of Money

Recently, GM decided to remove future pension liabilities from its balance sheet. To accomplish this, GM gave its salaried employees a choice: keep the pension payments as promised, although the pension payments would be made by Prudential, not GM, or take a lump sum payment now. So what information is necessary to make a decision such as this? The main components are the interest rate offered by the pension payments, the rate of return an employee could earn on the lump sum, and the difference in the risk between these two options, including the likelihood of default on the pension payments. While we doubt many GM employees made such a comprehensive analysis, 30 percent of the salaried employees took the lump sum option.

PE Ratios and Dividends Around The World

According to FactSet, the country with the lowest PE ratio is Russia at 5.22 times, while Mexico has the highest PE at 26.90 times. The PE ratio in the U.S. is about 15.20 times. In addition to Russia, Italy and New Zealand are the only countries with single digit PE ratios, while Mexico has the only PE ratio above 20. India's stock market has a dividend yield of 1.33 percent, while Spain's average dividend yield is 8.43 percent. By way of comparison, the average dividend yield on U.S. stocks is 2.18 percent.

No Greek Haircut

German Finance Minister Wolfgang Schaeuble announced that a "haircut", or restructuring, of Greek debt would not be possible. The Greek government had asked for a haircut on the country's debt, in this case a by reducing in the coupon rate and extending the maturity of Greece's debt. Schaeuble stated that refunding, or buying back outstanding bonds and replacing them with new debt, was a possibility.

Microsoft Wins Treasury Award

Microsoft has more than $1 billion in cash flowing through the company each day, so working capital management is a very important task. Recently, the company was awarded the Alexander Hamilton award by Treasury and Risk. Microsoft's working capital team worked on ways to improve cash forecasting. The team was able to reduce forecasting variances by 50 to 70 percent each month, resulting in a drop of over $200 million in the cash balances of subsidiaries.

Crowdfunding A Startup

A new potential source of financing for small businesses seems to be growing closer to reality. Crowdfunding, or small investments by many individuals, was part of the JOBS Act, which was enacted in April 2012. The new law will allow individual investors to invest in startups through the Internet. Although crowdfunding has been passed into law, the SEC must still set the rules and regulations for these new "exchanges". Investors in crowfunding must be accredited. For an individual, this means more than $1 million in net worth or more than $200,000 in income for two of the past three years. A recent article for small business owners explains some of the rules, drawbacks, and taxes for crowdfunding.

The Board Versus The CEO

At one time, a company's Board of Directors was viewed as a rubber stamp for the CEO. Recently, Boards have become more active in the management and control of the company. Citi CEO Vikram Pandit resigned last week after a clash with Citi's Board and in 2011 Yahoo's Board fired CEO Carol Bartz. Other companies that have lost CEOs or Board Chairman leaving because of discord include American International Group and Hewlett-Packard. A recent survey indicates that 21 percent of Board Chairman in 2011 were independent, up from only 10 percent in 2006. Other factors cited which may be leading to the increased activism of Boards includes the recent financial crisis, increased regulation, and fear of investor lawsuits.

Cash Balances

When things get risky and uncertain, cash is king. Many companies seem to be following this advice. In fact, the cash balance for the S&P 500 companies is approaching $1.5 trillion. CNBC recently compiled a list of 10 cash rich companies. For example, Priceline has $2.4 billion in cash, which is 63 percent of the company's assets, compared to an industry average of about 20 percent. And Altera Corp. has $3.44 billion in cash, which is 80 percent of assets, compared to an industry average of 27 percent.

The NPV Of A College Degree

While there has been debate about the cost of a college education, any analysis of cost should include both all outflows and all inflows. A recent article from Brookings discusses both the cost and financial benefits of a college degree. The Hamilton Project found that the return on a college degree doubled the stock market return since 1950 and is more than five times the return on corporate bonds, long-term government bonds, gold, or home ownership. The average IRR of a college education since 1950 was 15.2 percent. Since 1976, the IRR has fluctuated between 14 and 18 percent. In 1980, the NPV of a college degree was about $260,000 at a 5 percent rate and the NPV grew to more than $450,000 for someone starting college in 2010. Although the text deals with capital budgeting in a corporate context, remember that capital budgeting techniques can actually be applied any time a financial decision is being made.

Share Repurchases Set To Rise?

With the potential tax increase on dividends, the potential for smaller dividend increases offset by increases in share repurchases exists. If capital gains are taxed at a lower rate than dividends, capital gains should be preferred by investors. Another interesting point in the article is the reference to the performance of stocks in companies that follow through with share repurchases. Such companies have outperformed the market as a whole, which may indicate that share repurchases, when completed, give a similar signal as dividend payments.

Dividends Are Here To Stay

Why do companies pay dividends? According to finance theory, investors should be indifferent to dividends or capital gains assuming equal taxation. And when dividends are tax disadvantaged, investors should prefer no dividends and the subsequent increase in capital gains. Professor Douglas Skinner, an accounting professor at the University of Chicago, discusses the dividend puzzle. As is noted in DeAngelo, DeAngelo, and Skinner (2004), the top 25 dividend payers account for more than one-half of all dividend payments. Skinner points to continued dividend payments as a result of: 1) The signalling power of dividends. That is, dividends are a strong signal that the firm will continue to be able to pay dividends. 2) Dividends reduce the ability of managers to squander cash. 3) Widows, orphans, and regulations that force large institutions to invest in dividend paying stocks. As Dr. Skinner points out "Although we haven’t yet established the reason, the data are very clear: Dividends, even though they remain a puzzle, are here to stay."

Presidential Capital Budgeting

In September 2010, President Barack Obama spoke to A123 Systems Inc. CEO David Vieau and Michigan Governor Jennifer Graham about the opening of a new electric car battery plant in Livonia, Michigan. President Obama proclaimed that “This is about the birth of an entire new industry in America -- an industry that’s going to be central to the next generation of cars.” Unfortunately, the results from a new project can be wildly different from capital budgeting projections. Today, A123 filed for bankruptcy protection. Part of the reason for A123’s bankruptcy lies in the fact that the government targeted sales of 1 million electric vehicles by 2015, but as of September 2012, only 50,000 electric cars have been sold in the U.S. A potential suitor for A123 is Wanxiang Group Corp., China’s largest auto-parts maker. Such a bid would likely result in car batteries made in China, not the U.S., a stated goal of U.S. government support of A123.

Starbucks And U.K. Taxes

A common criticism of the U.S. tax code is that corporations do not pay a fair share of taxes on income. But this is more widespread than just the U.S. Since 1998, Starbucks has earned over £3 billion ($4.8 billion) in revenue in the U.K. yet has paid only £8.6 million pounds ($13.44 million) pounds in taxes. There is no indication that Starbucks has done anything illegal, but it has used the U.K. tax code to its advantage. Overall, Starbucks has paid 13 percent tax on its international operations. One way companies as diverse as Starbucks and Google avoid taxes is to charge subsidiaries for intellectual property from a business that is domiciled in a tax haven country. The second method used is that the coffee sold in the U.K. is roasted at a subsidiary in Amsterdam, which sets the price it charges U.K. Starbucks. A final method is inter-company loans. A subsidiary in a low or no tax country makes a loan to a subsidiary in a high tax country. The borrower can deduct the interest payments, but the low tax subsidiary pays little or no tax on the interest income.

