How ill-gotten gains are legally bypassed

As evident in the infographic below, investment banks and the Treasury Department make money via an unspoken collusion of rewarding ill-gotten gains via the guise of  economic stewardship. One need not look far to see how the Securities and Exchange Commission, and a seemingly weak or soft-handed judiciary has fallen short of firm financial regulation countless times.

In the past, the SEC has even admitted as much per the New York Times. Steve Denning, a contributor to Forbes magazine reiterates the problem that big banks are still getting away with risky derivatives trading that has the potential to cause another financial meltdown. Why? The reason, according to another NYT article by Gar Alperovitz, is that Wall Street is too big to regulate. However, the lucrative fines that are redistributed to the Treasury and cost-benefit of the fines to financial institutions offer another reason, specifically financial incentive.

Source: Wall Street Crimes: What Financial Advisors Don't Tell You via Infographic File: Infographics and Data Visualization

Is it safe to invest in China?

With annual GDP growth  between 8.7-9.3 percent forecasted through 2013 per the World Bank it is easy to think 'China' is a good investment. It is not quite that simple though. 'China' includes the sum total of its economic components which are managed by different policies and exist in a market quite different to the United States. Having a good grasp of China's economic drivers, and which ones offer good opportunities for investing if any, is a place to start evaluating the reality behind the beliefs.

In its July 16-17 Weekend Edition, The Wall Street Journal reported China is a good prospect for investors because problems are overestimated and Chinese Stocks are cheap. Yet in it its July 18-24 edition, Bloomberg-Businessweek  offers a completely different tone, one of caution. For example,  according to the latter source all that is needed to bring China to an economic crash or slowdown is GDP below 7 percent. Moreover, also per Bloomberg-Businessweek, the Chinese real-estate market is beginning to show signs of higher supply. This tends to affect prices to the downside and the affect on net worth follows and carries through into economic numbers such as GDP from real estate related production.

The Wall Street Journal suggests China's growth gives it more leeway to use aggressive monetary and fiscal policy, but historically, linear geometric growth for decade upon decade isn't exactly a swish shot in the basket for developing nations. Even the United States had bumps in the road via the 1929 stock market crash, the great depression and 1970's oil crisis. 

China's economy is somewhat dependent on the global economy as are most economies via globalization. If global demand for products subsides along with a plateau in real estate and cost driven inflation then there is room for doubt. Additionally, a restrictive monetary tightening during a period of growth encourages cyclical economics and China's inflation is still above 6 percent per Bloomberg meaning things are getting more expensive in reference to a  less than free-floating Yuan-Renminbi. That can also lead to a cyclical pattern or slowdown and is still rather high considering the Chinese Central Bank has been tightening money supply all year to date.

Then of course there are the actual securities and details. Exchange Traded Funds, Chinese currency, Treasuries, Businesses? Where and how to invest without losing money is more than a mere technicality. How well do fund managers invest in China? Past performance is not a guarantee of future success, and due diligence on Chinese companies isn't quite as easy as for U.S. businesses. Just like any investment, investing in China is a risk and that risk is probably best kept in mind despite China's current growth which is in excess of three times that of the United States. 

Understanding the Meaning of Market Risk

Market risks are threats investors face that are derived from conditions external to the investor him or herself. Market risk is sometimes referred to as systematic risk but is different from systemic risk.(2) To be more specific, market risk includes inherent uncertainties that can occur at any time regardless of preventative measures, whereas systemic risk is more influenced by controllable business variables rather than adjustments to individual investment strategy.

• Why market risk is mostly unavoidable

Market risk is unavoidable in any situation where an investor places money in a financial instrument such as stocks or bonds. Some financial instruments are exposed to less market risk than others, but all investments are not immune from market risk. For example, even government issued inflation protected securities are subject to risks having to do with the currency in which the securities pay interest. Inflation protection may be incorporated into the securities, but if that currency devalues against many other currencies, the purchasing power against those currencies can still decline.

• Types of market risk

A number of market risks exist, some of which are more probable than others depending on the type of investment and the market environment in which the investments are made. (1) For example, the above section states currency risk depreciates the value of inflation protected securities, but what if the currency is stable, or goods purchased with the currency are cheaply made and acquired domestically? The answer is other risks such as interest rate risk may also apply. Since interest rates are subject to economic conditions, in the case of floating rate inflation protected securities, they could still decline in interest payments even if inflation rises.

• How market risk affects investments

Market risk affects investments by making them worth less, but risk sometimes can preclude higher returns. Risk can also be priced into securities so that the more cautious investor feels they are exposing themselves to less market risk. An example of this is a risk premium added to bonds that are rated lower than investment grade; another word for these bonds is 'junk bonds'.  Market risk can also cause volatility in the value of an investment such as stocks. For example, if economic conditions change, and the industry in which stocks are held is affected by that change in economic climate, then the risk of business failure or profit decline emerges.

