Financial Education

Many have characterized Chinese stock markets as inefficient, casino-like and speculative. In the November 2007 Pacific Basin Finane Journal Eun and Huang show that China’s markets may be more rational than many credit.

China’s markets, more than others, are characterized by small investors with undiversified portfolios. Only 37% of shares are publicly tradable, and only 10% of listed companies can offer the B- or H- class shares available to foreign investors. In studying various preferences, the authors find the following:

1. Stocks are priced according to company-specific rather than systematic risk. There are strong size and value effects, similar to the results found in U.S. markets.
2. Investors will pay a premium for more liquid stocks.
3. Investors will pay a premium for dividend paying stocks, possibly because dividends may reduce the ability of managers to expropriate funds.
4. Investors require lower returns for A-share companies that also issue B- or H-shares, possibly because such companies must meet more stringent disclosure requirements.

Accounting systems take the cash and accruals from various transactions and generate financial reports and statements.

The first step is to create journal entries and adjusting entries. The journal is a chronological list of each transaction, the amount, and the accounts affected. Some systems allow entries to include notes or authorizations. Adjustments are typically made at the end of accounting periods to record accruals not yet reflected in the accounting system.

Next, the general ledger and T-accounts can show the transactions sorted by the accounts affected rather than in chronological order. This can be useful for reviewing the activity in an account such as inventory.

Third, a trial balance lists the balance of each account on a given date. Unlike a ledger, only the ending balance is presented. Trial balances represent the first step in producing financial statements.

Finally, financial statements are prepared as a final product of the system, based on the totals from an adjusted trial balance.

Business cycle conditions can affect the outcomes of investment decisions, but can be very difficult to predict. To the extent that decisions can be made based on predicting the business cycle, each stage of the cycle can present different opportunities.

Early Upswing

As the economy begins to pick up, confidence rises and momentum builds. Stocks and real estate tend to perform well.

Late Upswing

The longer a boom lasts, investors often seem to forget there is a cycle. Stocks and commodities continue to rise but are less attractive values. High yields can make bonds and interest-sensitive stocks attractive investments.

Slowdown

Declining growth usually coincides with declining interest rates, which helps investments in bonds.

Recession

Lower interest rates eventually help the economy stabilize. Late in a recession stocks and commodities are often cheap again.

Recovery

As the economy begins to pick up again, cyclical stocks and commodities are the first to recover. As more confidence builds, riskier assets begin to perform.

Overconfidence, in behavioral finance, causes analysts to overestimate the growth potential of growth companies. As a result, they tend to overemphasize good news and underemphasize bad news related to such firms, possibly in the belief that growth companies must also be good stocks.

The emphasis of news that confirms a pre-existing opinion is also called confirmation bias.

A securities market is informationally efficient when prices adjust rapidly to new information and thereby reflect all available information. In order for a market to be efficient, several conditions are necessary:

• A large number of profit-maximizing participants independently analyzing and valuing securities
• New information arrives randomly, and announcements are independent of each other
• Investors rapidly assimilate the new information and adjust security prices accordingly

Security prices are not necessarily perfect reflections of value in an efficient market, but the implication of the conditions above are that security prices reflect an unbiased estimate of the true value, and that there are no predictable variations between the true value and the market price.

When a stock is bought using a margin transaction, the investor provides a portion of the initial investment (the equity) and borrows the rest (the margin.) The initial margin cannot exceed 50% of the total transaction value under current regulations.

After purchase, the margin remains constant (excluding interest payments) but the amount of equity fluctuates disproportionately with the stock price. If 50% initial margin is used, a 10% change in the share price will result in a 20% change in the equity value.

The Federal Reserve also sets a minimum maintenance margin requirement, which is currently 25%. This means that if the equity falls below 25% of the total security value, the securities must be sold to repay the margin.

Consider a 50% margin purchase of 100 shares of a $100 stock. The investor’s initial equity (and margin) is $5,000. At future points, the equity will equal 100P - $5,000, or 100 shares times the current share price, less the margin amount.