Mutual Funds Underperform The Market

Although many professional money managers and investors would like to think that they can beat the market, the evidence is against this belief. New research shows that for the 12 months preceeding June 2012, the S&P Composite 1500 outperformed 89.84 percent of all actively managed U.S stock funds. For the prior three years and five years, the percentages were 73.24 percent and 67.72 percent, respectively. Mutual fund performance is even worse for bonds funds with 93.62 percent of actively managed long-term government bond funds trailing the Barclays Long Government index. These percentages lend support for the stock (and bond) market being semistrong form efficient.

Net Income Is Fiction, Cash Flow Is Fact

With all of the regulation regarding regarding financial reporting, including Sarbox, you might conclude that the earnings reported by a company would be precise and correct. However, recent research indicates that 20 percent of companies manage earnings. Managing earnings in this context means that companies may under-report earnings in one quarter to offset potential down earnings in future quarters. In a recent interview, Dr. John Graham discusses the results of his research and suggests that a more important measure of corporate performance is cash flows. While earnings can be manipulated through accounting choices, cash flow is much more difficult to manipulate.

30-Year Bond Issuance Rises

Companies are issuing 30-year bonds at a frenetic pace. So far in 2012, about $92 billion worth of 30-year bonds have been issued, more than in any full year since 1995. Companies are issuing long-term bonds because investors are willing to buy because of the almost non-existent short-term yields, and companies are locking in the low long-term yield. The investment grade YTM for 30-year bonds is at 2.77 percent, down from over 7 percent four years ago. Comcast recently sold $1 billion in 30-year bonds at 4.45 percent, compared to the 6.5 to 7 percent range the company had paid a couple of years ago. This resulted in a $20 million annual savings on interest payments. Even General Electric, which hadn't sold 30-year bonds for five years, issued $2 billion in 30-year bonds.

IPOs Up

For the year, 105 IPOs have been priced, more than the 96 that were priced in the same period in 2011. IPOs have raised $36.1 billion, 23.4 percent more than in 2011. On the downside, 50 IPOs have been cancelled during the year, the most recent by Dave & Buster's. Over the past nine years, an average of 55 IPOs have been cancelled each year, with 2008 seeing 103 cancellations.

Sprint Down And Down

Yesterday Deutsche Telekom, parent of T-Mobile, announced that it was entering negotiations to purchase MetroPCS. The stock price of telecom rival Sprint, which backed out of the acquisition of MetroPCS earlier this year, fell on the news. Today, a report by Bloomberg announced that Sprint was considering a counter-bid for MetroPCS. So what would you expect happened to Sprint shares on this announcement? The stock fell by an additional 3 percent. One interpretation is that the market views a T-Moblile/MetroPCS merger as a negative for Sprint, but a Sprint purchase of MetroPCS as even more negative, possibly because Sprint may be forced to overpay for MetroPCS in a bidding war.

U.K. Department of Transport Fails Finance

Sir Richard Branson's Virgin Trains, which has been operating a British railway line since 1997, recently lost on a bid to continue operating the line until 2027. So Virgin Trains sued over the decision. In the buildup to the court case, the U.K. Department of Transport (UKDT) retracted the offer to run the line by rival FirstGroup. So why the the UKDT back down? While the reason given was vague, it is probable that the UKDT did not properly evaluate the cash flows it would receive from the winning bid. As the article states, it seems likely that the UKDT did not discount the back-end loaded payments which made FirstGroup's bid appear larger than Virgin Trains.

It's September, Time To Buy

At the beginning of the month, we referenced an article which suggested that investors should sell in September. And we are happy we didn't follow the advice in the article. For the record, the S&P 500 increased by about 2.4 percent in September, from 1,406.58 to 1,440.67. We would be happy with that return in any month.

Duke Energy Coup, Part Deux

Back in July, we posted about the two hour CEO job that William Johnson held for two hours as CEO for the merged Duke Energy/Progress Energy. As with many complicated stories, time allows for more information to be disseminated. For example, in an interview, old/ex/new CEO Jim Rogers said that he had only given up his position as a CEO of Duke Energy in order to pay a lower premium for Progress Energy. This implies that William Johnson helped aid the sale of Progress at a discount in order to be the CEO of the combined company, an accusation he vehemently denies.

Investors Happy About RIM Loss

Research In Motion (RIMM), the manufacturer of the Blackberry, announced a loss of $235 million or 45 cents per share for the second quarter compared to a profit of $329 million or 63 cents per share in the second quarter last year. The loss per share excluding one-time expenses was 27 cents per share. While this would seem to be bad news, RIMM shot up 14 percent after the announcement. So why the big jump in the stock price? Analysts had expected a loss of 46 cents per share. As one analyst stated: "It's still bad, but it's a much smaller disaster than expected."

Student Loans Climb

The average student loan debt has climbed to $26,682. Currently, unsubsidized Stafford loans have an interest rate of 6.8 percent. So, if you graduate with an average student loan debt and pay off your loan over the next 20 years, what are your monthly payments? See if you don't agree that it will be $203.67 per month.

IPO Doubles Stock Market Size

Morgan Stanley has withdrawn as the lead underwriter for the Asiacell IPO, which is set to take place on the Iraqi bourse. It will be the first major IPO on the Iraqi market since 2003. One interesting fact about the IPO is the large size relative to the Iraqi bourse. The Iraq Stock Exchange has a market capitalization of about $3.4 billion and trades an average of $3 million per day. Asiacell is expected to have a market capitalization of about $4.4 billion on its own.

GM Looks For A Revolver

GM is seeking a new revolver, or revolving credit line, for between $8 and $10 billion. The revolver will be used to replace an existing revolver of $5 billion, pay down other debt, and to provide liquidity. The commitments from individual banks will start at $600 million and go down to $350 million for the second tier. The upfront fees are 35 to 50bp (bp is a basis point, or 1/100th of a percent. One basis point is equal to .01%) depending on the amount committed by the bank. The interest rate on the loan is expected to be 250bp over LIBOR, and GM will pay 37.5bp on the unused amount of the revolvers.

IPO Bump?

It is well documented that there are cycles in IPOs. Recently, the IPO market has been relatively slow, but some analysts believe that the time may be right for an increase in the number of IPOS. The stock markets have experienced good returns over the past year, recent IPOs have performed relatively well, and the VIX, the market's "fear gauge," is low.  Additionally, the JOBS Act, which allows companies to file a confidential first draft of its registration documents, may increase the number of publicly traded companies.