• Methods for dealing with market risk

Apart from industry regulation,(5) market risk can be limited through risk management methods such as investment techniques, calculated selection and market analysis. Just as one would not go out in a hurricane to buy a bag of apples, investing in certain market conditions is like walking into a hurricane. By studying the market, the specific risks that investments pose and ways to hedge against those risks, market risk can be reduced. Common techniques for risk reduction in include diversification and investment in FDIC insured accounts. The reasons why diversification is thought to be effective in reducing market risk is because it spreads out investment over a number of industries or businesses. However, it is important to note than in macro-economic instability, even diversification can fail.

• Measuring market risk

Market risk can be measured in a number of ways. According to the Financial Times, Systematic indices exist that keep track of risk levels of various investments.(3) Moreover, these indices specifically measure performance of investments that are known to be vulnerable to different kinds of risks. For example, a fund that trades currencies is not necessarily subject to the same risks as a fund that invests in precious metals.  Several other methods of measuring risk also exist, and for example, they may involve risk formulas(4) or qualitative evaluation of business management.

Sources:

1. http://bit.ly/aEUUxt (FINRA)
2. http://bit.ly/cJfwfw (Investopedia)
3. http://bit.ly/b2MMMm (Financial Times)
4. http://bit.ly/bogSd2 (University of Wisconsin)
5. http://bit.ly/anZomF (SEC)

Determining the Risks of Investing in Latin American Businesses

Investing in Latin-American businesses involves the same due diligence that is required for investment in any business. In the case of Latin-America however, the investing environment has its own nuances, risks, pitfalls and potential. Thus, a part of the due diligence required for investment in Latin-American businesses is identifying these investment risks.

Latin-America consists of several countries as far North as Mexico and as far South as Argentina. The business, legal, and economic environments for all these countries varies considerably, enough so to warrant individual research for each country prior to investing in them.

Generally speaking, Latin-America is susceptible to certain risks that other countries' businesses may not be. These risks include 1) inflation or deflation risk, 2) political risk, 3) sovereign risk, and 4) economic growth/demand risk. This article will review these potential investment risks facing existing and potential investors in Latin America.

Inflation or deflation risk

According to the Center for Economic Policy Research, several Latin American countries in 2009 are either subject to inflationary or deflationary pressures. Economically, there are many other potential risks, however for Latin-America inflation and deflation is one of them in addition to demand risk which will be discussed in the following section.

Inflation above 4-5% is fairly high and deflation is indicative of shrunken or shrinking economy. Several of the following countries have inflation values bordering on, or in excess of high or low inflationary and deflationary values. Headline inflation indicates overall annualized inflation rates whereas core inflation refers to a specific group of inflation measured products.

• Venezuela: 24% headline inflation, 20% core inflation
• Chile: -2% headline deflation, 5% core inflation
• Brazil: 4% headline and core inflation
• Colombia: 4% headline inflation, 4% core inflation
• Mexico: 10% headline inflation, 4% core inflation
• Dominican Republic: -20% headline deflation, 2% core inflation
• Peru: 5% headline and core inflation
• Ecuador: 0% headline inflation, 2.5% core inflation
• Bolivia: 2.5% headline inflation, 5% core inflation
• Guatemala: 0% headline inflation, 5% core inflation

In the short-term, deflation is a factor for stable economies with low inflation, whereas inflation is a risk for those Latin-American companies subject to either an over liquid money supply, and/or rising prices of goods and services. The above statistics are approximate figures obtained from the Center for Economic Policy Research going into 2009. Moreover, the inflation trend-lines for these values is up for Brazil, Venezuela, Columbia and Mexico and is down for Chile, Dominican Republic, Bolivia, Ecuador, Peru and Guatemala.

Political risk

Another investment risk facing some Latin American countries is political risk. For U.S. investors, these risks are higher with countries that have anti-American economic policy such as Venezuela and Panama. Up to date news and information on specific Latin-American countries can be found at http://www.latinamericanmonitor.com. Other political risk arises from single events rather than policies within a country.

In a 2007 essay from Professor Christopher Moser of the University of Mainz, Germany Department of Economics the possibility of market correlations with political events in Latin America is discussed. Specifically, the essays studies the market affects of changes in political structure on national bond spread pricing. The research by Moser indicates Latin-American countries are subject to political risk in terms of financial markets.

Politically, some Latin-American countries are more at risk than others. Those countries with weak leadership, rebellious movements, large economic problems and volatility, and a significant history of political turmoil are the higher candidates on the political risk scale. Naturally, the type of investment(s) also having bearing on how much political risk holds sway. For example, investment in local companies may be safer than investment in foreign subsidiaries operating in the Latin-American country.

