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27 Cards in this Set
- Front
- Back
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What's Ben Graham's advice in the 1st paragraph?
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To buy earnings cheaply and avoid companies w/ lots of debt.
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Is value investing's ability to protect the downside contentious?
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Yes.
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What's a bond?
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A bond, of course, is just an IOU, a promise to pay back money with interest by certain dates
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How are bond investors like a casino?
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If there's a 1 percent chance of default but they get an extra two percentage points in interest, they're ahead of the game overall
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How come mortgage pools are messier than most bonds?
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There's no guaranteed interest rate, since the amount of money homeowners collectively pay back every month is a function of how many have refinanced and how many have defaulted. There's certainly no fixed maturity date: Money shows up in irregular chunks as people pay down their mortgages at unpredictable times—for instance, when they decide to sell their house.
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What's most problematic about mortgage pools?
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And most problematic, there's no easy way to assign a single probability to the chance of default.
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How did Wall Street solve many of the messy problems with mortgage bonds?
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"tranching" , which divides a pool and allows for the creation of safe bonds with a risk-free triple-A credit rating.
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Why did ratings agencies and investors feel so safe about the triple-A tranches?
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The reason that ratings agencies and investors felt so safe with the triple-A tranches was that they believed there was no way hundreds of homeowners would all default on their loans at the same time. One person might lose his job, another might fall ill. But those are individual calamities that don't affect the mortgage pool much as a whole: Everybody else is still making their payments on time.
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Give an example of mortgage pool risk that affects a large number of people at once.
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House values dropping
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Correlation
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The degree to which one variable moves simultaneously with another
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Give an example of a situation from the 2 grade school girls that has high correlation and an example with low correlation.
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High correlation: students witness teacher slipping on a banana pill; Low correlation: winning the spelling B
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is measuring and predicting correclations a precise science?
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Nope.
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When did Wall Street's quant era begin?
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1980's
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what did Li use instead of historical data to model default correlation?
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he used market data about the prices of instruments known as credit default swaps.
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What are credit default swaps (CDS)?
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insurance against those same borrowers defaulting
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How is selling credit default swaps simiilar to lending directly to borrowers?
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Either way, you get a regular income stream—interest payments or insurance payments—and either way, if the borrower defaults, you lose a lot of money.
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Did Li use historical data to model the correlations?
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Nope.
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Did li's paper assume that the CDS market can price default risk correctly?
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yes
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List an asset besides mortgages that were pooled into collateralized debt obligations (CDOs).
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bonds, bank loans
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Was it possible for tranches with no triple-A securities to be rated triple-A?
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Yes.
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Calculate the compound growth rate of the credit default swap market from 2001 to 2007.
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37.44%
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What did Paul Wilmott say about the stability of correlations between financial quantities?
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the correlations between financial quantities are notoriously unstable."
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Did li's formula assume correlation was constant?
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yep
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Why were warnings about Li's cupola shortcomings ignored
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Banks dismissed them, partly because the managers empowered to apply the brakes didn't understand the arguments between various arms of the quant universe. Besides, they were making too much money to stop.
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The CDS prices used to calculate correlations were from what period of time?
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during a time when real estate only went up
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In financial markets, what usually happens when everyone does the same thing?
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everybody doing the same thing is the classic recipe for a bubble and inevitable bust.
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Why does Nassim Taleb say that, "co-association between securities is not measurable using correlation"?
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because past history can never prepare you for that one day when everything goes south. "Anything that relies on correlation is charlatanism."
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