Should FX Exposure Always Be Hedged?

For a company with an exposure to currency risk, hedging with derivatives is one way to reduce or eliminate that risk. However, a risk manager at one bank argues that companies should not automatically hedge exchange rate risk. For example, if a U.S. company is going to receive euros at a future date, it will lose if the dollar weakens. If the company expects the dollar to strengthen, a good hedging strategy may not involve a hedge at the current exchange rate, but to allow a small risk in order to give the market time to move in the expected direction. While we are not endorsing or condemning the particular strategy used in the article, we definitely agree that hedging is not a one size fits all activity and should be fit to the particular company and situation.

Turkey Issues Sukuk

Turkey announced that it was issuing its first sukuk, or bonds compliant with Islamic law. Turkey expects that it will sell $1 billion of the dollar-denominated bonds. Turkey will sell certificates to investors, who then lease them back at a fee. The offer is oversubscribed, with about $6 billion in orders for the bonds. The sukuk will pay an interest rate about the same as comparable Turkish government bonds. Overall, about $13 billion of the $24.3 billion worth of bonds issued in the Middle East in the first half of 2012 have been sukuk.

Cash They Can't Spend

Companies seem to have a lot of cash on hand recently. For example, Google has about $44 billion in cash and short-term investments and Apple has about $28 billion on its balance sheet. But the tech giant with perhaps the biggest cash horde is Microsoft, with about $63 billion in cash on its balance sheet. So why doesn't Microsoft spend some of this cash? One reason is that of the $63 billion in cash, $54 billion is held by the company's overseas subsidiaries. In order to spend this cash, Microsoft would need to repatriate it, resulting in taxes being paid on the overseas profits.

Twinkie Goes Stale?

According to the urban legend, a Twinkie never goes stale, but its parent has gone stale. Hostess, in the middle of bankruptcy filing, has asked the bankruptcy judge to force a new contract on one of its employees' unions. Hostess is in its second bankruptcy since 2004 and has argued that without a new labor contract it will be unable to continue operations. Fortunately for junk foodies, even if Hostess does not emerge from bankruptcy it is likely that most of the company's iconic brands such as Twinkies, Ding Dongs, and Cupcakes will be sold to another company.

Early Release for Lockups

Lockups, agreements that restrict the ability of insiders to sell stock in an IPO, have traditionally lasted for 180 days after the IPO. Recently, lockup provisions have been shortened for many IPOs. In fact, the lockup period for ExactTarget was only 7 days after the IPO. One reason may be an increase in fees for the underwriter. The lead IPO underwriter is almost always the underwriter on the secondary offering from the lockup shares if the secondary offering is less than 180 days from the IPO. After 180 days, the underwriter for the secondary offering is up for grabs.

I'll Take That Negative YTM Treasury

Recently the U.S. Treasury sold new bonds at a record low YTM of negative 1.286 percent over five years. The reason investors were willing to a take a negative YTM is that the bonds are TIPS. With TIPS, the government increases the par value each year by the inflation rate. Given that regular Treasuries with the same maturity had a YTM of .71 percent, buyers of the TIPS are expecting inflation to average about 2 percent over the next five years in order to break even. The expected break even inflation rate is 2.376 percent over 10 years and 2.39 percent over 30 years, all well below the average inflation rate of 3.1 percent since 1926.

Moody's May Downgrade U.S. Debt

In August 2011, S&P downgraded U.S. Treasury debt from its vaunted AAA credit rating. Over a year later, Moody's announced that it may also downgrade U.S. Treasury debt from its current Aaa rating. Moody's blamed the the possible downgrade on the "fiscal cliff". In January 2013, government spending cuts and tax increases are set to take place, which analysts believe may lead to another recession.

Chevrolet Volt: Bad Capital Budgeting

By most accounts, the Chevrolet Volt has been a dismal failure. Year-to-date, Chevrolet has sold just 13,500 Volts, well below the 40,000 cars that GM had projected for 2012. The car's $39,995 base price, along with long charge time, has not helped sales. Of course, reporting on the Volt's financial results can be as weak as the car's sales. For example, as the article notes, it currently costs GM between $75,000 and $88,000 to build each car, including development costs. GM spent between $1 billion and $1.2 billion in development and tooling costs, or just under $56,000 per car sold since the model's introduction. In any capital budgeting analysis, such calculation are meaningless for several reasons. One notable reason is the shaky analysis in the first line of the article that implies it isn't a good thing for GM to sell more Volts. The actual cost to build a Volt is estimated to be $20,000 to $32,000, so any sale above that variable cost increases the NPV of the project. One thing the article does point out is that the development of the of the Volt does provide technology that can be applied to future vehicles, a strategic option in green technology.

Profit Margin = Net Income / Sales?

When you are examining ratios, you must be careful that you know how that ratio is calculated. For example, the profit margin for private companies in 2012 has reached 9.1 percent over the past three months, about triple the profit margin in late 2009 and early 2010. You would think that everyone would calculate a ratio as basic as the profit margin in the same manner, but that isn't true. If you read the last paragraph carefully, you will find that the profit margin for private companies often excludes taxes and includes owner compensation in excess of market-rate salaries. In this case, we can't compare the profit margin for a private company and a public company even if they are in the same industry since the calculation of the profit margin is different.

Why Take This Class?

Based on our experience, many students have a negative view of Finance at the beginning of the class. So why take this class? A recent study found that most retail investors “have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.” Only 14 states currently have a required personal finance class. While we do not believe that this class will make you an informed investor by itself, many of the concepts are applicable to basic investment decisions and can serve as a foundation for your future financial literacy.

Sell In September?

"Sell in May and go away," an old stock market adage, advises investors to sell stocks in May and not reinvest until the fall, typically around Halloween. Since 1896, September has been the Dow Jones Industrial Average's worst month with an average loss of about 1 percent. And since 2000, September has seen an average loss of 2.12 percent. On the bright side, 5 of the last 7 Septembers have had positive returns.  Whether or not September 2012 has another negative return remains to be seen, but technical analysts should have already left the stock market.

EU Warned About Credit Problems

Moody's cut the European Union's creditworthiness from "stable" to "negative". In July, Moody's revised the outlook downward for Germany and the Netherlands. Moody's stated that it believed that member countries would likely back their sovereign debt rather than EU debt. The EU recently announced a bond buyback for the sovereign debt of Spain and Italy, two countries that have large deficits and borrowings, leading to very high sovereign debt interest rates.

Dividend Tax Expires, Stock Unaffected?

A recent opinion article in CFO argues that allowing the Bush dividend tax cut to expire will not affect stock prices. In other words, the author argues that tax rates on dividends do not affect stock prices for four reasons: 1) Dividends are critical to returns and smart investors do not turn their backs on dividends. 2) Dividend paying stocks remain in high demand, the widows and orphans argument. 3) Institutional investors will not be impacted, a rephrasing of the widows and orphans argument. 4) There is no evidence that companies adjust dividends based on shareholder taxation, an argument that Figure 14.5 would contradict on the surface.