Sovereign risk

The Political Risk Insurance center has performed an analysis of sovereign risk on Latin American countries. Specifically, this risk and studies of it, assist in determining how likely a country is to pay its national debt whether that debt be in the form of Bonds or other financial instruments. The PRI-Center study indicates a negative outlook on sovereign risk for Latin-America with some countries holding higher credit worthiness than others. Of those countries Brazil, Mexico, Trinidad & Tobago, Chile and Peru have the higher credit ratings in the B- to B+ range.

The countries with the lowest PRI-Center credit ratings include Uruguay, Jamaica, Argentina, Dominican Republic, Ecuador, El-Salvador and Costa Rica with credit ratings in the E to D+ range. Factors that can lead to increased sovereign risk include negative GDP growth, high inflation, and over extended debt burdens for a nation-state. Consequently, looking for a range of indicators such as inflation, national debt, GDP growth, trade deficit etc. can all point to different levels of investment risk of one kind or another.

Economic growth/Demand risk

In a 2009 report from the Brookings Institution entitled 'Latin America's Economic Outlook for 2009: No Time for Optimism', the economic factors contributing and/or related to the performance of investments within the region are discussed. A growth rate of 3% was predicted for the regions biggest economies, however this is a lower rate than originally forecasted.

Nevertheless, despite declining economic indicators in the region such as capital inflow, international and regional demand trends, and GDP growth, Latin-American countries as a whole are still expected to grow on average, just not a sustained pace similar to previous years. Other economic factors mentioned in the Brookings report included Asian treasury investment within Latin-American countries and those countries ' ability to raise capital, financial reserves, and exchange rates as they relate to investment in the region.

In light of the U.S. and global recession of 2008-2009, a contraction in economic conditions within Latin American countries is not surprising. However, economic conditions after such a contraction are key in determining how well investments in the region may perform. Lagging indicators despite global economic recovery may point to internal economic difficulties such as debt problems, demand declines and high inflation among other things.

Summary

It is a good idea to study the risks of international investments before proceeding with such either independently or via a fund or other financial instrument or investment product. In Latin-America, specific risks exist for different countries within the region. Among these are risks discussed, but not limited to those in this article.

Some of the key investment risks affecting Latin-American countries include inflation or deflation, demand, political risk, sovereign risk, regulatory and operational risk. Each Latin-American country is subject to different economic conditions except for those more regional in nature. Consequently, taking both national and regional investment risks into account when or before investing in Latin-America may also be financially prudent.

Sources:

1. http://seekingalpha.com/article/65523-investing-in-latin-america
2. http://tinyurl.com/5w73axv
3. http://www.cepr.net/documents/publications/inflation-latin-america-2009-02.pdf
4. http://ideas.repec.org/p/zbw/gdec07/6804.html
5. http://www.pri-center.com/documents/BMILatam.pdf
6. http://www.brookings.edu/opinions/2009/0122_latin_america_cardenas.aspx

Understanding Risk Premium in Finance

Risk premium is a financial value that equals return on investment over and above the risk free rate. The risk free rate is the amount an investor receives for investment with very little risk. For example, a government issued savings bond has a low return in comparison to a higher risk bond such as a corporate junk bond. If a risk free government bond has a rate of return of three percent, and the corporate junk bond has a rate of seven percent, then the difference between the two is the risk premium. In this case the risk premium would be four percent.

In finance, risk premium is an important component of risk management as it helps corporate and business decision makers assess the value of an investment via its potential risk and reward to revenue. The more accurate the risk forecasts are, the greater the utility of the risk premium measurement. For example, if a project is estimated to carry a risk premium of five percent, and the foretasted ROI is accurate, then cash-flow management, and liquidity can be planned and implemented for other business functions. The accuracy of forecasting risk premiums is consequently of great relevance if large financial decisions are made using the data.

How risk premium is calculated in finance helps investors determine whether or not the return on an investment justifies the investment risk. In other words, if a return on investment doesn't price in risks such as liquidity risk, market risk, and interest rate risk. For example, a bond that provides a return of three percent might not provide as high a return as bonds issued six months later. This is the interest rate risk inherent to investing in the bond even though it is a risk free bond. The difference between the interest rate risk and the risk free rate plus the risk premium is the opportunity cost.

Calculating risk premium is different from forecasting risk premium because historical values are used. Since return on investment is known for past investments, historical risk premium is easily calculated using basic arithmetic. For future investments however, calculating risk premium can be more complex.

