Let's face it. Volumes on SL Capital Exchanges (all of them) are dismal, and liquidity is a major concern for investors. "Why should I plunk down several thousand of my hard-earn Linden Dollars if it'll take me months just to sell at a break-even price, and that's if I'm lucky?" With liquidity locked up, major investors will have a hard time realizing a profit on their investments, even if the market values of the particular stocks rise. So how do we fix this?
It seems that whenever a SL company goes belly-up, the CEO simply throws their hands in the air and walks away. That's because it's a possibility in Second Life. There is no chain connecting the CEO to the viewer which makes him or her responsible. Threats of legal action are simply idle talk, as even recovering something like $20,000 USD (about L$5.4 million) would be silly in the context of lawyers' and courts' fees (not to mention your time) to get it.
Certain exchanges have made progress in the realm of removing the complete anonymity of CEOs by requesting IDs for IPO clearance. Nevertheless, even if you know their ID, what good does it do you? Again, legal fees are too prohibitive.
I hesitate to say it, but I think it may be time to tie some more legal strings around the CEOs of SL companies. Some have suggested using promissory notes, but it sounds more like a fidelity bond issue to me, if there was an insurer who would ever cover it. The point remains the same, though: sending a message to CEOs that this is more than a game (in spite of the hypocritical boilerplate language at most exchanges), it is a responsibility which will reach out and slap you in real life if needed.
Before I let this tirade go too far, I do realize that this is not always something that a CEO wants to take on. I daresay that the salaries earned by most SL CEOs are nowhere near enough to compensate for the trouble which these legal ties could cause in real life. Maybe that's the answer, but I hope not.
I'd love to know how to restore investor confidence, but I'm just not seeing a way of doing it without giving investors some sort of recourse for CEO inadequacy or fraudulant activity.
Anyone else have other ideas? Comments?
Showing posts with label finance. Show all posts
Showing posts with label finance. Show all posts
Saturday, August 2, 2008
Saturday, July 26, 2008
It's been awhile...
So, it turns out I've been pretty bad at posting over the last few months. I've had things to keep me busy: one of my actuarial exams, work, RL moving, vacation, getting engaged, etc., so it's not like I'm short on excuses. Nevertheless, I think I should try to post and keep updating this thing periodically.
It seems like interest has waned in the market. I'm not entirely surprised, as most of the markets are rocked by scandal after scandal. New money coming in is kind of rare, as it seems that those who are involved with the markets currently are the only ones who would like to be involved. The lack of liquidity also frightens new investors, as the market value of securities is significantly more than the liquidation value (that is, if you sold all your shares as fast as you could) for almost every security, and even for modest amounts of shares.
For example, take SLR, the company I'm CFO for. (This is in no way a critique of my shareholders, but if I'm going to pick on a company, I might as well hit home.) Suppose I owned 10,000 shares of SLR right now. The market price shown on CapEx is L$6,500. However, if I actually tried to sell all 10,000 shares, I would receive (after commission) L$5,153.02, which is 79.3% of the displayed price. Make it 50,000 shares and I would only receive 12.9% of my displayed market value!!! And we're not talking vast sums of money here - 50,000 SLR shares at market is worth about $120 USD. Enough to care, but not enough to break most of us financially.
You can play this game with almost any stock on any market. There are exceptions, where management has taken care to set aside cash reserves to prevent this from happening, but by and large putting money into the market means you will need to take your time getting money out of the market.
I've heard the idea of market makers being tossed around before. For those of you who don't know, a market maker is a person/firm that makes money off the bid-ask spread in the market. They provide liquidity. However, from my previous actuarial exam (which I passed, by the way!), Modeling Financial Economics, market makers need options in order to protect themselves. There are techniques whereby market makers can insure themselves against large price changes, or even set themselves up to make money if the market doesn't move. However, these require options, which no exchange in SL has been willing to set up yet.
If any exchange in SL is seriously interested in setting up options and market making and similar techniques, please contact me. While I'm sure I'm not the only person in SL who understands how to make it work, I'm likely one of the few, and I would love to help.
I suppose the question is this: How do we revitalize the markets now? I think liquidity is the major issue, but I would like to hear what others think as well.
It seems like interest has waned in the market. I'm not entirely surprised, as most of the markets are rocked by scandal after scandal. New money coming in is kind of rare, as it seems that those who are involved with the markets currently are the only ones who would like to be involved. The lack of liquidity also frightens new investors, as the market value of securities is significantly more than the liquidation value (that is, if you sold all your shares as fast as you could) for almost every security, and even for modest amounts of shares.
For example, take SLR, the company I'm CFO for. (This is in no way a critique of my shareholders, but if I'm going to pick on a company, I might as well hit home.) Suppose I owned 10,000 shares of SLR right now. The market price shown on CapEx is L$6,500. However, if I actually tried to sell all 10,000 shares, I would receive (after commission) L$5,153.02, which is 79.3% of the displayed price. Make it 50,000 shares and I would only receive 12.9% of my displayed market value!!! And we're not talking vast sums of money here - 50,000 SLR shares at market is worth about $120 USD. Enough to care, but not enough to break most of us financially.
You can play this game with almost any stock on any market. There are exceptions, where management has taken care to set aside cash reserves to prevent this from happening, but by and large putting money into the market means you will need to take your time getting money out of the market.
I've heard the idea of market makers being tossed around before. For those of you who don't know, a market maker is a person/firm that makes money off the bid-ask spread in the market. They provide liquidity. However, from my previous actuarial exam (which I passed, by the way!), Modeling Financial Economics, market makers need options in order to protect themselves. There are techniques whereby market makers can insure themselves against large price changes, or even set themselves up to make money if the market doesn't move. However, these require options, which no exchange in SL has been willing to set up yet.
