Municipal Bonds Trading in ETFs
(Aug 2013)
About a month ago, we spent a full week highlighting research conducted at our firm that shows the degree to which investors are harmed by excessive markups in municipal bond trading. In the paper, our colleagues argue that low-cost improvements in disclosure requirements could largely eliminate these transfers of wealth from taxpayers and investors to the brokerage industry.
After the research was completed, we began thinking about other ways investors gain exposure to municipal bonds. For...
Calculating Retirement Income and Fees from a 401(k) Account
(Jul 2013)
Saving for retirement means asking a lot of questions.
What monthly income will you need? Forbes claims this is the fundamental question that is often overlooked by 401(k) account holders.
"The lump sum in your 401(k) may seem like a lot, but when you translate it into a monthly income stream over 20 or 30 years, it may not be as much as you think," [Jeanne Thompson of Fidelity] says. "Breaking it down into how much the money will provide will give you a much better picture of how much you'll...
Why Banks Are Storing Physical Commodities, and Why it May Matter
(Jul 2013)
Physical commodities -- barrels of oil, bars of gold, bushels of wheat, etc. -- are used for a variety of industrial purposes, but can also be bought and sold in financial markets. Most commodities trading involves futures contracts, as trading the physical commodity itself involves transportation and storage costs. Traditionally, banks who traded commodities were only allowed to deal in derivatives such as futures contracts, rather than dealing in the physical commodity itself.
But since the...
The Basics of Insurance Linked Securities
(Jul 2013)
Financial innovation is typically associated with banks, but lately we've seen a number of new financial products developed and sold by insurance companies. Some of the most interesting products are known as insurance-linked securities, or ILS.
In the broadest sense, ILS transfer risk from insurance companies to investors. The largest segment of the ILS market is in catastrophe bonds (or 'cat bonds' for short), whose interest and principal payments depend on a specifically defined natural...
Misrepresentation of Asset Quality in RMBS
(Jul 2013)
Investors in Residential Mortgage Backed Securities (RMBS) have suffered tremendous losses since 2007. Many junior and mezzanine investors were wiped out by the asset pools' delinquency rates coupled with the subordination embedded in these structured securities. Since then, there has been a proliferation of litigation alleging that the underwriters and originators of RMBS misrepresented the risks of these products. An interesting new paper by Professors Piskorski and Witkin of Columbia...
Similar Structured Product Premia in US and Europe
(Jul 2013)
One point we've made again and again in our research is that structured products -- debt securities with market-contingent payoffs -- tend to be priced at a premium to face value. We have documented premia in reverse convertibles, autocallables, absolute return barrier notes, principal-protected notes, dual directionals, and over 17,000 individual products freely available in our searchable structured product database.
Recently, the SEC has required structured product issuers to disclose an...
VelocityShares' New Volatility ETFs
(Jul 2013)
You've heard it here before: hedging equity exposure with volatility derivatives is very tricky.
While the CBOE Volatility Index (VIX) and the S&P 500 are negatively correlated suggesting a possible hedging opportunity, you cannot invest in the VIX itself, you have to invest in derivatives (futures or options) linked to the VIX. The simple fact is that this indirect exposure to the VIX does not behave like the VIX itself, making it in the end a rather poor hedge to equities .
But issuers of...
Structured Investments Linked to Proprietary Indices
(Jun 2013)
Structured products are often linked to well known indices like the S&P 500 or the Dow Jones Industrial Average, but recently it has become more and more common for banks to issue structured investments linked to proprietary indices that they create themselves. The use of proprietary indices (also known as 'self-indexing') has begun to arouse suspicion from various sources and so we thought we'd take a step back and talk about the issue for a moment.
Structured products linked to well-known...
Reverse Convertibles and Event Risk
(Jun 2013)
Reverse convertibles are short-term debt securities issued by banks whose return of principal at maturity is contingent upon the returns of the linked stock. Although these notes typically pay relatively high coupons, they expose investors to losses on the underlying asset, especially if those losses are beyond the trigger level. Academic research shows that these coupons are not adequately compensating the investor for the market risk that they are bearing by investing in the notes. For...
