Tag Archives: Trading

Passing The CFA Level One Exam – Study Plan and Notes

My compilation of short articles has been a bit short of articles lately as a result of me beginning a new job and study for the CFA (Chartered Financial Anaylst) level one exam in December.

Firstly, I am working for a stock market research publication known as Intelligent Investor which applies value investing principles to analysis of Australian listed companies. For those out there that invest in Australian equities, either contact me or fill out the form below and I will organise a free trial of the service for you. It is regularly around $600 a year so there is some value here for the readers of my blog.

Now onto my plan for passing the CFA level one exam without a finance background. The following is a somewhat ordered plan of what I will do to pass the CFA level one exam (I found analyst forum very useful here and particularly thank saurya_s for his guidance):

  1. Overview - Watch the Schweser videos for each of the course modules with the course notes open on my second monitor at the same time. This will take approximately 48 hours by my estimation but will give me a solid introductory overview to what the whole course is about. I must ensure to cross reference the CFA learning outcome statements during this process. I need to have this done by the end of August 2008.
  2. Order of Study - Whilst I am most looking forward to a few key areas, I have been advised that following the order of Quantitative methods, Economics and then Financial Statement Analysis at first will be most beneficial as the course is cumulative. During my study, I plan to read each section and then devote at least a few hours afterwards to revise whatever I have just learned.
  3. Get familiar with financial Calculator – I have chosen to use either the Texas Instruments BA II plus or the BA II plus pro. Getting familiar with all the new functions will be important early.
  4. Identify and Read Schweser Notes - Identify strong and weak areas and begin reading and annotating the Schweser course notes (books 1-5). During this process, if i get stuck, I will refer to the CFAI texts if necessary or ask someone for help. I am lucky enough to work at a place with a bunch of very intelligent analysts so this should be fine. I estimate this part to take approximately 4 minutes per page as an average or somewhere around 80 hours.
  5. Listen – As odd as it may be, I plan to listen to audio tapes explaining the material on my way to work. Again, I will listen to the Schweser material that I have got my hands on.
  6. Complete Concept Checkers – Either whilst I am annotating the notes when I read through them or after completing my first read through, I will attack the concept checkers at the end fo each module in each book. I expect this to take approximately an hour per module or 16 hours. I will try to ensure my understanding on the concepts is spot on at this point but also be conscious of getting my time per question down to less than 60-70 seconds as time will be a factor in the exam.
  7. Reinforcement and Flashcards- If time permits, I will read through the Schweser CFA level one course notes one more time making reference to my annotations. I will then make flashcards to help me remember key parts of the course.
  8. Read Schweser Secret Sauce – This is a condensed 220 page version of the course. I will read through this once I am fairly comfortable with it all and use it to reinforce key concepts. I expect this to take 7-10 hours.
  9. Exam practice - practice exams, end of each book questions, Schweser question bank, and Schweser books 6 and 7 that are full of questions. The aim is to do so under time and to get above 80% in each of the more difficult Schweser practice exams. After I have done each question, I will think about what was tested and focus on the concept it is getting at.
  10. Exam strategy - Identify strong areas and weak areas.  I will not spend time on questions intended to throw me in the exam, it is well reported that this sends many candidates to their demise. Do the Volume 6 and 7 exams after you have finished all material. You should aim to get 75%. Schweser tests are difficult but if you crack 75% you will surely get at least that much in the real exam which is far more conceptual. By working with maths, you will know how things are affected.
  11. Things to remember about the CFA Level one exam - I need to get 70% in the real exam to guarantee a pass.The real exam is less numerical and more conceptual than the practice questions. Constantly revising and keeping tons of key messages in my mind will be crucial.

I may add to this plan over the coming months and write blogs as to my progress. It is August 10 now, I have 120 odd days left.

Updates: CFA Blog Level One reflections Part One. Another great link for CFA study advice. Contact me below if you need help locating any of the materials I mentioned above.

Understanding Technical Analysis and Fundamental Analysis in Investing

This article is primarily intended to give an introduction to how technical analysis is used to make investment and stock market trading decisions. It will then compare the position of technical analysts to fundamental analysts in terms of what information and data each group uses in their quest for high returns.

I have sourced most of the information below from a copy of the 2007 CFA Level 1 course notes that I have been reading.

