Last week, the Federal Reserve announced that it would increase the Fed Funds rate by 0.25%. While the increase was small and the overall rate still remains low, by historical standards, concerns about the implications to the stock market surfaced almost immediately.http://www.nytimes.com/2010/02/19/business/19fed.htmlWhile, at first sight, this seems like unmitigated bad news - higher interest rates, after all, hurt stock prices - the effects of central bank interest rate policies on equity values is a little more ambiguous. There are several forces that come into play:a. The Interest rate effect:...
Transactions Costs and Beating the Market
One of my books, Investment Fables, is directed at answering one of the most puzzling questions in investments: How is that there seem to be so many ways to beat the market on paper but that so few money managers seem to do it in practice? A key reason, in my view, is that transactions costs have a much greater impact on returns than we realize.Let's start with the good news. Both academics and practitioners have found dozens of ways to beat the market. To see the academic list of market inefficiencies, try this link:http://www.amazon.com/Inefficient-Stock-Market-Robert-Haugen/dp/0130323667And...
The Credit Default Swap (CDS) Market
The Credit Default Swap (CDS) market has been in the news recently, as Greece goes through the throes of imminent or not-so-imminent default. I thought it would make sense to put down my thoughts on the market:a. What is a CDS?A CDS allows you to buy insurance against default by a specific entity - government or corporate. Consider, for instance, the 5-year CDS against Brazilian default. On February 11, 2010, it would have cost you 137 basis points to buy this swap on the CDS market. In practical terms, if you had $ 100 million in $ denominated 5-year bonds issued by the Brazilian government,...
Thoughts on the riskfree rate
Early in my blogging life, September 20, 2008, to be precise, I posted my thoughts on riskfree rates generally and about using the US treasury bond rate as a riskfree rate, in particular. With the turmoil sweeping through the European sovereign bond market right now, the time may be ripe to revisit the topic.Let us start by stating the obvious. Knowing what you can make on a riskfree investment is a prerequisite for any type of corporate financial analysis or valuation. In most textbooks on finance, though, the riskfree rate is taken as a given.Backing up a bit, consider the three conditions that...