I suppose the question is this: How do we revitalize the markets now? I think liquidity is the major issue, but I would like to hear what others think as well.
Saturday, May 17, 2008
Options: Lesson 2
Guardian's Note: This is a continuation (though much overdue) of a previous post which I wrote awhile ago. Reading that post will likely be necessary for a good understanding of this one.
Now that you have a good intuitive understanding of what a call and put option on a stock are, and how to use them, let's think about how to price them.
When building a model for options pricing, there tend to be a set of convenient assumptions made to simplify the process. First, there are no transaction costs or taxes. Secondly, you can buy or sell as much of any stock/option without altering the price. Thirdly, volatility (we'll get to that later) will be known and constant. I think that's all I'll need for this lesson.
Certainly, the value of the option is determined by the value of the stock at some given point in time. If the option is European, then the only relevant value is the price at the end of the time period.
Suppose we have a stock at price S0 currently, and there is a European call option expiring at time 1 with strike price K = S0. Now, in this particular oversimplified world, the stock can only take on two values at time 1: Su and Sd, standing for an "up" movement and a "down" movement. Since the option is at strike K = S0, the option will pay (Su - S0) at Su and zero at Sd. We'll denote these values by Cu and Cd respectively (representing the value of the call at an up movement and the value of the call at a down movement).
The price of the option can then be calculated as
Where v is the present value factor to discount the payoff with interest back to time zero. We'll need an interest rate to do that, which we'll call r. We'll also need P(up movement) (the probability of an up movement) to calculate the price.
Through some mathemagic which I think I'll gloss over for now (but if you all want to see it, I'll happily spell it out), a probability which correctly calculates the price can be found using this formula:
Where r is the continuously compounded rate of return, d is the continuously compounded rate of dividend payments, h is the time period (in years), d is the multiplicative factor by which S can decrease over h, and u is the multiplicative factor by which S can increase over h.
There are also formulas for u and d, but if you need those I suggest reading this.
With all of that in place, there is now a formula for pricing a call option where the stock has only two movements, up or down. This model can be expanded to include more periods, use discrete dividends (say the stock pays $10 at time 0.75), handle American options, and do a variety of other nice tricks. However, the more important fact is that this is the backbone of the famed Black and Scholes model, which I will discuss in Lesson 3.
I hope you can see how this all gets very hairy mathematically very quickly. Some of the background I jumped over is done not by mathematical proof, but by economic logic, which may not sit well with some mathematicians. I have also tried to simplify a lot of this to be read by the general audience, whereas for the last four months I've been studying the specifics of this, and more complex models, extensively. If any of you readers are curious about this topic on a deeper level, feel free to post here, IM me in world, or email me at guardian.market@gmail.com. I can't guarantee I'll know the answer (it's a big world out there with options!) but I'll try to at least point you in the right direction.
Now that you have a good intuitive understanding of what a call and put option on a stock are, and how to use them, let's think about how to price them.
When building a model for options pricing, there tend to be a set of convenient assumptions made to simplify the process. First, there are no transaction costs or taxes. Secondly, you can buy or sell as much of any stock/option without altering the price. Thirdly, volatility (we'll get to that later) will be known and constant. I think that's all I'll need for this lesson.
Certainly, the value of the option is determined by the value of the stock at some given point in time. If the option is European, then the only relevant value is the price at the end of the time period.
Suppose we have a stock at price S0 currently, and there is a European call option expiring at time 1 with strike price K = S0. Now, in this particular oversimplified world, the stock can only take on two values at time 1: Su and Sd, standing for an "up" movement and a "down" movement. Since the option is at strike K = S0, the option will pay (Su - S0) at Su and zero at Sd. We'll denote these values by Cu and Cd respectively (representing the value of the call at an up movement and the value of the call at a down movement).
The price of the option can then be calculated as
Cu * P(up movement) * v
Where v is the present value factor to discount the payoff with interest back to time zero. We'll need an interest rate to do that, which we'll call r. We'll also need P(up movement) (the probability of an up movement) to calculate the price.
Through some mathemagic which I think I'll gloss over for now (but if you all want to see it, I'll happily spell it out), a probability which correctly calculates the price can be found using this formula:
P(up movement) = (e(r-d)*h-d)/(u-d)
Where r is the continuously compounded rate of return, d is the continuously compounded rate of dividend payments, h is the time period (in years), d is the multiplicative factor by which S can decrease over h, and u is the multiplicative factor by which S can increase over h.
There are also formulas for u and d, but if you need those I suggest reading this.
With all of that in place, there is now a formula for pricing a call option where the stock has only two movements, up or down. This model can be expanded to include more periods, use discrete dividends (say the stock pays $10 at time 0.75), handle American options, and do a variety of other nice tricks. However, the more important fact is that this is the backbone of the famed Black and Scholes model, which I will discuss in Lesson 3.
I hope you can see how this all gets very hairy mathematically very quickly. Some of the background I jumped over is done not by mathematical proof, but by economic logic, which may not sit well with some mathematicians. I have also tried to simplify a lot of this to be read by the general audience, whereas for the last four months I've been studying the specifics of this, and more complex models, extensively. If any of you readers are curious about this topic on a deeper level, feel free to post here, IM me in world, or email me at guardian.market@gmail.com. I can't guarantee I'll know the answer (it's a big world out there with options!) but I'll try to at least point you in the right direction.
Friday, March 14, 2008
Options: Lesson 1
One of my favorite topics in finance is that of options. I've mentioned options in a few previous posts, and I would like to dedicate a few posts to the mechanics of options and option pricing. Coincidentally, this is also the same material that I'm studying for my next RL actuarial exam, exam MFE (Modeling: Financial Economics).