Technical Analysis

Technical analysis involves the examination of past market data, such as stock prices and the volume of
trading, to lead to an estimate of future price trends and subsequently an investment decision.

The assumptions underpinning the technical analysis model are as follows:

  1. The market value of any good or service is determined solely by the interaction of supply and demand.
  2. Supply and demand are governed by numerous factors (examples include people’s moods, guesses and opinions). The market weighs all these factors continuously and automatically.
  3. The prices for individual securities and the overall value of the market tend to move in trends, which persist for appreciable lengths of time. That is, when new information enters the market, it leads to an adjustment of stock prices.
  4. Prevailing trends change in reaction to shifts in the supply and demand relationship. These shifts can be detected at some point in the action of the market itself.

The philosophy behind technical analysis is in sharp contrast to the efficient market hypothesis and fundamental analysis.

Fundamental Analysis Versus Technical Analysis

Fundamental Analysis involves making investment decisions based on the difference between the fundamental value of a company and the current price of that company’s stock.

Fundamental analysis involves an examination of the economy, a particular industry, and financial company data in order to lead to an estimate of value for that company. If this value is then compared to the current stock price, investment decisions can be made assuming that the market will correct and move towards the estimated value at some point in the future.

Although both fundamental and technical analysts agree that the price of a security is determined by the interaction of supply and demand, technical analysts and fundamental analysis have different opinions on the influence of irrational factors. A technical analyst might expect that an irrational influence may persist for some time, whereas other market analysts would expect only a short-run effect with rational beliefs prevailing over the long-run.

A bigger difference exists between the two regarding the speed of adjustments of stock prices to changes in supply and demand. Technical analysts believe that new information comes to the market over a period of time because of different sources of information or because certain investors receive the information or perceive fundamental changes earlier than others. Based on this belief they expect stock prices to move in trends that persist for long periods, and a gradual price adjustment to reflect the gradual flow of the information.

However, fundamental analysts believe that new information comes to the market very quickly and they expect stock prices to change abruptly as a result of this.

How do Technical and Fundamental Analysts make investment decisions?

  • Technical analysts make investment decisions by examining past market data to estimate future price trends. They identify new trends and take appropriate actions to profit from the trends. Technical analysts use market data and non-quantifiable variables like psychological factors and claim that their method is not heavily dependent on company financial accounting statements.
  • Fundamental analysts make investment decisions by examining the economy, the industry and the company to estimate the intrinsic value of the company’s stock. They then compare the intrinsic value to the prevailing market price and take appropriate actions. Fundamental analysts typically use economic data (including accounting data and information released by the company to the market).

Why Technical Analysts believe Technical Analysis is superior

According to technical analysts, it is important to recognise that the fundamental analysts can experience superior returns only if they obtain new information before other investors and process it correctly and quickly. Technical analysts do not beleive that most investors do so consistently.

Secondly, Technical analysts believe that it is too difficult for fundamental analysts to pinpoint a specific time to take investment actions even if they have identified the under-valued or over-valued securities.

Technical analysts need only quickly recognise a movement to a new equilibrium value for whatever reason (they need not know about an event and determine the effect of the event on the value of the firm and its stock). In addition, because they don’t invest until the move to the new equilibrium is under way, they contend that they are more likely to experience ideal timing compared to the method of fundamental analysts.

Finally, technical analysts believe that financial statement analysis is not sufficently accurate to depend on to make investment decisions and therefore consider it advantageous not to depend on such statements.

I will later write an article about the potential fundamental analysts’ responses to these points but more can be read about fundamental analysis and Warren Buffett’s concept of Value Investing in one of my previous articles (includes a video).

Click here for a look at Company Valuation methodologies like multiples and discounted cashflow analysis.

Hedge Fund Trading Styles and Strategies Uncovered

There are four broad styles of hedge funds and multiple strategies beneath each style which are discussed at length in the book Hedge Funds Demystified by Scott Frush. This article summarises the four broad hedge fund styles and provides an insight into the management of hedge funds.

In many cases, Hedge Fund managers combine strategies from the styles below but regardless of the strategy, each has the aim of generating attractive absolute returns. This is the fundamental difference between most investing funds (eg mutual funds) and hedge funds; hedge funds aim to deliver absolute returns in both a bull and a bear market.