The investor will receive a margin call when the value of the equity falls to 25% of the total security value, which can be calculated as follows:

(100P - $5,000)/100P = 0.25, which algebraically becomes

100P - 5,000 = 25P

75P = 5,000

P =  $66.67

If the stock price falls to $66.67, the investor will be required to sell the shares and repay the initial $5,000 margin. Only $1,666.67 of the original $5,000 would remain - a 66% loss.

There are three significant limitations to achieving fully efficient markets: the cost of information, the cost of trading, and limits of arbitrage.

Cost of Information

A fully efficient market requires that all new information be processed instantaneously and fully reflected in the share price. However, if all information is fully priced instantaneously there is no incentive for any market participant to process the information. The time and effort expended would not earn a return. In order for markets to become efficient, there must be just enough inefficiency to make the efforts worthwhile.

Cost of Trading

Trading costs include brokerage fees, taxes, and research time. High trading costs reduce the incentive to trade, and small inefficiencies may not be priced away.

Limitations to Arbitrage

Ideally, if two securities are mispriced relative to their risk one can be sold short and the other purchased. The sale of one and purchase of the other will drive both toward their efficient price. In practice, there are four problems associated with this.

1. It is uncertain when, if ever, prices will return to equilibrium. The mispricing could become even more pronounced in the meantime, potentially forcing the arbitrageur to close the position.
2. Two assets rarely have identical risks. If there are no close substitutes for a given security, no arbitrage may be possible.
3. Arbitrageurs have limited access to capital. Only the most egregious mispricings can be exploited.
4. Arbitrageurs may face restrictions on trading by the owners of the capital they employ.

In the United States, capital gains on stocks held for less than one year are taxed as ordinary income, while gains on securities held longer than one year receive a preferential tax rate. Many investors and advisors hold stocks past the magic one year in order to maximize the after tax gain. In the Journal of Technical Analysis, Issue 64, Jerome Harti examines whether this tendency results in predictable (and thus exploitable) stock price patterns.

The author proposes that a sharp, downward, high-volume trading day and subsequent recovery should be followed one year later by a corresponding period of underperformance as those investors who have delayed realization of capital gains close their long positions.

Based on a sample of Russell 2000 stocks from the 2004-2005 period, the author finds that during the 10-day “anniversary window” beginning one year after the initial event the experimental group underperformed a control group by 4.36%.

As anyone with a mailbox well knows, hardly a day goes by without receiving one or more offers for new credit cards. The problem is not so much getting credit, but choosing the card that best meets an individual’s needs. With this in mind, Apex Credit Cards has built a site around credit card comparisons.

The site has summarized offers for more than 170 credit cards. Users can click on a category, such as “Low APR,” to compare a dozen or more offers from different issuers. Included in the summary are details of the permanent APR, any introductory APR and the term of the introductory APR, annual fees, setup fees and the credit rating one needs in order to be approved for the card. When you find a card that fits your needs, you can click on an “apply” button to go directly to that card’s application.

Other categories include:

• Top rated
• Bad credit
• Business
• Canadian
• Prepaid debit
• Reward cards (which has 15 sub-categories)
• Spanish
• Student
• Teenagers

All in all, the site allows comparison of MasterCard, Visa, Discover and American Express offers from no less than 23 issuers. There is also a way for current holders to review each card offer, though there have not been many reviews submitted so far.

Professionals with degrees in accounting and finance are in greater demand than ever, as companies of all sizes face greater oversight by government agencies, stockholders, lenders and suppliers. Given the number of opportunities available in the field, it is no surprise that many students are turning to online learning to supplement their existing knowledge through degree and certificate programs. The problem then becomes deciding which program will work best.

Earnmydegree.com allows students to browse a large number of online programs by subject, degree, and provider. It even categorizes on-campus opportunities by location. Featured programs include the University of Phoenix, Kaplan University Online, American InterContinental University Online, Westwood College Online, and FMU Online. However, the number of accounting and finance choices is at least 30. The site notes that:

After working with more than a dozen online education providers, we recognized the need for a convenient, one-stop resource that could bring new students and educators together. Since its launch in May 2003, EarnMyDegree.com has successfully connected more than 3 million students to the adult online education programs of their choice.

From my own look at the site, it certainly provides a wealth of information about a large number of available programs. Interested students would likely find it to be a convenient first stop.