Options are power. There are no markets in Second Life that trade options. Some are afraid investors will use them without understanding them. Others are swamped fixing other bugs so that the thought of including derivatives is nearly impossible at present. Regardless, options exist in real life, and they're useful in real life. Whether they ever exist in SL, these lessons will teach you about what options are, how they operate, and how to price them (at least basically). I'll be using some mathematics for this, and the lessons will build on each other.
For our purposes, we will concentrate on options on an underlying stock. However, you should know that options also exist on futures, currencies, indexes, and even other options. Each of these brings a new caveat to the stage, but for my sanity I'm going to stick to cash and stocks.
There are two broad types of options. I'm going to go over them very slowly:
A call option gives the owner the right, but not the obligation, to buy an underlying stock at a specified strike price (K) by time T.
A put option gives the owner the right, but not the obligation, to sell an underlying stock at a specified strike price (K) by time T.
Read those two sentences again. And again. One more time.
Also know that I'm describing American options in the definitions above. If they were European options, they would have ended with "at time T" instead of "by time T." Some of the pricing models will only value European options, but I'll make sure to warn you ahead of time.
If the price of the underlying stock is denoted as S, then the payoff of the call option is
Call Payoff = Max{0,S-K}
This is because if the stock price (S) is below the strike price (K), then you simply choose not to exercise the option (why buy the stock at K when it's selling at S?). If S > K, though, you can buy at K and then sell at S, netting S-K for yourself. Similarly, the payoff for a put option is
Put Payoff = Max{0,K-S}
If the stock price (S) is below the strike price (K), then you can buy the stock at S and sell it at K, netting you K-S. If S > K, then you would prefer to sell at S, and so it is not advantageous to exercise your put option (and thus the value is zero).
Wikipedia has some nice graphs of a call payoff and put payoff, which I encourage you to look at.
That's it for lesson 1. Subsequent lessons will get into the pricing, and then the all-important parity equation and how that functions. More math coming, I promise!
Please, if you have questions, ASK! This material can be very confusing, even for advanced traders. I'm probably going to speed up, not slow down, in the next lesson, so get questions out of the way now. If you're too shy to post them here (even anonymously), then email me at guardian.market@gmail.com.
Options are power. There are no markets in Second Life that trade options. Some are afraid investors will use them without understanding them. Others are swamped fixing other bugs so that the thought of including derivatives is nearly impossible at present. Regardless, options exist in real life, and they're useful in real life. Whether they ever exist in SL, these lessons will teach you about what options are, how they operate, and how to price them (at least basically). I'll be using some mathematics for this, and the lessons will build on each other.
For our purposes, we will concentrate on options on an underlying stock. However, you should know that options also exist on futures, currencies, indexes, and even other options. Each of these brings a new caveat to the stage, but for my sanity I'm going to stick to cash and stocks.
There are two broad types of options. I'm going to go over them very slowly:
A call option gives the owner the right, but not the obligation, to buy an underlying stock at a specified strike price (K) by time T.
A put option gives the owner the right, but not the obligation, to sell an underlying stock at a specified strike price (K) by time T.
Read those two sentences again. And again. One more time.
Also know that I'm describing American options in the definitions above. If they were European options, they would have ended with "at time T" instead of "by time T." Some of the pricing models will only value European options, but I'll make sure to warn you ahead of time.
If the price of the underlying stock is denoted as S, then the payoff of the call option is
Call Payoff = Max{0,S-K}
This is because if the stock price (S) is below the strike price (K), then you simply choose not to exercise the option (why buy the stock at K when it's selling at S?). If S > K, though, you can buy at K and then sell at S, netting S-K for yourself. Similarly, the payoff for a put option is
Put Payoff = Max{0,K-S}
If the stock price (S) is below the strike price (K), then you can buy the stock at S and sell it at K, netting you K-S. If S > K, then you would prefer to sell at S, and so it is not advantageous to exercise your put option (and thus the value is zero).
That's it for lesson 1. Subsequent lessons will get into the pricing, and then the all-important parity equation and how that functions. More math coming, I promise!
Please, if you have questions, ASK! This material can be very confusing, even for advanced traders. I'm probably going to speed up, not slow down, in the next lesson, so get questions out of the way now. If you're too shy to post them here (even anonymously), then email me at guardian.market@gmail.com.
Sunday, February 24, 2008
Lessons in FM: Part VII - Futures
In one of my previous posts, I mentioned something about the mathematics of futures contracts and asked if anyone would like for me to expound upon the reference I made, and my co-author Samantha Goldflake (as well as other readers) called me out on it, so here goes.
First, I'd like to introduce what a financial derivative is, and from that what a futures contract is and how to value it. A financial derivative has nothing to do with the slope of a tangent line, but rather is an asset which derives its value from some underlying asset. Examples of this include mutual funds, put and call options, interest rate swaps, and futures. These assets all have no value whatsoever on their own, but only derive their value from what some other asset is doing. Many of the stocks in SL are actually financial derivatives.
As a personal note, I love financial derivatives. Financial derivatives are power. I've been asked, and have provided, guides and advice as to how to implement financial derivatives in Second Life to various exchange bigwigs, but so far nothing has come above of it. If any of you are considering doing something with derivatives, please send me an IM - I'd love to be involved.
To me, the most viable financial derivative for Second Life would be a futures contract. A futures contract specifies that an investor will either buy or deliver a set amount of an underlying asset at a set price at a set time. There is no option as to whether or not this sale/purchase will take place - it is set by the contract.
A lot of the numbers you hear tossed about in First Life financial commodities are actually futures numbers. The price of oil, for example, is almost always quoted as a futures price. The same is true with gold, silver, and other precious metals.
So how could you use this in Second Life? Simple - futures on the LindeX. Set up a price and a date, and then you've got a futures contract with USD for L$. Measures would have to be taken to prevent simply bailing out on the contract, but having investors place and x% deposit for taking the contract would probably suffice, depending on what x is.