The following are the primary strategies employed by hedge funds (such as the infamous Long Term Capital Management Fund), grouped by style:

Tactical (also known as directional)

  1. Macrocentric – Strategy where the hedge fund manager invests in securities that capitalise on domestic and global market opportunities. Trading strategies are generally systematic or discretionary; systematic traders tend to use price and market-specific information (often based on technical trading rules) to make trading decisions, while discretionary managers use a judgmental approach regarding differences between current financial market valuations and what is perceived as the ‘correct’ or fundamental valuation.
  2. Managed futures - Strategy where the hedge fund manager invests in commodities derivatives with a momentum focus, hoping to ride the trend to attractive profits.
  3. Long/short equity - Strategy where the hedge fund manager combines long holdings of securities that are expected to increase in price with short sales of securities that are expected to decrease in price. Long/short portfolios are directional – that is, the investment strategy is based on the manager’s expectation of future movements in the overall market – and may be net long or net short. Short positions are expected to add to the return of the portfolio, but may also act as a partial hedge against market risk. However, long/short portfolios tend to be quite heavily concentrated and thus the effectiveness of the short positions as a hedge against market risk may be limited.
  4. Sector-specific – Strategy where the hedge fund manager invests in markets in specific sectors by going long, short, or both.
  5. Emerging markets – Strategy where the hedge fund manager invests in less developed, but emerging markets.
  6. Market timing – Strategy where the hedge fund manager either times mutual fund buys and sells or invests in asset classes that are forecast to perform well in the short term.
  7. Selling short – Strategy where the hedge fund manager sells short borrowed securities with the aim of buying them back in the future at lower prices thus making a profit.

Relative value (also called arbitrage)

  1. Convertible arbitrage - Strategy where the hedge fund manager takes advantage of perceived price inequality with convertible bonds and the associated equity securities.
  2. Fixed-income arbitrage - Strategy where the hedge fund manager purchases a fixed-income security and immediately sells short another fixed-income security to minimize market risk and profit from changing price spreads. This was one of the key strategies employed by Long Term Capital Management before its demise. This is known as a non-directional spread trade. Managers take equal long and short positions in two related securities when their prices diverge from their typical relationship. Positive returns are generated when the prices of the two securities re-converge. Because arbitrage opportunities can be limited and the returns from these trades tend to be quite small, arbitrage strategies often employ higher leverage than other funds in an attempt to maximise the profit from exploiting these perceived mis-pricings.
  3. Equity-market-neutral - Strategy where the hedge fund manager buys an equity security and sells short a related equity index to offset market risk. An example of this would be buying Coke stock and selling Pepsi short. Market neutral managers attempt to eliminate market risk by constructing portfolios of long and short positions which, when added together, will be largely unaffected by movements in the overall market. Positive returns are generated when the securities which are held long outperform the securities which are held short. Market neutral portfolios tend to be more heavily leveraged than the long/short directional portfolios discussed above.

Event-driven

Event-driven strategies seek to take advantage of opportunities created by significant corporate transactions such as mergers and takeovers. A typical event-driven strategy involves purchasing securities of the target firm and shorting securities of the acquiring firm in an announced or expected takeover. Profits from event-driven strategies depend on the manager’s success in predicting the outcome and timing of the corporate event. Event-driven managers do not rely on market direction for results; however, major market declines, which might cause corporate transactions to be repriced or unfinished, may have a negative impact on the strategy.

  1. Distressed securities - Strategy where the hedge fund manager invests in the equity or debt of struggling companies at steep discounts to estimated values.
  2. Reasonable value – Strategy where the hedge fund manager invests in securities that are selling at discounts to their estimated values as a result of being out of favor or being relatively unknown in the investment community.
  3. Merger arbitrage - Strategy where the hedge fund manager invests in merger-related situations where there are unique opportunities for profit.
  4. Opportunistic events - Strategy where the hedge fund manager invests in securities given short-term event-driven situations considered to offer temporary profitable opportunities. An example of this may be if a piece of legislation is about to change and particular companies are likely to benefit.

Hybrid

  1. Multistrategy - Strategy where the hedge fund manager employs two or more of the above strategies at one time. Managers may elect to employ a multi-strategy approach in order to better diversify their portfolio or to avoid constraints on their investment opportunities.
  2. Funds of funds - Strategy where the hedge fund manager invests in two or more stand-alone hedge funds rather than directly investing in securities.
  3. Values-based - Strategy where the hedge fund manager invests according to certain personal values and principles.