The Bonds They Are A Changin'

Goldman Sachs recently pulled its Dylan bonds from the market. Goldman had originally expected to sell $300 million worth of the bonds, backed by the royalties received from songs written by Bob Dylan. The bonds were expected to be issued with a BBB- rating, but Goldman pulled the bonds to separate the cash flows into two classes, or "tranches". The senior tranche will carry a higher credit rating, while the subordinated, or junior, tranche will have a lower credit rating and bear more default risk than the senior tranche.

Samurai Bond Issuance Rises

Samurai bond issuance is rising due to low Japanese interest rates and demand from Japanese investors. About $7.2 billion worth of Samurai bonds have been issued this year by Asia-Pacific borrowers. While this is down from the $8.2 billion issued over the same period the previous year, it is up 20 percent from 2010. Japanese investors are eager for the samurai bonds after the 2011 tsunami revealed the problems with too much domestic debt exposure, resulting in "reverse roadshows". Typically, a lender will have a roadshow to attract potential investors, but demand for samurai bonds is so high that borrowers are running reverse roadshows in which they search for potential lenders to offer samurai bonds.

Corporate Bond Sales Record

Corporate bond sales in August reached a record $237.6 billion. A major reason was likely low interest rates, which reached 3.72 percent according to the Bank of America Merrill Lynch index. Siemens issued 13 year bonds at 2.75 percent and 30 year bonds at 3.75 percent. JP Morgan issued 5 year bonds at a 2 percent yield and perpetual preferred shares at 5.5 percent, an especially low rate considering the preferred stock was rated as junk.

A Cheap Stock Market

Compared to five years ago, the S&P 500 is 15 percent cheaper. The PE for the S&P 500 based on forward earnings is currently 12.7 times, down from 15.1 times at its peak in 2007.

Yelp Up After Lockup Expiration

Generally when lockups expire 180 days after an IPO, the stock price falls. Contrary to expectations, Yelp was up as much as 22 percent on the day of its lockup expiration. About 52.7 million shares were freed up today, or seven times the current number of shares available for trading. The fact that no large sales were made by insiders is likely the cause. A large number of Yelp shares had been short sold, and with the lack of a price drop, short sellers could be buying to cover their position.

LIBOR Lawsuits

Lawsuits over LIBOR manipulation are growing, from individual and institutional investors who argue that their bond returns were artificially lowered to cities and hedge funds who argue that their financial contracts cost more because of trader actions. The size of the potential payouts by banks varies dramatically from $7.8 billion to $176 billion. Many of the lawsuits will be class action, especially for individual investors. For example, the lead plaintiff on one case lost about $100 in interest over a 34 month period. As with many lawsuits, it will likely take years in the courts to be resolved.

You Spent How Much?

Energy companies have been under scrutiny for their large net incomes in recent years, but as the saying goes, "It takes money to make money." In our discussion of capital budgeting, we note that good estimates are necessary because of the large sums involved. So how large is large? You would think the $28 billion price tag for the Three Gorges Dam in China is fairly large, and indeed it is. But compared to the $116 billion Kashagan project in Kazakhstan, it is relatively small.

Death Annuities

Like many terms in Finance, annuity has several different meanings. In the textbook, we define an annuity as a stream of payments over some specific period. In the insurance industry, an annuity is a tax-deferred account that allows for savings and investment. The investment vehicles can vary from a fixed rate investment to a variable annuity that allows for investments in the stock market. The insurance annuity is similar to our textbook definition of an annuity since unless it is terminated early, at some point the annuity will be annuitized, that is, a stream of payments will be made from the balance of the account. Since they are sold by insurance companies, an annuity also has a death benefit. However, a loophole in annuity contracts has allowed Joseph Caramadre to make upwards of $15 million from the death of annuitants. For an audio version, listen here.

Best Buy Changes Mind...Again

In a surprising move, Best Buy has given founder Richard Schulze the go-ahead to pursue his potential acquisition of the company. Just last week, Best Buy rebuked Schulze's initial offer and hired turnaround specialist Hubert Joly as its new CEO. Schulze has been given access to the company's financial information and is allowed to recruit partners for the potential acquisition. Schulze has 60 days to make an offer. If rejected, he would have to wait until January to make another offer.

The Downside To A Fast Cash Cycle

As PC sales have slowed industry wide, Dell's sales have slipped as well. One of Dell's claims to fame and a reason for its profitability is a fast cash cycle. In fact, during many years, Dell had a negative cash cycle. But Dell's slowing sales and cash cycle have caused a problem. When sales are increasing, the company is getting paid to make products faster than it is making them. When sales slow, the cash needed to pay for old orders can become greater than the cash received from new orders.

Sirius Board Sued

The City of Miami (Florida) Police Relief and Pension Fund is suing the Board of Directors of Sirius for not fighting a takeover by Liberty Media Corp. With Sirius facing bankruptcy three years ago, Liberty loaned Sirius $530 million with a caveat that Sirius not adopt a poison pill or any other defense measures that would stop Liberty form acquiring Sirius after three years from the date of the loan. Liberty has acquired more than 50 percent of the stock in Sirius without paying a premium on the shares, which  is typical in an acquisition. The pension fund states that the Board's agreement not to fight a takeover by Liberty Media was a violation of the Board's fiduciary duty to stockholders.

Should Facebook Fire Peter Thiel?

We are not proponents of Facebook co-founder Peter Thiel's plan to pay students $100,000 to drop out of college, an offer that made a big splash. Thiel is back in the news again when it was announced that he had sold 90 percent of his stake in Facebook. Since Thiel sits on Facebook's Board of Directors, some have called for his resignation, citing the sale as a lack of conviction in Facebook's future. Others have argued that Thiel was an early investor, has made his profit, and it is time for him to move on. Thiel invested $500,000 in 2004. His original investment had grown to over $1 billion, an annual return of more than 159 percent. In either case, it is likely that potential agency problems have increased since Thiel's wealth is now less aligned with that of other Facebook investors.

Municipal Bond Default Rates

Between 1970 and 2011, Moody's reported that there were 71 municipal bond defaults. Similarly, S&P said that there were 47 municipal defaults from 1986 to 2011. These default numbers are over two different periods but appear similar, so we should be able to believe both numbers. But the Federal Reserve reports there were 2,521 and 2,366 defaults over the same periods! So now who do we believe? It depends on how you count. Both Moody's and S&P reported only defaults for rated bonds, while the Fed included defaults for unrated municipal bond issues, most definitely a riskier class of municipal bonds. The data also shows that general obligation bonds are unlikely to have defaulted, while revenue bonds and industrial development bonds were much more likely to have defaulted.