Regardless, we may wish to know how to price these funky things called futures. It's actually surprisingly simple, and most of the mathematics I've already covered in my first Lessons in FM: Part I - Present Value. Technically, futures contracts with strike prices (the price specified in the contract) equal to the expected cost have zero premium, although in real trading there is always some transaction cost to doing this.
I slipped in the word "expected" to the definition above for a reason. Suppose we're doing a futures contract on a five-year zero-coupon bond yielding 10% per year, costing 1000 now and with an expiration date of 6 months from now. If the strike price is 1000, that contract will actually trade at a premium because 6 months from now the bond is worth more than 1000. We would expect it to be worth
1000*(1.10)1/2 = 1048.81
So the contract actually has a value of 48.81. For the contract to have zero premium, it must have a strike at the expected price of 1048.81, and then it will have zero premium.
First, I'd like to introduce what a financial derivative is, and from that what a futures contract is and how to value it. A financial derivative has nothing to do with the slope of a tangent line, but rather is an asset which derives its value from some underlying asset. Examples of this include mutual funds, put and call options, interest rate swaps, and futures. These assets all have no value whatsoever on their own, but only derive their value from what some other asset is doing. Many of the stocks in SL are actually financial derivatives.
As a personal note, I love financial derivatives. Financial derivatives are power. I've been asked, and have provided, guides and advice as to how to implement financial derivatives in Second Life to various exchange bigwigs, but so far nothing has come above of it. If any of you are considering doing something with derivatives, please send me an IM - I'd love to be involved.
To me, the most viable financial derivative for Second Life would be a futures contract. A futures contract specifies that an investor will either buy or deliver a set amount of an underlying asset at a set price at a set time. There is no option as to whether or not this sale/purchase will take place - it is set by the contract.
A lot of the numbers you hear tossed about in First Life financial commodities are actually futures numbers. The price of oil, for example, is almost always quoted as a futures price. The same is true with gold, silver, and other precious metals.
So how could you use this in Second Life? Simple - futures on the LindeX. Set up a price and a date, and then you've got a futures contract with USD for L$. Measures would have to be taken to prevent simply bailing out on the contract, but having investors place and x% deposit for taking the contract would probably suffice, depending on what x is.
Regardless, we may wish to know how to price these funky things called futures. It's actually surprisingly simple, and most of the mathematics I've already covered in my first Lessons in FM: Part I - Present Value. Technically, futures contracts with strike prices (the price specified in the contract) equal to the expected cost have zero premium, although in real trading there is always some transaction cost to doing this.
I slipped in the word "expected" to the definition above for a reason. Suppose we're doing a futures contract on a five-year zero-coupon bond yielding 10% per year, costing 1000 now and with an expiration date of 6 months from now. If the strike price is 1000, that contract will actually trade at a premium because 6 months from now the bond is worth more than 1000. We would expect it to be worth
So the contract actually has a value of 48.81. For the contract to have zero premium, it must have a strike at the expected price of 1048.81, and then it will have zero premium.
To value these contracts then, you have to figure out your payoff and then discount it back to the present value. That's where my previous post comes into play - present value. The payoff on a forward contract is simply:
With the profit equal to
Therefore, to calculate the value for a futures contract expiring at time t, just calculate
Where i is the interest rate being used. i varies depending on what you're valuing. With bonds, it's the interest rate. With stocks, it tends to be the dividend yield. With currencies, it's the interest rate in the currency you're using. So, for my futures contract on the LindeX, we'd have to use the Second Life interest rate (or USD interest rate, if we were buying the Lindens) to discount to present value.
I hope this helps demonstrate what futures are and how they work. As I mentioned above, they're used quite frequently in real-life commodity trading, and almost every farmer in the United States is familiar with them. (They tend to sell futures contracts early in the season to ensure they sell their crop at harvest.) If you have any questions, by all means ask!
GM
Thursday, February 7, 2008
Musings
I've been studying more for my next RL actuarial exam, Modeling Financial Economics, and it always makes me think about the depth of subtleties of markets. The lesson on equivalent, or replicating, portfolios that I gave in a Lessons in FM has so much power to it, but is something that is also so hidden very few can see it. Did you know, for example, that you can replicate a call option by simply buying and selling stocks and low-risk bonds? (Specifically, for call options, you borrow some money, aka sell a bond, to buy the stock, and then they become equivalent. Of course, you have to get the proportions right, and that's not exactly easy to do...)
Yet, despite the depth and breadth of these studies, which I just get exposed to the tip of the iceberg on, it saddens me that so few are in on these great secrets. I doubt less than 1% of the avatars involved in the SL finances could tell me what an option delta is. If we make it only CEOs, maybe we can move that up to 20%. Can any fund managers in SL tell me what the volatility of their portfolio is? How is it correlated to the market (aka its beta)? Where is the greatest risk exposure? I laugh (usually aloud) at any prospectus which simply lists SL closing down or the devaluation of the Linden Dollar as the lone risk factors to their business.
Please note, I'm not trying to criticize anyone here. The subjects I'm talking about are definitely high-end mathematics, and would require some study which is not required of CEOs in SL. I'm only sad that although the SL capital markets have come so far in the past year, they still have so very far to go.
Sunday, February 3, 2008
Watching
This week should be an interesting week in SL finances. We've got a couple of big events which I expect to break, and there will of course be the others that we never see coming.
First up, I'm curious to see how the Metaverse Investment Fund does on its second week in the market. I wrote an (objective) article about the MIF on SL Reports, but this is my space to post so I don't have to be objective here - just respectful - something a few of the commentators on that story seem to be having trouble understanding.
Anyway, I've known Shaun since my early days in SL, and he's a good fox and has done very well investing. That being said, I don't think this market merits any new investments whatsoever, and I'm still not convinced about the 3.5% commissions on both sides of the transaction. That means you've got to earn about 6.9% just to break even! That's too steep for my value investment mindset.
