In a 55 minute Pbs-video it becomes clear what kind of serious derivatives (OTC) problems we still have.
Warning! Watching this video will dramatically change your view on risks and players in the financial system. If you want to protect yourself on the short term against the effects of what is going on in the skyscrapers of the financial markets: don't watch this video! Don't blame yourself, because it's not 'just funny' to become aware of risks you can't handle anyway....
However, if you are professionally active in investment risk or if you're a member of a (pension fund) Investment Committee, hiding is no option and this video is a good investment and a 'must see'......
Last decades, our perceptions of Financial Risk haven been constantly changing and - for sure - they will continue to do so in the future.
In the sixties and seventies of the 20th century 'risk' was mainly plain 'technical risk'. Risk Management was mainly used to support current strategies, as a defensive instrument.
More de-Tailed studies of risk in the nineties, created new instruments and models to manage (investment) risks. This led to the understanding that it was possible to take more risk because we could understand and manage it in a better way.
Next, at the beginning of the 21th century, these new risk models were expanded and transformed from passive to active instruments. New products and markets were developed by combining, cutting and mixing traditional asset products (stock, bonds, mortgages) with derivates. And just like in chemistry, where mixing innocent individual molecules could lead to an explosive new molecule, the asset markets got flooded with toxic, unknown risk-correlated products.
For most of us it became clear that it was not the risk ingredients (bonds, stocks, derivatives, etc) themselves that caused this turmoil, but our own (irresponsible) behavior, e.g. the way we ourselves were managing the asset products and models. Behavioral Finance was born.
After we poisoned the investment market landscape in the second half of this last decade, things turned for the worse. Instead of looking what we had done, where we were on the risk map and how we could clean up this mess, we kept on building debt and - except for sub prime mortgages - refused to restructure the market 0r to restrict the use of derivatives. No restrictions nor ethical guidelines on making money just from money (who pays for making money of money?).
Instead, with the latest development High Frequency Trading (1,000 orders per second ! ), covering about 60% of all U.S. equity trading and nearly half of U.S. futures trading, we finally lost our site on what is ethical or not. Main question is: Who has the guts and the power to stop this development?
Anyway, it's clear that our 'behavior' and a 'map of the risk landscape' are critical in understanding where we are heading with Risk...... Let's start with behavioral finance
Behavioral Finance One of the world’s best experts in the field of behavioral finance is James Montier. His book Behavioural Finance is a classical must-read.
In a 2002 classic report titled 'Part Man, Part Monkey', Montier gives a number of common mental investment pitfalls. Here's a sum up of those pitfalls that might apply to actuaries just as well:
You know less than you think you do
Be less certain in your views, aim for timid forecasts and bold choices
Don't get hung up on one technique, tool, approach or view - flexibility and pragmatism are the order of the day
Listen to those who don't agree with you
You didn't know it all along, you just think you did
Forget relative valuation, forget market price, work out what the stock is worth (use reverse DCFs)
Don't take information at face value, think carefully about how it was presented to you
Trinity of Risk According to Montier the word 'Risk' is perhaps the most misunderstood concept in finance. In classical finance, risk is identified as the relative price volatility (beta). However that's not what risk really is about. 'Downside risk' (ie loss) is what really matters when it comes down to performance measurement. From an investment point of view, risk can be split up into three interrelated elements, the so called 'trinity of risk':
Business Risk (risk of business going broke)
Financial Risk (risk of using leverage)
Valuation risk (the margin of safety)
Valuation risk is the most tricky type of risk, as is explained in an excellent article 'The Biggest Mistakes in Valuation...' by Donald R. van Deventer from Kamakura Corporation. Here's the wrap up of the top 7 valuation mistakes in a humorous "daily life analogy"
The Fake Rolex Watch Mistake Ask the investment bank which sold you a fake Rolex what the Watch is worth
The Poker Game Mistake Ask someone else playing in the same game how you should bet
The War of the Worlds Mistake Believe in a valuation technique Because everyone else thinks it's true
The Cash Card Mistake Tell an investment banker exactly how your firm evaluates complex securities
The Carton of Eggs Mistake Don't check to see if the eggs are broken, just look at the egg carton before buying
The "My Brother-In-Law Told Me It Was a Good Investment" Mistake Bernie Madoff and the rating agencies
The 2+2=5 Mistake Technical errors in valuation
Financial Crisis 2008-201x Back to Montier, who's very clear about the role of Bernanke with regard to the role of the FD in the current
Speech Bernanke FED May 17, 2007 “We believe the effect of the troubles in the subprime sector on the broader housing market will be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”
Montier believes Bernanke missed the boat, had poor ideas on how to recover and on top of this, failed to learn from his mistakes. Montier guesses: There are none so blind as those who will not see!
Happy Investor For those of you who -after all this - don't succeed in becoming a happy investor, Montier has a simple advice on improving (plain) happiness. Here's the wrap up:
Don’t equate happiness with money.
Exercise regularly.
Devote time and effort to close relationships.
Pause for reflection, meditate on the good things in life.
Seek work that engages your skills, look to enjoy your job.
Give your body the sleep it needs.
Don’t pursue happiness for its own sake, enjoy the moment.
Take control of your life, set yourself achievable goals.