The Collapse of Long Term Capital Management; Hedge Funds and Leverage

After watching a short excerpt of a Warren Buffet speech, I thought I may quickly summarise the collapse of the famous Hedge Fund, Long Term Capital Management. But First, Watch this excerpt, it is both funny and informative.

I have sourced most of the information below from an excellent paper done by Gregory Connor and Mason Woo (LSE) called An Introduction to Hedge Funds. I will separately write an introduction to Hedge Fund Strategies article after this article to have a more detailed look at Hedge Funds.

Long Term Capital Management

During the late 90’s, the largest tremor through the hedge fund industry was the collapse of the hedge fund Long-Term Capital Management (LTCM). LTCM was the premier quantitative-strategy hedge fund, and its managing partners came from the very top tier of Wall Street and academia. These funds are commonly known as “quant funds” or quantum funds and they typically use ma thematic strategies based on past market performance to predict future performance. They are typically very short term and are capable of providing very high returns.

From 1995-1997, LTCM had an annual average return of 33.7% after fees. At the start of 1998, LTCM had $4.8 billion in capital and positions totalling $120 billion on its balance sheet [Eichengreen, 1999].

Long Term Capital Management Strategy and Leverage ratio

LTCM largely (although not exclusively) used relative value strategies, involving global fixed income arbitrage and equity index futures arbitrage. As an example, LTCM exploited small interest rates spreads, some less than a dozen basis points, between debt securities across countries within the European Monetary System. Since European exchange rates were tied together, LTCM counted on the reconvergence of the
associated interest rates.

Its techniques were designed to pay off many sets of small returns, with extremely low volatility. To achieve a higher return from these small price discrepancies, LTCM employed very high leverage. Before its collapse LTCM controlled $120 billion in positions with $4.8 billion in capital. In terms of calculating this leverage, this represented an extremely high leverage ratio (120/4.8 = 25). Banks were willing to extend almost limitless credit to LTCM at very low interest rates, because the banks thought that LTCM had latched onto a certain way to make money.

LTCM was not an isolated example of size-able leverage. At that time, more than 10 hedge funds with assets under management of over $100 million were using leverage at least ten times over [President’s Working Group, 1999].


The Collapse of Long Term Capital Management

In the summer of 1998, the Russian debt crisis caused global interest rate anomalies. All over the world, fixed income investors sought the safe haven of high quality debt. Spreads between government debt and risky debt unexpectedly widened in almost all the LTCM trades.

LTCM lost 90% of its value and experienced a severe liquidity crisis. It could not sell billions in illiquid assets at fair prices, nor could it find more capital to maintain its positions until volatility decreased and interest rate credit spreads returned to normal.

Emergency credit had to be arranged to avoid bankruptcy, the default of billions of dollars of loans, and the possible destabilisation of global financial markets. Over the weekend of September 19-20, 1998, the Federal Reserve Bank of New York brought together 14 banks and investment houses with LTCM and carefully bailed out LTCM by extending additional credit in exchange for the orderly liquidation of LTCM’s holdings.

This bail out of Long Term Capital Management is similar to the recent bail out by the New York Federal Reserve of Bear Sterns. I will not go into whether or not one was more justified than the other but I read an excellent article Brave New Fed which is worth reading if you are interested.

Since the collapse of LTCM, hedge fund leverage ratios have fallen substantially.The aftermath of the Russian debt crisis and LTCM debacle temporarily stalled the growth of the hedge fund industry. In 1998, more hedge funds died and fewer were created than in any other year in the 1990s [Liang, 2001].

The number of hedge funds as well as assets under management (AUM) declined slightly in 1998 and the first half of 1999. After that the growth of hedge funds resumed with no major changes to regulations but with guidelines for additional risk management. [Lhabitant, 2002; Financial Stability Forum, 2000].

To see an excellent written summary of the Warren Buffest speech, see Warren Buffett on long term Value Investing or to see another Warren Buffett Video, click here.

What the media got wrong about the Opes Prime Collapse and Beconwood ruling

After reading the article Opes client loses court Bid, by Chris Zappone in the SMH and the Age, I had a desire to not only consider a career in popular legal journalism but to write a blog about the ANZ Bank, Beconwood Securities and the rest of the companies and individuals that have been affected by collapse of the stockbroker Opes Prime.