Next, this week should see the re-opening of the World Stock Exchange. As was posted on January 6, 2008,
First up, I'm curious to see how the Metaverse Investment Fund does on its second week in the market. I wrote an (objective) article about the MIF on SL Reports, but this is my space to post so I don't have to be objective here - just respectful - something a few of the commentators on that story seem to be having trouble understanding.
Anyway, I've known Shaun since my early days in SL, and he's a good fox and has done very well investing. That being said, I don't think this market merits any new investments whatsoever, and I'm still not convinced about the 3.5% commissions on both sides of the transaction. That means you've got to earn about 6.9% just to break even! That's too steep for my value investment mindset.
Next, this week should see the re-opening of the World Stock Exchange. As was posted on January 6, 2008,
We are upgrading many areas of our services and the website as part of our launch for the WSE 4.0 platform. This is a huge undertaking and we have now entered a phase of development that requires the WSE to close all trading and transactions for "up to" 30 days.
I still haven't figured out why "up to" deserves quotes, but I do know how to count, and February 5th is 30 days from January 6th. Day traders get ready - I expect some serious volatility, mostly in the downward direction, when WSE goes live again. There will be lots of investors just wanting to get their cash out, and they've been cooped up for a whole month to get nervous about it. Extremely brave souls can find a good buyers market here. I'm just hoping we lose that audio announcement on the front page.
Finally, during this week we'll get a peek inside the financials of companies required to do monthly reporting. It'll be our first glance at how badly the banking ban hit the Second Life economy, and the Lindens should be releasing economic statistics sometime in the near future as well.
This past week, I posted my first set of financials for SL Reports...and only one person ventured a question. I'm hoping this is because my statements and commentary were sufficient, but honestly I was expecting an onslaught of inquiries, both on forums and in-world. Oh well - no news is good news...unless you need web traffic.
GM
Tuesday, January 29, 2008
Currency Trading
So I've begun my first foray into trading on the LindeX for profit, as opposed to simple conversion. It seems to be going well so far - the worst case scenario is that I could get stuck with surplus US Dollars that I couldn't get rid of. Oh darn.
It seems to me that the profitability at the current best rates (Sell = L$265/USD, Buy = L$276/USD) approaches 0.005 or so as the amount of Lindens trades increases to infinity. This takes into account the 3.5% transaction fee on the sell side, but disregards the $0.30USD fee on the buy side (argument: as the amount of money trades increase, the 30 cent fee becomes insignificant on the total rate of return). Here's the equation, for those interested:
(1 - .035) * 276 / 265 = 1.00506604...
I've also noticed that those selling Linden Dollars appear to be smarter than those buying them. The reason is because I sold my Lindens pretty quickly, meaning there were lots of market buys (people trading USD at whatever rate for L$). However, my USD have been sitting tight for over 24 hours now, despite the quantity offered at 276 being much lower than that offered at 265. That means that not as many SL'ers are pushing the "sell at market" button when they go to sell their Lindens. Interesting, and slightly reminiscent of P.T. Barnum.
Any hints for me from those of you out there who have more experience than I do in this realm?
GM
P.S. I have a cute Excel workbook for my trades, if anyone's interested. Appears to be accurate within 0.01USD, although your results may vary.
It seems to me that the profitability at the current best rates (Sell = L$265/USD, Buy = L$276/USD) approaches 0.005 or so as the amount of Lindens trades increases to infinity. This takes into account the 3.5% transaction fee on the sell side, but disregards the $0.30USD fee on the buy side (argument: as the amount of money trades increase, the 30 cent fee becomes insignificant on the total rate of return). Here's the equation, for those interested:
(1 - .035) * 276 / 265 = 1.00506604...
I've also noticed that those selling Linden Dollars appear to be smarter than those buying them. The reason is because I sold my Lindens pretty quickly, meaning there were lots of market buys (people trading USD at whatever rate for L$). However, my USD have been sitting tight for over 24 hours now, despite the quantity offered at 276 being much lower than that offered at 265. That means that not as many SL'ers are pushing the "sell at market" button when they go to sell their Lindens. Interesting, and slightly reminiscent of P.T. Barnum.
Any hints for me from those of you out there who have more experience than I do in this realm?
GM
P.S. I have a cute Excel workbook for my trades, if anyone's interested. Appears to be accurate within 0.01USD, although your results may vary.
Monday, January 7, 2008
BNT: An Example in Expectations
Over on AnCapEx, Brautigan & Tuck holdings has published their quarterly (ok, four-month) financial statements. To quote the announcement,
In my economics classes, we learned about some of the common market forces which affect demand curves, such as income, tastes and preferences, price of compliments/substitutes, and (most mysteriously to me) expectations.
In my finance classes, we learned about why investors choose to invest in a given security or project. We learned that investors prefer more money to less money, money sooner to money later, and less risk to more risk. The interplay of these preferences creates the wonderful stock charts we all know and love from First Life and Second Life.
I think that within these simple concepts lies the heart of the situation above. Despite having assets at three times the share price, investors simply don't expect to get anything from them. To be honest, BNT hasn't given them much to hope for: to my recollection, there has only been one dividend and no buybacks (although Intlibber did eliminate a large swath of his own holdings, this had little effect on the market price since it didn't affect the floating shares) to speak of. The most faithful shareholders of BNT, those that purchased the stock at its IPO on the World Stock Exchange, have lost 76% on their L$1.00 per share investment.
So is it any wonder that the price flutters with the whims of the day traders instead of reaching its NAV? With no history of dividends, buybacks, and little hope of actually getting L$0.72 per share for your BNT, the market seems perfectly justified (to me) in withholding its Lindens from purchasing anything but a token amount of BNT, and so it seems to have progressed.
