Hedge funds. What are they? [Note to self]

Here is another post inspired by the book "Ascent of Money" written by Niall Ferguson. You will probably get better information on hedge funds and hedging from Wikipedia, but here is my take on the subject and what I saw as important in Ferguson's presentation of the matter.

Hedging and hedge funds have their roots in agriculture. For a farmer there are two things that affect his income: first one is the amount of crop and second one is price of the crop. The amount of crop depends on the weather and there is not much you can do about it. The price the farmer gets paid depends on the market price. The farmer pretty much knows what his expenses will be when sows his seeds. What he does not know is how much he will be paid at harvest. The farmer could protect himself against price fluctuations by making a deal with, for example, bakery that it will by all of his wheat with certain price. At harvest the market price may be lower than the price the farmer and agreed upon, in this case the farmer wins. It also could be that the market price is higher than agreed in which case the bakery wins, because it gets it wheat at a cheaper price than if it would by the same amount of raw material with market prices.

The first standardised future contracts that were traded in after markets were created in Chicago. The Chicago Produce Exchange was the first permanent place for trading futures.

Since this type of elimination of risk requires a speculator as a counter part trading in futures has been viewed as nothing more than a casino. Partly because of that only 1970s trading of interest and currency futures was permitted. In 1982 the future contracts were allowed to stock trade.


Since all futures contracts are derived from the value of the property the contract is based on all futures contracts are so called derivatives. Here are some derivatives that Ferguson presents in his books. There is a good list of derivatives on Wikipedia.

Options are form of derivative financial instrument closely related to futures contracts. There basically are two types of options selling and buying options. The option grants the owner of the contract the option (not an obligation) to buy/sell a certain amount of goods at a price agreed in the contract.

Swaps are a form of derivative where two parties basically bet on, for example, the development of interest rates. Someone who receives income from loan where interest is fixed can swap the interest rate to floating rate. 

Credit default swap is a contract where the buyer of the CDS makes a payment to the seller and receives a pay off if a instrument goes default.

There are also weather derivatives which enable you to insure against natural catastrophes and extreme weather patterns. In 2006 the nominal value of weather derivative was 46 billion dollars.

Nowadays most of the derivatives are no longer standardized but tailor made and sold in so called over the counter (OTC) trade outside the stock exchanges. Banks are the usual seller of OTC derivatives and majority are temporarily arranged between two parties.

The problem with derivatives and future contracts is that it has divided world into those that have money to protect themselves to those that don't. It usually takes a seven-figure-sum of money to protect against unexpected fluctuations in interest rates or in commodity prices etc.

Facts About Financial Crisis Of 2008 [Note to self]

I recently listened to an interesting radio programme where Heikki Koskenkylä explained some facts that contributed to the financial crisis of 2008. The radio programme was a series produced by YLE and you find link to the programme here.

Here are some interesting points that I picked up from the programme:

1. Community Reinvestment Act = CRA Banks are obligated to issue loans to the area from which they receive deposits. Initially created to support housing industry and expand house ownership. 
2. Sub-prime loans where only 15% of the total number of mortgages in U.S. Only about 20% were left unattended, and the amount of bad debt was not that large.
3. Sub-prime loans where bundled together with other loans (student loans, car loans, credit cards) and sold to investors. On paper the profit from these bonds where higher than from normal mortgage loans.
4. The problem was that "bad" and "good" loans where mixed together and rating agencies gave these bonds AAA-rating. There was wide belief that housing market could not collapse and these mortgage and loan bundles were built on safe ground.
5. Already in 2007 there were couple of instances where banks where affected by the sub prime crisis (1 English bank winter of 2007, couple more in the summer.)
6. On 7th of September 2008 Fannie Mae and Freddie Mac were put under the control of federal government.
7. In Europe many thought that it would be the hedge funds that would start crumbling, not the institutions that issue mortgages. 
8. Basic problem in the U.S. was that people with know in come where allowed to purchase houses. Europe had it problems too. In Spain (circa 07/08) there were unsold apartments as much as in Germany and France combined. But unlike in U.S. in Spain no "bad" credit was given.
9. Week after the take over of Freddie and Fannie Bank of America purchased Merrill Lynch
10. On 15th of September  Lehman Brothers declared it was entering company reorganisation procedures (Chapter 11).
11. On 17th of September Federal Government issued a emergency credit of 85 billion dollars to American International Group and as collateral the government got 79,9% of stock and withheld a veto to all significant decisions in the company. AIG had large investment in credit default swaps (check next post for explanation) which led to it's down fall. The insurance part of AIG's business was healthy but it had issued credit risk insurance (hedging credit risks) amounting to hundreds of millions of dollars. The company failed totally in evaluating the risk and the price to be paid for these insurance were very low during the economic up turn.
12. The complexity of the system was a partial contributor to the crisis. It was very hard to comprehend the risks and due to how deeply the whole system is interconnected it was difficult to determine who would take the losses.