Poway's Time Value of Money

Recently, the Poway Unified School District in California issued a very interesting bond. The bond issue was for $105 million. No payments will be made for 20 years, then the first payment of $30 million will be made. The next year, $47 will be due, then $50 million a year for the next 18 years. Check for yourself that the interest rate on this debt is 7.84 percent. While we think this is a relatively high interest rate in the current environment (although California municipal bonds are likely a very risky investment), assume that the interest rate is correct for this investment. If Poway had taken out an amortized loan with equal payment, the payments would have been for about $8.659 million per year, or a total of $346.4 million over 40 years. A normal bond issue with interest payments and a repayment of principal at the end of the loan would have annual interest payments of $8.237 million, for a total repayment of $442.7 million. Under the current bond terms, the total repayment will be $977 million. The multi-million dollar question: From a pure time value of money perspective, which of these bond terms is preferable? Answer: They are all the same! Why?

Capital Structure: U.S. Versus Europe

A major difference in the capital structure of U.S and European companies' balance sheets is the source of debt. European companies have traditionally relied heavily on bank debt rather than publicly traded debt. The total publicly traded debt of European companies is just 7 percent of GDP, compared to 35 percent in the U.S. With the recent banking turmoil in Europe, European banks have been deleveraging balance sheets. As a result, European companies have been issuing bonds in large amounts. For example, AB InBev issued $7.5 billion worth of bonds and Unilever issued $1 billion in bonds. Because of new banking regulations and economic problems, European banks are expected to shed $2 trillion over the next several years, which will likely increase corporate bond issues in Europe even further.

A Positive: Smaller Free Cash Flows

Free cash flows available to companies to pay dividends or buy back stock fell in the first quarter of 2012, but that is not necessarily a bad thing. While free cash flow fell slightly, selling, general and administrative expenses rose, as did capital spending. Longer cash cycles during the quarter also slowed free cash flows. Because of the generally positive reasons for the decreased free cash flows, indications are that this is positive news.

Hostess' Chapter 22

While bankruptcy is very often a difficult process for many companies, the second bankruptcy for Hostess this decade is definitely not a piece of cake. A recent article outlines how the original bankruptcy process looked like it would allow Hostess to move forward as a going, profitable concern. However, the recent recession coupled with Hostess' high labor costs and high leverage have forced the company back into bankruptcy court. The company pension plan is underfunded by about $2 billion and labor relations are stained. If the pension liability is eliminated by the bankruptcy court, the Teamsters Union has already had a strike by its members ratified. And while it is difficult to liquidate a Twinkie, the manufacturer of this iconic yellow treat may be headed for such a fate.

Social Impact Bonds

Bonds come in a variety of exotic types and one of the newest is a social impact bond. Through Goldman Sachs, New York City just offered a $9.6 million social impact bond to help Rikers Island inmates from returning to jail after they are released. Social impact bonds provide money upfront to nonprofits to provide social services. If the nonprofit doesn't meet its goal, the government doesn't lose money...and the investors won't get paid in full.  

Strong Dollar, Weak Earnings

A common message from U.S. based multinational companies during recent earnings announcements is the pain of the strong dollar. While most multinationals use various hedging procedures to protect against currency fluctuations, the fact that the dollar has appreciated by about 5 percent against the euro in the most recent quarter has caught many by surprise. A strong dollar makes U.S. products more expensive overseas and the foreign sales are worth less when they are converted back to dollars. To give a couple of examples, currency losses reduced Tupperware's sales by about 10 percent and reduced Colgate-Palmolive's profits by about 10 percent as well.

Pay Your Debt

Berlin, Germany has close to €63 billion in debt, but that amount may grow if Mittenwalde, Germany has its way. An archivist recently found a certificate of debt that indicated Mittenwalde had loaned Berlin 400 guilders on May 28, 1562 at an interest rate of 6 percent per year. It was reported that the debt would now be at 11,200 guilders, or €112 million ($136.79 million). In fuzzy reporting, how this amount was calculated is not given. A quick time value of money calculation indicates that the actual amount owed by Berlin is about 97.66 trillion guilders, or about €976.6 quadrillion!

Excess Euros

Apparently European companies could do a much better job of managing working capital. According to recent research, European companies could free up €886 billion ($1.09 trillion) in cash by improving working capital. The report found that the best performing companies collect 16 days faster, pay 16 days slower, and have about one-half of the working capital of a typical company. And very few companies appear to be stellar working capital managers. Of the 925 companies examined, only 99 improved working capital every year for three years and no company managed to improve the receivables period, inventory period, and payables period each year.

An Olympic Capital Budget

While it may come as a surprise, even the Olympics can be viewed as a capital budgeting project. And the London Olympics could have had better financial planning. The 2012 Summer Olympics cost London nearly $15 billion, or about five times the original estimate. London gets repaid with broadcast dollars, and the broadcasters get repaid with sponsors' advertisements. Whether the sponsors actually receive a return on investment is more difficult to calculate.

Happy Birthday Sarbox!

Ten years ago, Sarbanes-Oxley, better known as Sarbox, was enacted into law. Experts say that for the most part, Sarbox is working. The law has strengthened accounting and helped reduce the likelihood of another Enron-sized book-cooking meltdown. Although Sarbox requires financial statement certification by executives, only a handful of criminal charges have been filed for violations, but over 200 civil cases have been filed under the law. Another indication of Sarbox's success is that restatement of financial reports has dropped from 1,790 in 2006 to around 790 for the past two years.

Cash, Taxes, And Dividends

More than a few companies are sitting on piles of cash. For example, Apple has more than $117 billion in cash, Microsoft has more than $60 billion, and Google has more than $43 billion. Since these companies are in relatively saturated markets, there is less room for capital investment. So why don't these companies pay larger dividends? One argument is the repatriation of foreign income. Many of the cash piles are in foreign subsidiaries. If the cash is repatriated to the parent, the company must pay a 35 percent tax rate (less any foreign taxes paid) on the repatriated funds. Then shareholders are forced to pay a further 15 percent on the dividend income, a combined tax rate of nearly 50 percent.

How Much Is That Degree?

The average cost for a year of college is $15,100 at a public university and $32,900 at a private university. Over the last 10 years, the cost of a year of education at a public university has increased 6.5 percent per year. As a result of the (unfortunate in this case) exponential effect of compounding, this means that in 2030 the average cost per year of a public college will be $44,047.

Share Repurchases Slow In Being Fulfilled

Over the last 12 months, 565 companies have announced share repurchases for $185.9 billion, but to date only about $68.8 billion in stock has been repurchased. However, in July 2010, a similar report found that only one-half of the companies that announced share repurchases had actually begun buying shares. All 565 companies that have announced share repurchases have made at least minimal buybacks. Further, some evidence suggests that only one-third of share repurchase announcements are ever fully completed.