There has been some comparison of BNT to Microsoft (NYSE:MSFT) in the past. I can't link to it because I don't think it has been explicitly written down before, but trust me on this one. However, the differences are beginning to show between the technological juggernaut and BNT holdings:
...while our profits are nothing to boast about, we were able to post nearly 27% growth in NAV despite a downturn in real estate asset values. NAV is now L$ 0.76, above the L$ 0.60 value BNT was at after we restructured our shares and eliminated 67 million of the CEOs personal shares in the largest voluntary elimination of personal wealth in SL history.Well, this is an interesting situation. As of this writing, the price of a share of BNT stock is L$0.24, and it has been around that level for some time. If the NAV of this stock is L$0.72 as claimed, why aren't market forces pushing it up to that level?
The growth in our NAV is confirmation that BNT's long term strategy of no dividends, focusing on growth, has been the right one. Despite an in-world depression, banking crash, and downturn in the capital markets as well as real estate markets, BNT continues to grow, and by growing is returning value to the shareholder the old fashioned way. This share value is not short term gimmickry like those CEOs who fake up big dividends that mostly winds up in their own pockets. This is real value in a real company.
In my economics classes, we learned about some of the common market forces which affect demand curves, such as income, tastes and preferences, price of compliments/substitutes, and (most mysteriously to me) expectations.
In my finance classes, we learned about why investors choose to invest in a given security or project. We learned that investors prefer more money to less money, money sooner to money later, and less risk to more risk. The interplay of these preferences creates the wonderful stock charts we all know and love from First Life and Second Life.
I think that within these simple concepts lies the heart of the situation above. Despite having assets at three times the share price, investors simply don't expect to get anything from them. To be honest, BNT hasn't given them much to hope for: to my recollection, there has only been one dividend and no buybacks (although Intlibber did eliminate a large swath of his own holdings, this had little effect on the market price since it didn't affect the floating shares) to speak of. The most faithful shareholders of BNT, those that purchased the stock at its IPO on the World Stock Exchange, have lost 76% on their L$1.00 per share investment.
So is it any wonder that the price flutters with the whims of the day traders instead of reaching its NAV? With no history of dividends, buybacks, and little hope of actually getting L$0.72 per share for your BNT, the market seems perfectly justified (to me) in withholding its Lindens from purchasing anything but a token amount of BNT, and so it seems to have progressed.
There has been some comparison of BNT to Microsoft (NYSE:MSFT) in the past. I can't link to it because I don't think it has been explicitly written down before, but trust me on this one. However, the differences are beginning to show between the technological juggernaut and BNT holdings:
- Microsoft has split nine (!!!) times in its history. BNT has split zero times.
- MSFT increased its stock price 273% (!!!) in its first year out of IPO. BNT has lost 76% to date (true, it hasn't been out a year yet, but at 3/4 of the way through the year, MSFT was still up about 160%).
- MSFT made no theories or announcements about how people were out to get them in their first year of operations (to my knowledge). BNT has made a few.
Sunday, January 6, 2008
Street Name
I would like to throw a new idea about the representation of shareholders in the SL Capital Markets out there. Ironically, this idea is currently in place and my suggestion is to remove some of it (how's that for backwards!). The idea is registered shareholders, and my suggestion is to add shares in street name to the mixture.
First, why? There has been longstanding debate between (long-term) investors and (short-term) day traders in the SL Capital Markets. I think both sides have their merits (and profitability) but its clear that the interests of the two parties are entirely different. A day trader probably isn't interested in long-term matters of the corporation, whereas an investor is very interested in those issues.
So what does adding street name do? If investors could voluntarily register their shares with a corporation, then that corporation would know it needs to pay attention to them because they're interested for the long haul. If the shares are in street name, then the company can be less concerned (not unconcerned, but less so) with these shares, because they will change hands frequently. As to voting, I think the street name share should abstain from votes, since that is basically why they are street name shares.
There should also be some (nominal) fee and some incentive to registering shares: the fee to show you're serious, the incentive to reap the benefits thereof. Perhaps a fee of L$10, but then you have the ability to sell share directly to the company during a buyback, or they refund part of your trading fees if you sell directly to the corporate treasury. Obviously this would require some changes to existing exchange coding, but I think there are benefits to be had as well.
Thoughts?
First, why? There has been longstanding debate between (long-term) investors and (short-term) day traders in the SL Capital Markets. I think both sides have their merits (and profitability) but its clear that the interests of the two parties are entirely different. A day trader probably isn't interested in long-term matters of the corporation, whereas an investor is very interested in those issues.
So what does adding street name do? If investors could voluntarily register their shares with a corporation, then that corporation would know it needs to pay attention to them because they're interested for the long haul. If the shares are in street name, then the company can be less concerned (not unconcerned, but less so) with these shares, because they will change hands frequently. As to voting, I think the street name share should abstain from votes, since that is basically why they are street name shares.
There should also be some (nominal) fee and some incentive to registering shares: the fee to show you're serious, the incentive to reap the benefits thereof. Perhaps a fee of L$10, but then you have the ability to sell share directly to the company during a buyback, or they refund part of your trading fees if you sell directly to the corporate treasury. Obviously this would require some changes to existing exchange coding, but I think there are benefits to be had as well.
Thoughts?
Thursday, January 3, 2008
Lessons in FM: Part VI - Rate of Return
Note: This is a continuation of the series Lessons in Financial Mathematics. Reading previous posts about this topic may aid in your understanding of this article. Note that this article is a direct continuation of Part V, and so reading that one would probably be a good idea.
Last week, I discussed my pseudo-accounting method of keeping track of the (Linden) dollar value of your gains and losses in an SL capital market. Now we turn to the topic of finding the rate of return earned over that month. I'll be using the same example as I came up with last time.