Kit, Kit, Kit(once again): Camelbak Cloudwalker reservoir backbag

Camelbak Cloudwalker

Since I started geocaching I've been hiking and biking a lot more than before. When you are on the move for three hours or more a single half a litre bottle does not get you far. You just need to have more drinking water with you. Secondly my old backbag was a bit too big for short hikes and bike rides. Luckily I spotted a used (in this case used 3-4 times) Camelbak Cloudwalker at an on-line auction and managed to purchase it at very good price.

I've used the backbag almost daily and used the water reservoir couple of times on short hikes and I must say that I am very pleased. It is just amazing what a difference having enough to drink makes on your stamina. I could quite easily walk for three hours and when I got to home I wasn't that tired. Hydration is important! But now to the properties of Cloudwalker.

The backbag is designed so that it does not make your whole back sweat after half an hour. Somehow the design is better ventilated and the bag is narrow so it does not cover all of your back. I also like the 10l of carrying space. It fits quite easily the equipment I need for geocaching (flashlight, multitool, camera etc.). Last weekend I had my jacket and some food in the backbag and it all fit quite well inside. Pocket in front of the bag hold easily your wallet, phone, gps or what ever you need to take with you to the trail. The front compartment has two pocket with zippers so your stuff won't be flailing around.

Pocket for the water reservoir.

The drink reservoir itself fits quite nicely to the pocket in the backbag and there is loop inside the pocket that holds the reservoir in place. Having the reservoir in place does not affect the carrying comfort in anyway. The bag still feels comfy. If you are a runner this is not the bag for you, the water inside the reservoir does start slosh the moment you start running. The reservoir holds 2 litres of water and if you are not drinking all the time it should be enough also for longer workouts. After you come home you most likely want to dry the reservoir. The operation calls for little creativity. I use the drinking tube to hold the reservoir open by making a loop out of the tube and sticking it inside the bag. The tube itself is a bit harder to dry. Mine has been in the cupboard for a week and it still contains some moisture. I guess I need to remove the nozzle next time.

Nozzle and valve

The drinking nozzle is really ingenuous. When you squeeze the tip of the nozzle with your lips it opens up and you can take your sip of water. The seam is really tight when closed and no water will run out. There is also a valve in the nozzle (the yellow bit in the picture) that turns and closes the pipe if you want to be extra sure that no water gets out. The valve comes useful, for example, when you want to keep the drinking  tube inside the bag.

Over all Cloudwalker very good backbag for me. I am pretty sure it will serve me for a long time on my geocaching adventures, hikes and bike rides.

Rothschilds

This the second post related to a book I am reading. It is written by Niall Ferguson and it is titled "Ascent of money". This post will quickly summarize the story of how the rise of Rothschild's is represented in the book. It may or may not be entirely accurate but I found it very interesting.

Let it be reminded once again that this post is more of a mental note for myself.

Rise of Rothschilds'

The story of Rothschilds is very fascinating. For centuries the family has had significant power in the financial world. It was quite fascinating to find out that their success was preceded by a gigantic miscalculation. Any way let's start from the beginning. Or not all the way to the beginning, but to the wars Britain fought against Napoleon.

Britain had been fighting against Napoleon for several years without much success. The war efforts were financed by issuing war bonds. The problem was that the only universal currency at that time was gold and the wars where fought in regions were it was impossible to use pounds. In 1814 Britain needed gold fast and they turned to Nathan Rothschild to procure the gold. Nathan had brothers and relatives running banks in the major financial centres. This network allowed him to buy gold from all over Europe quickly. He actually was able to buy double the amount that he asked to acquire. British government paid Rothschild's commission on the gold he delivered, but there was another way how Rothschilds made money during this operation. They were able take advantage of the differences of gold prices in Europe. For example, if price of gold in Amsterdam was lower than in London Nathan would sell gold bonds (is this the right term in English, don't know) send the money Amsterdam where the money was used to buy gold. The gold was then sent back to London, the bond was redeemed and the gold that was left over was kept as profit. In April of 1814 the Coalition forced Napoleon to surrender and sent him to exile to Elba.