Apple Cashes In On Cash

By any account, the performance of Apple's stock has been fantastic in recent years and at least part of that performance can be traced back to its management of fixed assets and net working capital. Apple manufactures nothing, but instead contracts out production of iPhones, iPads, and Macs to someone else. These manufacturers are then forced to make large capital investments necessary for production, reducing Apple's need for fixed assets. And many of these suppliers produce products only for Apple, meaning that Apple has leverage in negotiations with its suppliers. Apple pays it payables 83 days on average after receiving the invoice. On the receivables side, Apple collects in 18 days on average and has just 4 days of inventory on hand. As a result, Apple's cash conversion cycle is an incredible negative 61 days!

Credit Rating Falls, YTM Declines?

One year ago, S&P dropped the credit rating on U.S. government debt from AAA to AA. Normally a decline in the credit rating results in an increase in the YTM of the debt. However, in the year since the credit rating drop, interest rates on 10-year U.S Treasury notes have fallen from 2.56 percent to 1.51 percent. Additionally, mortgage rates have fallen, the dollar has strengthened against an index of major currencies, and the  DJIA has risen 12 percent. The contrarian drop in interest rates is largely attributable to the size and resilience of the U.S. economy and the fact that the U.S. dollar is still the world's currency.

Who Is Your Landlord?

Securitized bonds are bonds backed by a financial asset. Practically any financial asset can be securitized and many have been. For example, mortgage backed securities (MBSs) were widely attributed as a cause of the recent recession. Other financial assets such as song catalog royalties, credit card balances, car loans, and life insurance have been securitized as well. A recent addition to the securitized bond market are rental-backed bonds. Financial firms are buying foreclosed homes and renting them out. They then sell bonds whose interest payments are made from the rental cash flows from these houses. Whether the model of selling rental bonds will work remains to be seen, but it appears that there are several investment banks prepared to make the plunge.

Spain's Default Risk Premium

Spain sold about €3 billion ($3.68 billion) of sovereign debt recently. Unfortunately for the Spanish government and taxpayers, the YTM of its 10-year bonds was about 7.02 percent, dramatically higher than the 1.22 percent for comparable German government bonds. Evidence of the financial problems in the Spanish government is seen by the government's request for a €100 billion bailout. Perhaps even more worrisome for Spain is that the YTM on its 2-year bonds was 5.20 percent.

Fender Dented

On Friday, Fender, the manufacturer of guitars played by such legends as Eric Clapton and Jimi Hendrix, withdrew its IPO. The company had planned to raise about $150 million and use about $90 million of that amount to pay down debt. Fender has lost money every year since 2007. Many investors felt that the industry and company were both risky at this time. Other IPOs this week have performed much better. Both Palo Alto Networks and Kayak jumped about 30 percent in the first day, and Five Below jumped about than 55 percent

Managing Earnings

A recent academic survey indicates that companies manage earnings and disagree with the direction that accounting standards are heading. As the authors state in the abstract: "Our key findings include (i) high-quality earnings are sustainable and are backed by actual cash flows; they also reflect consistent reporting choices over time and avoid long-term estimates; (ii) about 50% of earnings quality is driven by innate factors; (iii) about 20% of firms manage earnings to misrepresent economic performance, and for such firms 10% of EPS is typically managed; (iv) CFOs believe that earnings manipulation is hard to unravel from the outside but suggest a number of red flags to identify managed earnings; and (v) CFOs disagree with the direction the FASB is headed on a number of issues including the sheer number of promulgated rules, the top-down approach to rule making, the curtailed reporting discretion, the de-emphasis of the matching principle, and the over-emphasis on fair value accounting."

Will They Ever Be Comfortable?

A recent survey indicates that 52 percent of investors under the age of 31 say that they will never be comfortable investing in stocks. While the majority of the experience by young investors is the recent bear market, historically equities have outperformed bonds and savings accounts. The fear of equities is evidenced by one investor who has not even set up her 401k to receive the company match. One rule of thumb for investments is that you should be able to go to sleep at night and not worry about your investments. While we can agree with this statement, many people worry only about potential losses. Never forget that if you are saving for retirement that you will need sufficient funds available for retirement and we doubt that a one percent return will allow you to achieve your retirement goals and be comfortable in retirement.

It's All In The Diversification

Diversification is a powerful tool to help reduce the risk of a portfolio. Unfortunately, it seems that many people on Wall Street seem to ignore the benefits of diversification. During 2011, employees at the five largest Wall Street banks lost a combined $2 billion in their 401k accounts, mainly due to the falling stock prices of their employers. For example, Morgan Stanley employees hold an average of 24 percent of their 401k balance in Morgan Stanley company stock. During 2011, these employees lost a combined $570 million on the investment. Since an employee is already relying on their employer for income and benefits, buying company stock as well results in a concentrated portfolio. Experts recommend that an employee invest no more than 5 percent in company stock. http://www.businessweek.com/articles/2012-07-12/wall-street-workers-bad-401-k-bet

LIE-BOR Scandal Grows

The investigation into the apparent LIBOR raet fixing by Barclays and other banks is growing. Apparently, the New York Federal Reserve knew of potential LIBOR rate fixing as early as 2007, but no action was taken. The Justice Department's criminal division is investigating several banks and their employees, building a criminal case. Charges are expected to be filed against at least one bank by the end of the year. While most regulators can only pursue civil action and levy fines, the Justice Department investigation could lead to fraud charges and possible jail sentences for traders and other employees. The Attorneys General in New York, Connecticut and Massachusetts are also investigating LIBOR manipulation to determine the effects on states' investments and borrowings. And the Commodities Futures Trading Commission is pursuing a civil case against UBS.

Financial Reintermediation

In the 1970s, financial disintermediation occurred  when investors left the safety of bank deposits for higher yielding money market mutual funds (MMMFs). Recently, the SEC has been in discussions about possible changes to the structure and regulation of MMMFs, which has helped lead to financial reintermediation, that is the increased use of bank deposits. In the recent 2012 AFP Liquidity Survey, 74 percent of corporate short-term assets are in bank deposits, MMMFs, and U.S. Treasury bills. Interestingly, since 2006, the percentage of short-term assets in bank deposits has increased from 23 percent of short-term investments to 51 percent.  http://www.afponline.org/liquidity/

A Coup At Duke

What would it be like to be CEO for a day? Former Duke Energy/Progress Energy CEO Bill Johnson found out. Eighteen months ago, Duke and Progress announced that when the merger took place, Progress CEO Mr. Johnson would be the CEO of the combined company. The merger closed on July 2, 2012 and Mr. Johnson retired at 12:01 AM on July 3rd, forced out by the Board of Directors of the new company. Most of the Board consisted of old Board members from Duke Energy. The action has caused a controversy since the merger had to pass through the North Carolina Utilities Commission, and an investigation has been launched by the North Carolina Attorney General's Office.  http://online.wsj.com/article/SB10001424052702303567704577519013679855528.html?KEYWORDS=duke+progress+merger

Chapter 55

Strauss Auto may have just set a new bankruptcy record. With its latest Chapter 11 bankruptcy filing, Strauss has now reached a Chapter 55 bankruptcy, that is five Chapter 11 bankruptcy filings.  http://online.wsj.com/article/SB10001424052702303561504577492532234404676.html?KEYWORDS=strauss

Repurchase Stock Or Buy A Company?