To be mathematically precise, the rate of return can become a very ugly equation very quickly. The reason is because you have to take into account all the cash flows in and out of your account at the times that they were taken. Basically, you're going to know your cash flows at time t (Ct), as well as the initial and final balances, and you have to solve something like this for i (and this is only for regular investment intervals!):
This gets really ugly really fast. Normally even financial calculators wind up using a numerical method like Newton's Method to figure this one out. (You can tell this is a hard calculation on a financial calculator because often the calculator will pause for a few seconds before spitting out the answer.)
It is time to introduce you all to the XIRR function. IRR stands for "internal rate of return," and is used to calculate that ugly polynomial I referred to up there. XIRR takes the form XIRR(values,dates,[guess]). "Values" are the cash flows (positive for coming in, negative for going out), "dates" are the dates that correspond to the cash flows, and "guess" is where the iterative method starts from (just use .10 or leave it blank). XIRR returns the decimal of your return. For example, a 15% return is expressed as .15, not 15% or 1.15.
However, XIRR is based on a 365 day period, and we were dealing with a one-month period. That means that it isn't discounting quite correctly. Therefore, I suggest adjusting (mathematically: transforming) the date values so that they correspond to a year-long period, rather than a month. To do this, we'll use the YEARFRAC function, which takes a start date and end date and produces the fraction of a (365-day) year that occurs between those two dates. The syntax is YEARFRAC(start_date,end_date). To complete the transformation we want to take that fraction of the year between our start date and our (1-month) dates, multiply that by 365 (number of days different), multiply that by 12 (to stretch it to 1 year instead of 1 month), and then add it to our original starting date (to transform it). The formula looks like this:
YEARFRAC(start_date,end_date) * 12 * 365 + start_date = transformed_date
We know it works because our last day of the month transforms to the day before 1 year after the first day. We started at 12/1/2007, and the last date is 11/30/2008. We win.
The only other adjustment is a small annoyance with XIRR, and that is that our cash flows need to have their signs reversed. Also, one of the balances (preferably the beginning one) needs to be the opposing sign of the other one. I've made the beginning one negative.
XIRR turns out negative for our example because we've only included the realized gains. To get a more complete picture, I've made another couple columns with L$1,500 in unrealized gains included in the ending balance (completely arbitrary, as all unrealized gains calculations are). This results in a much nicer-looking positive rate of return.
You can find the completed spreadsheet here. It's the same as last time, but with a new tab marked "Rate of Return" where you can find these calculations. Once again, I'll happily pass out free copies of the spreadsheet so that you all can read the formulas if you like. Just email me at guardian.market@gmail.com.
I think that takes care of my first reader request. I love to answer questions and help people understand topics, so keep 'em coming. Anyone else want to provide a challenge?
Last week, I discussed my pseudo-accounting method of keeping track of the (Linden) dollar value of your gains and losses in an SL capital market. Now we turn to the topic of finding the rate of return earned over that month. I'll be using the same example as I came up with last time.
To be mathematically precise, the rate of return can become a very ugly equation very quickly. The reason is because you have to take into account all the cash flows in and out of your account at the times that they were taken. Basically, you're going to know your cash flows at time t (Ct), as well as the initial and final balances, and you have to solve something like this for i (and this is only for regular investment intervals!):
Final = Initial * (1+i)t + C1 * (1+i)(n-1)/t - C2 * (1+i)(n-2)/t + ... + Cn-1 * (1+i)1/t
This gets really ugly really fast. Normally even financial calculators wind up using a numerical method like Newton's Method to figure this one out. (You can tell this is a hard calculation on a financial calculator because often the calculator will pause for a few seconds before spitting out the answer.)
That being said, there are several things which can make this calculation easier:
- Having no cash flows. That chops that ugly polynomial down to a simple exponential problem rather quickly.
- Assume all cash flows occur at a certain time (such as at the middle of the month). This, combined with a simple interest assumption, results in a very compact formula which can be very close to the real rate of return, or very far off (if you're unlucky).
- Put your cash flows at fixed intervals. This makes it more like an annuity calculation, discussed in Part II of my Lessons in FM.
- Harness the power of Excel.
It is time to introduce you all to the XIRR function. IRR stands for "internal rate of return," and is used to calculate that ugly polynomial I referred to up there. XIRR takes the form XIRR(values,dates,[guess]). "Values" are the cash flows (positive for coming in, negative for going out), "dates" are the dates that correspond to the cash flows, and "guess" is where the iterative method starts from (just use .10 or leave it blank). XIRR returns the decimal of your return. For example, a 15% return is expressed as .15, not 15% or 1.15.
However, XIRR is based on a 365 day period, and we were dealing with a one-month period. That means that it isn't discounting quite correctly. Therefore, I suggest adjusting (mathematically: transforming) the date values so that they correspond to a year-long period, rather than a month. To do this, we'll use the YEARFRAC function, which takes a start date and end date and produces the fraction of a (365-day) year that occurs between those two dates. The syntax is YEARFRAC(start_date,end_date). To complete the transformation we want to take that fraction of the year between our start date and our (1-month) dates, multiply that by 365 (number of days different), multiply that by 12 (to stretch it to 1 year instead of 1 month), and then add it to our original starting date (to transform it). The formula looks like this:
YEARFRAC(start_date,end_date) * 12 * 365 + start_date = transformed_date
We know it works because our last day of the month transforms to the day before 1 year after the first day. We started at 12/1/2007, and the last date is 11/30/2008. We win.
The only other adjustment is a small annoyance with XIRR, and that is that our cash flows need to have their signs reversed. Also, one of the balances (preferably the beginning one) needs to be the opposing sign of the other one. I've made the beginning one negative.
XIRR turns out negative for our example because we've only included the realized gains. To get a more complete picture, I've made another couple columns with L$1,500 in unrealized gains included in the ending balance (completely arbitrary, as all unrealized gains calculations are). This results in a much nicer-looking positive rate of return.