Specifically, I will outline why the article above is void of legal comprehension of the decision of Justice Finkelstein in Beconwood Securities Pty Ltd v Australia and New Zealand Banking Group Limited. I will do this by responding to quotations of what was written in the article with my own and Justice Finkelstein’s thoughts as a result of decision.

Luckily for those who are interested in actually knowing what is going on, I have been staying well up to speed with the collapse of Opes Prime. From the controversial sale of millions of shares of Australian public companies by the ANZ to the underworld revenge paths of Mick Gatto, I have been glued to my various news feeds. Throw in lawyer Chris Murphy, many people who have lost millions of dollars (including a good percentage of 7 million dollars of Beconwood’s ‘securites’) and a collapse that is tougher than usual for the average reader to understand and you arrive at what most would consider a media frenzy.

To say that the media err on the side of caution when reporting legal decisions and reasoning to the public would probably not be in line with the approach taken in the above article. Minutes after the “26-page ruling” (direct quote from Chris) was handed down, apparently a sound analysis of the ruling had been made and an article was quickly packaged for the hungry RSS readers such as myself and sent to the front [on]lines.

Other than being aware that the ruling was 26 pages pages long and that Justice Finkelstein answered ‘no’ to a question that I’m not certain the author understood, the article illustrates a shocking understanding of what was actually decided in the case. Further to this, despite the fact that the result is clearly not ideal for those affected by the collapse of Opes Prime which the article outlines, it blatantly mistakes the legal position of the clients of Opes Prime in its first sentence:

Clients of collapsed stockbroker Opes Prime do not have a legal claim allowing them to recover their shares, according to a Federal Court ruling this morning.

It goes on to discuss an agreement at issue that Beconwood didn’t even enter into (Beconwood entered into a varied Securities Lending Agreement (SLA), not the standard AMSLA) and proclaims the validity of this agreement when the construction of the agreement, not its validity, was what was being considered.

“Justice Finkelstein has upheld the legal status of the Australian Master Securities Lending Agreement used by Opes Prime,” the bank said. “That agreement does what it says. Full ownership of the shares is transferred…In a 26-page ruling released in the Federal Court in Melbourne, Justice Finkelstein found that the agreement signed by Beconwood Securities was valid and the plaintiff didn’t have “equity of redemption or other equitable estate or equitable interest” once the shares were lent to the stockbroker.

To outline the significant error in these statements, an introduction to the case is required but put simply, Opes clients still have several causes of action if their alleged misrepresentation did in fact occur. For those of you who are unfamiliar with this whole matter, this introduction will hopefully make it clearer.


The ‘Opes Prime Primer’

Beconwood Securities is one of the many angry clients of collapsed stock broker Opes Prime who is trying to recover the securities (approximately $7 million worth) that were transferred through a securities lending and borrowing agreement (SLA) to Opes Prime in exchange for about 1.1 million dollars of cash that was used to invest in the stock market. As a result of Opes Prime not actually having the money, they had a separate agreement with the ANZ to receive the money in exchange for transferring ownership of the shares transferred by Beconwood to ANZ.

Note here that Opes Prime is effectively acting as a middle man that charges a fee for broking services and advice whilst the ANZ is ultimately the company funding the investments of Opes Prime clients in return for the security offered by each client which in this case were shares in Destra and a few other Australian companies.

As a result of the decline in the stock market in recent times and stockbroking advice you can only assume that you wouldn’t want to pay a fee for, a number of margin calls came in requiring more security from Opes’ clients and ultimately Opes Prime’s liquidity dropped below acceptable levels as a result of a number of factors I will not go into here.

Shortly after, Opes prime was put into administration. Like many other Opes clients, Beconwood had transferred significantly more securities (value-wise) than the amount of cash that they had received and are making any attempts possible to legally compel the return of their shares (they will receive a certain amount as a result of the liquidation but this is not at issue). Separately, I will discuss the reports of certain high profile Opes clients having received significantly more cash than the security they had transferred but suffice it to say that there may be some very interesting outcomes if this is properly looked into.