In a study performed by Aswath Damodran, several forms of risk measurement including the Capital Asset Pricing Model (CAPM), Arbitrage Pricing Model (ARM), Multi-Factor Model and Proxy Model are outlined. Several of these models use a calculation called beta that measures risk. As Damodran points out, in so far as beta calculations are used to determine risk in CAPM, the values that go into the beta are broad market based indicators and somewhat irresolute i.e. subject to any number of factors of change. Similar variability exists in the measurement of beta for ARM, and the Multi-Factor Model,

Determining which risk model to use is a matter of applicability. For example, if risk is less a function of economic factors and more operational in nature, then the Multi-Factor Model would be less useful. In such case, an in house risk assessment might be useful to a company. For example, a producer of parts for use in equipment might incorporate operational performance of manufacturing machinery into a risk model so as to account for shut-downs, repairs or lower capacity utilization.

In this case, the replacement risk variables such as machine utilization and cost can be calculated as lost ouput of works in progress as a function of product demand. In other words, the risks to any investment should be identified and assessed realistically rather than haphazardly using risk metrics that don't necessarily apply.

Sources:

1. http://bit.ly/9egOlQ (NYU: Stern School of Business)
2. http://bit.ly/aN6pYh (Financial Regulatory Authority)
3. http://bit.ly/cerRlq (Investopedia)

How to Avoid Common Investment Mistakes

"Zut alors" echoes the investing disenchantment, "not again". Avoiding the mantra of common investment mistakes, and while we are on the topic, common financial advice, can cost money and are therefore ideally taken with a little thought.

The first step in avoiding common investment mistakes is to leap into a new way of thinking about your investments and then look at your past investing from that perspective. The reason being, if you look at investments with the same reasoning every time, you're likely to get similar if not the same solutions every time as well. What good is that if the standard investment advice yields lethargic results? Keep reading to find out.

According to the CFA Institute, an organization that certifies financial professionals, there are several common investment errors some of which include poor strategy, too many investment expenses, high investment turnover, and inadequate buying and selling habits. (cfainstitute.org). These investment mistakes are important and should be avoided but what they are not is individual specific. Standard investment advice often leads to standard investment results. So, in light of this, the first investment mistake discussed here will be tuning into financial gurus too much.

• Financial guru syndrome

Financial guru syndrome is the ongoing belief in the steady stream of re-wrapped investment terminology, information and reasoning. Financial gurus be they hedge fund managers, Chief Executive Officers of Banks, or mainstream economists may be wise, learned, and have a lot of experience and know how within the financial sphere but what they are most definitely not, is you, the individual investor. In the media, financial gurus speak to the masses not to the individual and who is more important than you when it comes to investing. Get it? The same advice for Mr. A may also apply to Mr. B, but that doesn't mean it applies to Mr. B's investments in the way Mr. B wants it to.

• Mono-economic financial planning

Another technique to consider when avoiding investment mistakes is dual economic financial planning. If this sounds confusing don't be fooled because it's not. Dual economic financial planning involves investing for both good and bad economic times. Many investors choose conservative investments so they can withstand poor market performance, but that only goes half way in investing for dual economies. Taking investing to the next level, and rethinking investments for all scenarios is a useful step in avoiding the common investment mistake of ignoring down markets. By investing for both up and down markets one is not merely hedging bets, but banking on the good and the bad.

• Rewriting investment history

Ever get the feeling your "new investment strategy" isn't quite as new as it should be? If yes, you could be rewriting investment history. Consider an investor who is within 5 years of retirement and has just lost 25% of retirement net worth. Using a retain worth conservative pre-retirement strategy is useful and not to be underestimated, however, this doesn't solve the problem of weak past investment performance or loss.

One way to approach this particular investment situation would be for the investor to realize not all that money will be needed in the first few years of retirement. That opens the door to a longer term investment horizon within which the investor can regain and potentially increase his or retirement funding. Overused financial strategies can lead to a rewriting of investment history. If you want to avoid that mistake, improve your approach to investing.

• Tubular dollar vision

Tubular dollar vision is essentially the same as financial tunnel vision, and financial tunnel vision can be harmful to your financial health. By not rethinking investment strategy and technique in a new way, with new goals reduces the possibility of enhanced investment performance. For example, Mrs. Y has done reasonably well and achieved an individual average ROI of 12% after investment taxes and expenses.

Tubular dollar vision might say, that's good, keep on keeping on with that and the power of compounding and consistent ROI will leave you in good shape in such and such an amount of time. In Mrs. Y's case, tubular dollar vision might not be so debilitating, but this does not necessarily mean Mrs. Y is making the most of her money. To avoid tubular dollar vision, try a tri-kaleidoscopic frame of financial reference to avoid common investment mistakes and reach new financial attainments.