In 1815 Napoleon escaped because of rumours that he would exiled to a remote island in the Atlantic Ocean. Napoleon managed to gather a sizeable army and decided to go in to offensive. Nathan Rothschild thought that this meant that there would be another lengthy war and started to gather gold so that he would ready when the governments came to him asking for gold. The battle of Waterloo was a success to the Coalition. Napoleon was crushed and sent to exile in Saint Helena. To Nathan Rothschild this was a disaster he was sitting on a pile  of gold that nobody needed.

Nathan decided to bet on the government bonds of Great Britain. He evaluated that since there was no longer a state of war the government would need less money and government would not release as many bonds. That would decrease the supply of government bonds on the market and according to basic principles of market economy if the supply decreases the prices should go up. Not to mention that Nathan drove the  price up by hoarding government bonds. After one year the price of government bonds had risen by 40%. At this point Nathan started to sell and made profit of 600 million pounds in todays money (figure from Ferguson). This move basically secured Rothschilds' as the one of the leading banks in the financing sector.

I'll write more about financing if I find anything else that interest me in Ferguson's book.

Quick note on government bonds

I am reading a book by Niall Ferguson titled " Ascent of Money". The book so far has been a bit of a disappointment, but still I have learned quite a bit about government bonds and general topics related to financing. Again this a posting that is more of mental note for myself. The majority of the material here is from Ferguson's book. I've made the illustrations myself and condensed and added some ideas of my own.


Basics of how government bonds work

In this section I'll try and explain what government bonds are and how they work as I understand them. These days virtually every government needs to borrow money from the market. In the early days government bonds where used to collect money to pay for wars but today they are used to finance government expenditure.

The basic idea behind a government bond is that the state sells a piece of paper with nominal value of 5000 and promises to pay 5% interest(paid from the nominal value) per annum for the next 10 years to the holder of the bond. This means that the buyer can sell the bonds at market price if faced with a acute need of money or if the owner sees that the money can make better profit when invested differently.

The concept of effective interest is something worth discussing. It is calculated like this:

What this means that if you purchase a bond from after market at price of 4500 the effective interest rate is higher than the one marked on the bond. But there is catch. As we all know there is no such thing as a free lunch. Why has the market price of of Brutopias 10 year bond declined? Well it means that the consensus on the market is that Brutopias ability to take care of it's debts has decreased. This means that investors may not get their money at the end of the ten year loan time, or the payment might be delayed.

This means that really big profits can be made when the governments financial situation is some compromised. Also when investing to government bonds of foreign nation you must take into account the changes in exchange rates and the inflation rate in that country as it may quite quickly eat up any profit you expect to make.

In general government bonds are safe investments as it is usually quite impossible for country to go bankrupt, because it can always tax it's citizens. However the profits are not that big either. 

Battlestar Galactica Online

I found a great I new MMO. Battlestar Galactica Online is a game based on the universe of Battlestar Galactica. The game is a played in space and at the beginning you can choose a raptor or the legendary viper MKII as your ship. You can buy other ships as you advance in the game. The range of ships is pretty large and the biggest ships are giant juggernauts that can destroy almost any ship. This means that the biggest battles in BSGO are fights between two giant fleets consisting of large command ships, support ships that are focused on electronic warfare and fighters like vipers and raiders. The list of ships can be seen here.

I had a bit of trouble at first. I created a profile on the server Sagittoron and exited the game without doing the right log out procedure which caused my profile to crash and I can't enter the server any more. I do not if the fault is in the game or in my browser. Luckily I did not get too far. Now I am playing on the Virgon server. It turned out that entering the full browser mode in Firefox caused the game to freeze. I had to install Chrome and you that as the browser to play the game. On Chrome the game works perfectly.

I must say that I enjoy flying a viper. It just feels so cool. The basics of the game can be learned quite easily but the there seems to a lot of strategic details that you need to take into account when you advance in the game. I encourage you to give this game a try. It is wonderful.

Battlestar Galactica Online

Colonial outpost and my Viper

Mac Optical Audio Issue Part 2.

In my previous blog post (Apple Remote - A Quick Complaint) I complained about the "features" of optical audio out of Mac. Last nite Apple realesed a update that supposedly addressed this problem. The update realesed last nite was 10.6.8 Update v.1.1 and 10.6.8 Supplemental Update. At least for me this has not worked. So far I have not found any comments on forums if this update has worked for other Mac users or if there is anything else I need to do to get the update working.

Did the update fix the issue of optical audio not working? Is there anything I've missed? Please drop a line.

PS. I am running Macbook Pro (late 2010) and Snow Leopard.

EDIT: Today I started to watch a mkv-file using VLC-player and hey presto the remote control was able to change the audio volume of VLC-player. So forget Quick Time and use VLC-player.