Recent research suggests that business-service companies would better serve shareholders by acquiring other companies than share repurchases. In two periods, 2002 through 2006 and 2007 through 2011, business-service companies that acquired other companies had much better performance than comparable companies that had stock repurchases. Whether this applies to other industries is unclear. Business-service companies have a strong cash return and require little capital to grow internally. For industries with different operating characteristics, this may not hold true. http://www3.cfo.com/article/2012/7/cash-flow_business-services-companies-cash-flow-pitney-bowes-buybacks?currpage=1

Dump This, Abandon That

While most people are familiar with Android devices, Gmail, and Google maps, failures at Google are less often remembered. Today, Google announced that it would close iGoogle in November 2013. iGoogle allowed users to personalize a home page with applications such as news feeds, stock quotes, and weather. This is the 30th product scrapped by Google since Larry Page became CEO 15 months ago. Apparently, Google realizes that there is an option to abandon an unsuccessful product. http://finance.yahoo.com/news/google-phasing-igoogle-latest-purge-185517633.html

How To Get Rich In Bankruptcy

Alvarez & Marsal, advisers for Lehman Brothers during the current three and one-half years of bankruptcy have requested a $31.5 million incentive fee for work already done and $59.2 million in incentive fees for work it will continue to do. If granted, the incentive fees will bring the total billed by Alvarez & Marsal to more than $620 million. The lead attorneys in the Lehman case have received nearly $390 million to date. http://online.wsj.com/article/SB10001424052702304708604577502962731820288.html?KEYWORDS=lehman+advisers

Let's Stay Home, The Currency is Falling

One of the major determinants of international travel is the exchange rate. The decrease in the value of the Indian rupee has caused Indians to experience an increase of 30-40 percent in international travel costs over the past six months. One Indian travel agency reported a drop of 25 percent in travel volume this year. http://finance.yahoo.com/news/weak-rupee-makes-foreign-trips-054946511.html

LIBOR Manipulation

In the wake of Barclays £290 million ($453 million) fine for manipulating LIBOR rates, the British government ordered a review of how LIBOR rates are determined. Currently, Thomson Reuters determines the interest rate based on the average of the interbank interest rate offered by contributor banks. Barclays underreported the interest rate at which it could borrow, thereby lowering the average interest rate for all banks. A proposed method for the new calculation of LIBOR rates to use actual quotes to calculate the interest rate. http://online.wsj.com/article/SB10001424052702304211804577500820816753362.html?KEYWORDS=Barclays

And in what may be the first of several resignations/firings due to the scandal, Barclays' Chairman Marcus Agius resigned. http://online.wsj.com/article/SB10001424052702303933404577501220607485322.html?KEYWORDS=Barclays

Why Is There No Corporate Investment?

During the recent financial crisis, blame has been placed on corporations for a lack of new investments. While corporate cash balances have been climbing, new investments have stalled. One reason may be an increasing equity risk premium, or market risk premium (MRP), as we call it in the text. An increase in the MRP premium increases the cost of capital for any project, making the NPV less favorable. A recent article in CFO argues that an increase in the MRP is a factor behind the slowdown in capital investments. This may be part of the problem, but we would like you to consider a couple of things.

While the MRP may have increased, the cost of debt has decreased, so the overall cost of capital could have remained the same, or even decreased.  As the article points out, calculating the MRP is not an exact science. An increase in the MRP may be a factor, but the impact is unknown at this time.

While we hope your education is teaching you to critically examine arguments you hear or read, we would also like to point out a glaring error in the logic of the argument presented in this article. The article states that "stock investors are questioning the very integrity of the markets, and the perceived risk of holding an equity portfolio has increased." One reason given for this is the Facebook IPO debacle. And while the Facebook IPO problems may have affected investors' beliefs about risk and market integrity, the Facebook IPO occurred about six weeks ago, much too recently to have had any effect on the MRP during most of the period in question.  http://www3.cfo.com/blogs/banking-cap-markets/banking--capital-markets/2012/06/the-real-reason-companies-aren’t-investing

The Global IPO Slowdown

In the second quarter of 2012, there were 201 IPOs worldwide, less than one-half of the 428 IPOs during the second quarter of 2011. The dollar value of new IPOs fell from $62.4 billion to $40.1 billion for the same period. The U.S. was the sole bright spot, with deals of $22.5 billion during the quarter, although $16 billion of that amount was raised by Facebook. However, in part because of the problems with the Facebook IPO, no IPOs occurred in the U.S. for a five-week stretch afterward. http://online.wsj.com/article/SB10001424052702304830704577497062475691348.html?mod=WSJ_GoogleNews&mod=igoogle_wsj_gadgv1

Should Germany Leave The Euro?

If Germany were to leave the euro zone, the resulting devaluation of the euro could benefit the remaining members of the European Union. A recent op-ed by Kenneth Griffin and Anil Kashyap argues that a German exit from the euro back to the Deutsche mark could be beneficial to all parties in the long run. http://www.nytimes.com/2012/06/27/opinion/to-save-the-euro-germany-must-leave-it.html?_r=1&smid=pl-share

Moody's Downgrades Banks

Moody's downgraded numerous large banks citing exposure to violent swings in the global financial markets. The banks were grouped into three categories. The safest banks have large consumer deposits, lending and credit card business. The second group relies heavily on investment income, and the riskiest group has problems in risk management. In a nod to the efficient markets hypothesis, many banks stock rose after the announcement, an indication that the downgrades had been expected by the stock market. http://www.garp.org/risk-news-and-resources/risk-headlines/story.aspx?newsid=48640

Corporate Governance at Mutual Funds

Charles Schwab's YieldPlus bond fund was one of many bond funds that tanked in 2008. One thing that makes this unusual is that fund managers claimed that the average maturity of the fund's holdings was about six months when in actuality it was as high as 2.2 years. A mutual fund's Board of Trustees is designed to protect fund investors, similar to the Board of Director's role as shareholder protector in a corporation, yet some people argue that most mutual fund's Board of Trustees are relatively passive and do little to protect investors. One potential problem raised is that individuals will often sit on multiple mutual fund boards. For example, Fergus Reid III, serves as chairman for all 154 J.P. Morgan mutual funds, while simultaneously serving on the board of 105 Morgan Stanley mutual funds. A telling statement of the apparent lack of power held by a Board of Trustees is evident in the statement by mutual fund manager Donald Yacktman, who said "I've never changed my fees because of pressure from the board." http://www.smartmoney.com/invest/mutual-funds/why-mutual-fund-guardians-are-failing-1339088682278/#tabs 