Map of Risk Risk is an interesting and never ending subject of discussion and development. Drawing a map of Risk, literally helps you to oversee the Risk battlefield. Draw your own map of risk in life to remember where you are, where you've been and where you'll be heading.....
To help you get on the way, take a look at my Isle of Risk
Whether you're an actuary, accountant, consultant or salesman, when we take up a new challenging project, we're inclined to spend most of our time on data mining, modeling, reconsidering, detailing, arguing, making things perfect and finally, drawing the conclusions and writing the exhaustive proposal report....
Fortunately - in this case - your right on schedule! You've got exactly one day left before your Board presentation of the project. Still completely in a rush and overexcited about the stunning results of your successful investigation, you start up your laptop to wrap up your proposal report in a full flash Powerpoint presentation.
That night at 01.00 AM, you successfully finish your ppt presentation. Just in time! Completely satisfied about this phenomenal achievement, you e-mail the ppt to Nosica, the Board's secretary you know well. She, as well as the Board, will be impressed by your 'night shift work'. Who said that actuaries had a 9 to 5 job?
The next day, at 14.00 AM you enter the Board room, full of confidence. Your presentation is start-ready, the beamer glows, you're fully concentrated on your audience and in a 'cashing' flow....
After 20 minutes of presentation, including your ten recommended practices and some questions, you leave the 26th floor. All went well... Time for a drink and a well earned good night sleep...
Next morning, 09.00 AM, the Board's secretary replacement calls you: Your proposal has been declined....
You're flabbergasted, how could this happen? After all this work you've been through.
What went wrong?
The answer is simple, you denied Wayne Burggraff's Law of Presentation:
It takes one hour of preparation for each minute of presentation time
So next time, in case of a 20 minutes presentation, invest 20 hours of your time in research, development, organizing, outlining, fleshing out, and rehearsing your presentation. In essence: if you fail to prepare well, you are well prepared to fail.
Tips..... Here are some practical tips that might help you with your preparation:
Ask yourself: ''If I had only sixty seconds on the stage, what would I absolutely have to say to get my message across." -- Jeff Dewar --
The simplest way to customize is to phone members of the audience in advance and ask them what they expect from your session and why they expect it. Then use their quotes throughout your presentation." -- Alan Pease --
No one can remember more than three points. -- Philip Crosby --
Fear of presentation As actuaries it's surprising to see that people are more afraid (41%) of speaking to a group than of death (19%). Now it's clear why we search the help of Powerpoint to 'survive' on stage.
Powerpoint Mortality We all know Powerpoint..... Powerpoint itself is not good or bad, it's the way you use it.
The mortality rate of Powerpoint is humorously demonstrated by Don McMillan:
Who Needs Powerpoint? Last January I was heading for a presentation with the help of Powerpoint. Full house. However, on the supreme moment the local beamer gave up. I simply decided to bring my message in an interactive session with my audience, without the help of Powerpoint.
Yes, it was different, challenging and even fun! Because of my thorough preparation - I was able to concentrate on almost everyone of my audience. So...., another Maggid's tip could be:
Prepare your presentation without Powerpoint!
A presentation try out In the mid nineties my employer's company was heading to get listed at the stock exchange. I remember I had to give a presentation before a panel of 70 international analysts, who would probably raise all kind of difficult questions. In order to prepare 'abap', I called my strategy director as well as my CFO and asked them to act as my 'try out analysts audience'.
I told my colleagues I would give the presentation three times in a row. In the first two presentations they were obliged to interrupt me as much as possible, to raise difficult or weird questions and to put me to test (keeping my humor and concentration). During the third presentation they had to act as normal audience.
To make a long story short: after three presentations, my two colleagues kept their breath in combination with a desperate look in their eyes. I told them not to worry and reassured them my presentation at the analyst session would be successful.
And so it was, as I was fully prepared on every possible question and didn't had the need to look at my ppt presentation, I could fully focus on my audience. Lesson: Make the preparation tough, you'll benefit from it in the final presentation.
The actuarial master Yes, there are a lot of rules, regarding the use of Powerpoint. The Golden Rule is that all PowerPoint presentation rules, principles, and guidelines are just secondary to doing what is ultimately right for your audience. Critical point is, you can only break the presentation rules if you know them .
It's just like in actuarial science, once you've become an actuary (a master) the real art of your profession is not anymore in applying equations and methods 'by the book'. Now it comes down to break the existing rules and conventions in a such a professional way, that new risk and social challenges are being (re)solved in a different way. Key point here is that not only your professional skills have to be outrageous, but your presentation skills as well. As the success of a good peace of actuarial craftsmanship, is completely dependent on the way it is presented.
Mindmapping Let's conclude with some practical free(ware) presentation tips. Although you're probably aware not to overuse clip art, it's good practice to set up your presentation in a consistent and well polished style.
Of course you can use expensive business packages to illustrate your presentations, but there's also an excellent freeware application called: EDraw Mindmap 4
With the help of Edraw, creating presentations and mind-mapping is a question of minutes.
Enjoy preparing and giving presentations, learn to be(come) yourself on stage and overcome any possible fear of speaking to groups......
Actuary Info is a brain teaser Blog with non-conventional, witty, remarkable and serendipitous financial and actuarial related news.
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