Beconwood’s ‘legal claims’

After actually reading the 26 page ruling by Justice Finkelstein, I am able to summarise and reference Beconwood’s actual legal claims. I will say at this point that i know that popular news is not required to get the majority of what it got wrong in this case correct but that perhaps articles like this will make it slightly more likely.

I only do this so that we may have some idea about what was decided and what other legal avenues remain open to Beconwood rather than assuming judges make popular-culture-friendly decisions with unjustified sweeping claims void of reasoning. I might also add at this point that the judgment was very funny in places and well worth a read:

Beconwood proposed to the court that it had a security interest in the shares held by ANZ on a number of bases, of which only two were considered. Thus, Beconwood and the other Opes Prime clients may still have a legal claim as outlined by Justice Finkelstein below:

I emphasise that for present purposes it is neither necessary nor proper to consider (and I expressly have not considered) precisely what representations were or were not made in the meetings and correspondence between Beconwood and OPS, or what Beconwood may or may not have understood regarding the meaning of the terms of the proposed securities facility. At present, it necessary only to note that Beconwood entered into the SLA, the construction of whose written terms is now at issue. It must be remembered, however, that Beconwood contends that if it has not made out its case on the SLA alone, it will still be able to do so when account is taken of representations allegedly made by OPS and which form part of the arrangement, or inform that arrangement.

Justice Finkelstein outlines the two claims considered as follows:

First, Beconwood says that, on its true construction, the legal effect of the SLA is to create a mortgage of its shares in favour of Opes Prime with the consequence that the shares can be redeemed on repayment of the money received from Opes Prime…Beconwood believed that the true character of the SLA is that of a mortgage pursuant to which it borrowed money from OPS and put up its shares by way of security. It follows, so the argument goes, that Beconwood has an equity of redemption in respect of those shares.

The second basis is that Beconwood has an equitable charge over the shares [as a result of the nature of the agreement]…[Therefore], by reason of the SLA Beconwood has a charge over the shares which is enforceable in equity.

The corollary of each argument is that under the arrangement Opes Prime did not become the absolute owner of the shares.

If successfull on either of these claims, Beconwood would have an interest as either a mortgagor or chargee respectively over the securities that are now the legal property of ANZ (this would lead to an equitable interest and an ‘equity of redemption’ respectively). For those who have not studied equity, this would lead to Beconwood being more likely to have its shares returned.

An Finkelstein outlines, it would then separately have to prove that either of these equitable interests have priority over ANZ’s current and very real legal interest (another question not considered in the judgment).

Opes Prime clients and steps forward from here

Another of Zappone’s comments leads well into the result of the case and likely steps forward from here:

Beconwood Managing Director Paul Choiselat said he was disappointed and was yet to decide whether to appeal.

When deciding whether to appeal the decision, Mr Choiselat will likely consider the clarity of Justice Finkelstein’s reasoning in denying the two claims. He does have an appeal channel open but he is more likely to await thefull decision that will be completed by Justice Finkelystein on the other points of law raised in his claims.

If he were to appeal, he would have to appeal the construction of the agreement made by Justice Finkelstein. Without intending to turn this piece into a discussion of equity and property assignment, the ratio for the decisions appears very sound to me and provides little hope for success on these two claims. I will post a separate blog with a summary of the reasoning behind the decision if people are interested but for those who are keen read from paragraph 35 in the judgment.

Thus, if Beconwood Securities is to have a chance at getting its shares returned, it would in my opinion be much better off waiting for the final decision which may be considering claims such as innocent or fraudulent misrepresentation (assuming their claims are true) than appealing the two claims put forward in this case. However, even in this case, as it is an institutional investor, it would be quite difficult to prove that the actual agreement was anything other than that which is clearly stated in the agreement as outlined below:

Clause 3.1 provides: “The Parties must execute and deliver all necessary documents and give all necessary instructions to procure that all right, title and interest in [any Securities, Equivalent Securities, Collateral or Equivalent Collateral] will pass absolutely from one Party to the other, free from all liens, charges, equities and encumbrances, on delivery or redelivery of the same in accordance with this Agreement.”

I personallly wish Beconwood the best of luck in their hopes of recovering the money in the event that there was misleading conduct and hope that any suspicious behaviour allowing this to happen is properly investigated (including any Opes client accounts that were significantly undersecured and Australia’s severe incongruence with the more secure American SEC regulations in this area).

If you liked or disliked this blog, please comment below and let me know.