2011 Executive Pay

Despite the recession and Say On Pay, median executive compensation increased about 5 percent in 2011. The largest pay package, an astounding $378 million, was given to Apple's Timothy D. Cook. And David Simon of the Simon Property Group received $137 million last year even though 73.3 percent of shareholders voted against his pay package. Median pay for the 200 top-paid CEOs in 2011 was $14.5 million. http://www.nytimes.com/2012/06/17/business/executive-pay-still-climbing-despite-a-shareholder-din.html?pagewanted=1&_r=1&partner=rss&emc=rss

McWages and PPP

Absolute purchasing power parity states that a good should cost the same no matter the currency. Since labor is a good, it stands to reason that labor should result in the same purchasing power across currencies as well. New research by two economists, Orley Ashenfelter and Stepan Jurajda, examines PPP-adjusted wages across different currencies. By taking the cost of a Big Mac and dividing by the hourly wages paid to a typical McDonald's employee in that country, the result is Big Macs earned per hour. The research show that Western European and Canadian McDonald's workers earn 2.2 Big Macs per hour, while Chinese and Indian McDonald's workers earn only .6 and .4 Big Macs per hour, respectively. These results indicate that absolute PPP does not hold across currencies for labor. http://www.economist.com/blogs/freeexchange/2012/06/purchasing-power-parity

A Trillion Here, A Trillion There

So what happens to corporate debt when it matures? To maintain its capital structure, most companies refinance the maturing debt with new debt. In the next four years, the total amount of debt needed to refinance existing debt as well as fund growth is expected to be $46 trillion combined in the U.S., Euro zone, U.K., Japan, and China. $30 million is expected to be needed to refinance maturing debt, and $13 to $16 trillion needed for growth. China leads the way with $16 to $18 trillion, while U.S. companies will need only $13 to $16 trillion. http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245333370039

Happy Birthday! Say On Pay Turns 2

For the past two years shareholders have had the ability to vote on executive pay. And although only about 2 percent of executive compensation packages have received a no vote, it appears that there have been changes in those companies that have received a no vote. For example, HP's new CEO, Meg Whitman, has a $1 salary, with much of her pay package based on the company's stock performance. This is the result of the backlash against the former CEO. One factor that does appear to increase the chance of a no vote is poor stock performance over the previous five years. http://www.businessweek.com/articles/2012-06-07/say-on-pay-boards-listen-when-shareholders-speak

Negative Net Working Capital

Negative numbers are generally bad, however a recent survey of the communications sector in 2011 found that the best performing companies actually had negative working capital. While negative working capital can be dangerous, especially if liquidity gets tighter, the advantage is that you are actually using other companies' money for free. http://www3.cfo.com/article/2012/6/cash-flow_cash-flow-operating-working-capital-digitalglobe

Capital Budgeting and Taxes

Tax credits on renewable-energy are set to expire beginning at the end of 2012, which will likely reduce capital investments in these projects. In fact, one analyst notes that wind projects have already slowed down since a project begun now could not be completed by the end of the year and capture the tax break. Obviously, the tax credits are an important cash flow to these renewable-energy projects. The article also states that before the recession, solar facilities earned a 6 to 8 percent aftertax IRR, while the current aftertax IRR is more than 10 percent. A question: Since the article states an aftertax IRR, is this any different than the IRR calculated in the textbook? http://www3.cfo.com/article/2012/6/tax_renewable-energy-wind-solar-investment-tax-credit-production-tax-credit?currpage=1

But It Is Only $3.6 Million Per Year

Last month, LightSquared, Inc., filed bankruptcy. In any bankruptcy, there are numerous court filings, including the costs associated with the bankruptcy. In a recent filing, it was disclosed that the cost per hour for former Solicitor General Theodore Olson to work on the bankruptcy was a staggering $1,800. Fortunately, David Fotouhi, an associate at the same firm, was only charging $445 per hour. http://blogs.wsj.com/law/2012/06/06/bankruptcy-fees-the-ted-olson-edition/

King Cash

A basic tenet of Finance is that cash is king, especially in difficult economic environments. A recent survey sponsored by CFO shows how working capital management has changed in mid-sized companies since the recent recession began. A couple of interesting findings: Companies surveyed feel that their working capital positions have improved over the past three years (page 7), receivables and inventory management are key working capital priorities going forward (page 8), and larger firms are forcing smaller companies to accept longer receivables periods (pages 10 and 11). https://secure.cfo.com/research/index.cfm/displayresearch/14624750?action=download

IPO Flops

Just because a company undergoes an IPO doesn't mean that is is a good investment. Here are 10 recent IPOs that flopped after going public, including a couple of bankruptcies only a few of years after the IPO. http://www.investmentnews.com/gallery/20120524/FREE/524009999/PH

JPMorgan Nixes Stock Repurchases

In the text, we argue that stock repurchases are a close substitute for cash dividends. However, an important caveat is that this is true when a stock repurchase is made, not when it is announced. JPMorgan announced today that it is suspending its stock repurchase plan, which was expected to be $13 billion through 2013. While stock repurchases have increased, so has the cancellation of previously announced stock repurchase plans. http://finance.yahoo.com/news/jpmorgan-suspends-stock-repurchase-plans-141833976.html

U.S Corporate Tax Rate Increases

A report by accounting firm PricewaterhouseCoopers found that the average effective three-year corporate tax rate for U.S. based corporations rose to 26.3 percent, up 0.7 percent from the previous year. The effective tax rate is the tax rate after expenses and tax offsets.  http://www3.cfo.com/article/2012/5/tax_tax-incentives-effective-tax-rate-

The IPO Guy and Facebook

On May 17, 2012, Facebook sold its shares in the IPO market for $38 each and the shares began trading on the NASDAQ the next day at a price of $42.05, a relatively modest price increase of about 11 percent. Unfortunately for shareholders, the stock price dropped to $38.23 by the end of the day. All in all, the Facebook IPO was relatively mild by IPO standards. Because of the pricing of the stock prior to the IPO, we would have expected a bigger first-day "pop" in the stock price. For an explanation of the partial adjustment effect and more on Facebook, you can watch this interview with world-renowned IPO expert Professor Jay R. Ritter. http://www.bloomberg.com/video/92947929/

Advice for Managing a New Project

So your company has accepted a new project and you are put in charge of seeing the project through to completion. What are the some of the challenges and pitfalls in your way? A recent article in CFO discusses some of these practical matters. http://www3.cfo.com/article/2012/5/leadership_project-management-best-practices?currpage=1

Evaluating the PE Ratio

As we noted, the evaluation of any ratio must be undertaken with great care. For example, did you know that if we look at two companies that are exactly the same except for the amount of debt, the company with higher debt will have a lower PE ratio? A recent article in McKinsey Quarterly outlines the reason this occurs, but more importantly points out that that a management goal of increasing the PE ratio does not generally result in shareholder wealth creation. https://www.mckinseyquarterly.com/Corporate_Finance/Valuation/Why_bad_multiples_happen_to_good_companies_2967