Archive | September, 2011

THE END OF “RISK-FREE” FINANCIAL INSTITUTIONS

26 Sep

In my opinion, there aren´t any financial institutions truly 100% credit worthy. Government bonds, for example, are considered to be risk-free bonds because governments can raise taxes or print money to repay their debt. In other words, a government can´t go bankrupt so in theory will never default.

Nevertheless, investors in government securities still face a small amount of credit risk. To be more specific, there have been cases where governments have defaulted on their domestic debt, for example Russia in 1998 and Argentina between the years 1991-2001. Moreover, a perfect representation of this concern is being held right now in Greece. Even after receiving a rescue package due to the financial crisis of 2007, Greece is again facing a risk of default. As a result, every market is afraid of a contagion due to a possible default.

Likewise, governments are seeing credit rating downgrades that are also affecting the credibility of the markets. Even the “big” countries like the USA are facing this kind of situations, where debt constitutes much of the GDP. This is a result of macro effects that economists and financial analysts can´t predict; major economic forces that affect most of the financial institutions, if not all, and that may spread around the world, just like back in 1929 and just recently in 2007.

Following, we can definitely conclude that there aren´t any 100% credit worthy financial institutions, or at least not at this point of history.

Question of the week: When should you use the Poisson Distribution vs. the Binomial Distribution?

IMPORTANCE OF LEARNING CALCULUS

19 Sep

Learning calculus has had positive effects on my life because it has facilitated processes which I would have otherwise not understood. More specifically, it has improved my ability to recognize and comprehend the theory behind formulas and procedures that are difficult to appreciate at first sight (i.e. the study of differential equations). Furthermore, calculus becomes very important to interpret data, which is very useful in serious statistical modeling and/or experiments (and basically, many jobs require such skills).

Moreover, calculus is much diversified in the sense that one can obtain the same answer using different methods. Applied to life, this becomes very helpful when facing a difficult problem, since most of the times there are various ways to get with it. In other words, analysis,  in addition to the fact that calculus also helps developing logic and reasoning skills, is probably the most valuable asset obtained by learning it. Together, analysis, logic, and reasoning, become very beneficial and crucial in the real world, when time management and quick decisions are fundamental.

In the end, I think it is not about just learning the math and playing around with equations and numbers, but realizing that learning it will improve the brain´s capacity to process data, ideas, and information.

Question of the week: How can Kelly´s strategy be helpful in trading (considering that it is a theory solely based on betting)?

GAMBLING VS. INVESTING

12 Sep

Gambling and investing both involve taking risks and making choices in order to gain a return or profit. The Dictionary.com defines the action of gambling as: “To bet on an uncertain outcome, as of a contest; to take a risk in the hope of gaining an advantage or a benefit.” Where areas, the action of investing is defined as: “To commit money or capital in order to gain a financial return.” Thus, what is the difference between the two actions? In my opinion, these two differ in the following main aspects: risk management tools and time based decisions.

Investors have various risk management tools, like diversification, which permit them to minimize losses. Gamblers, however, lack such tools to avoid a total loss capital. For example, a gambler who bets $100 in a horse race might win or lose. If his horse losses, then he losses %100 of his capital. In comparison, a broker is able to spread out the risks in his portfolio, being able to make up for the losses with gains on other stocks. Additionally, there are certain types of investments, like annuities, that pay interest every specified period, so in short terminology, it is very difficult to lose everything.

Furthermore, investors make their decisions based on real time data, driven by market and information forces. Even though prices constantly fluctuate, investors also rely on a wide set of external factors, like interest rates, maturity dates, etc, and research which allows them to invest thinking in the long-term returns. Gamblers, nevertheless, rely only on short-term bases and immediate circumstances. Also, they can´t base their bets on previous research or information of their surroundings because they are either using probability theory (which only some professional gamblers do) or are driven by luck and/or           emotions.

Question of the week: Why are the random return and log return different?