You can find the completed spreadsheet here. It's the same as last time, but with a new tab marked "Rate of Return" where you can find these calculations. Once again, I'll happily pass out free copies of the spreadsheet so that you all can read the formulas if you like. Just email me at guardian.market@gmail.com.
I think that takes care of my first reader request. I love to answer questions and help people understand topics, so keep 'em coming. Anyone else want to provide a challenge?
Sunday, December 30, 2007
Lessons in FM: Part V - Gains and Losses
Note: This is a continuation of the series Lessons in Financial Mathematics. Reading previous posts about this topic may aid in your understanding of this article, but may not be necessary for this one. Also note that this topic is by request.
I got an email from a reader asking me to shed some light on the mystery of how to calculate your portfolio return from a mess of buys and sells that is done over the course of a period of time (the reader suggested one month). To be honest, this is not an easy problem. Even Maelstrom Baphomet has (more or less) admitted defeat on this issue.
Please take note that the tracking of financial position is a question perhaps better posed to accountants, but I'm going to show you how I would do it. I'm going to use some techniques accountants will (hopefully) recognize, but without some rigidity they demand. I will also be publishing another Lesson in FM which will be a continuation of this topic, but dealing with how to find the rate of return for your portfolio over a given time period.
I'm first going to tackle the problem of finding the (Linden) dollar value of your return and then address the problem of calculating the rate of return for the given time period. Throughout this article, I will be using one month as the time period in question.
For those of you wanting to track your gains and losses precisely, I'm going to need a few things from all of you who want to know your gains and losses.
Because of this, unrealized gains can be nearly impossible to track. I'm going to give you a way to track the realized gains/losses (things that either directly cost you cash or gave you cash) and let you estimate the unrealized gains/losses as you so choose. To find the total profit/loss, then, just add the two. For the rate of return calculation, you will need to estimate your unrealized gains/losses, but for the realized portion it is not necessary.
To compute realized gains/losses, you need to know how much you have paid for a security. At first, this may seem like a nightmare, as you may have purchased different amounts at different prices, making some sort of odd average seem very difficult. However, if we just use some Excel commands, we can easily compute the total number of shares held along with how much was paid for them.
Here is a spreadsheet with some transactions (all made-up) for the month of December. Apologies to any companies whose tickers I used inadvertently. I've only got 8 transactions in there to keep life simple, so that readers can check my formulas without too much trouble if need be. I've also listed the beginning and ending balances for the month. The bolded portion of the worksheet represents the part that comes straight off of the download from CapEx - everything else I've added. (Note that because the CapEx format lists cash flows from sells as negative and buys as positive, you must subtract the sum of those cash flows rather than adding them to your beginning balance.)
You'll have to do some scrolling to see the full worksheet. What I've done is separate out the buys and the sells so that I can add them more easily later. I've put buys on the left and sells on the right, and done it for both the cash value traded, as well as the number of shares traded. IF() statements are very useful for doing this quickly.
In Excel, there is a very nice command called SUMIF, which takes the following arguments: SUMIF(lookup_range,condition,sum_range). "lookup_range" refers to the range where the condition is located. "sum_range" is then the corresponding range to sum if the condition is met. For my purposes, the ticker symbol is a nice condition to sum on. Using SUMIF, you get the small chart I have at the bottom-right.
I want to go over the formula I have in the "realized gains/(losses)" cell, however. It reads:
ROUND(Cash_In - Cash_Out * (Shares_Sold / Shares_Bought), 2)
What I'm doing is averaging what your price paid for the stock was, and what you sold it for. All of this is on average. Cash_In is fine as is - you get 100% (less commission) of your sale price as a gain. The Cash_Out, on the other hand, may have been for more shares than you sold. Say you wanted to reduce your holdings in a company. You may still hang on to some shares, but you may have realized a profit on the ones that you did sell. Because of this, I'm multiplying the Cash_Out by the percentage of your shares that you sold. In the line detailing ABC, for example, the investor sold 80% of the holdings, so only 80% of the Cash_Out is applied to the Cash_In when computing these gains/losses.
The final cell calculates a basis for the remaining shares, although not complete in the strict, IRS sense of the word. However, it will provide a nice way for you to track shares carried over from month-to-month using that as your price.
In my happy example, the investor has realized L$103.79 in gains.
A few final comments:
I got an email from a reader asking me to shed some light on the mystery of how to calculate your portfolio return from a mess of buys and sells that is done over the course of a period of time (the reader suggested one month). To be honest, this is not an easy problem. Even Maelstrom Baphomet has (more or less) admitted defeat on this issue.
Please take note that the tracking of financial position is a question perhaps better posed to accountants, but I'm going to show you how I would do it. I'm going to use some techniques accountants will (hopefully) recognize, but without some rigidity they demand. I will also be publishing another Lesson in FM which will be a continuation of this topic, but dealing with how to find the rate of return for your portfolio over a given time period.
I'm first going to tackle the problem of finding the (Linden) dollar value of your return and then address the problem of calculating the rate of return for the given time period. Throughout this article, I will be using one month as the time period in question.
For those of you wanting to track your gains and losses precisely, I'm going to need a few things from all of you who want to know your gains and losses.
- First, keep track of every transaction you make, including date, ticker, share amount, and share price on Excel. A few of the exchanges also allow you to download this information. I'll be starting with a CapEx download style and building from there.
- Secondly, make sure you have some way of notating which is a buy and a sell. I'm going to use separate columns for each type (debits and credits, anyone?).
- Lastly, if you can spare a few seconds, having some notes in your spreadsheet will help you out greatly when you look over it later.
Because of this, unrealized gains can be nearly impossible to track. I'm going to give you a way to track the realized gains/losses (things that either directly cost you cash or gave you cash) and let you estimate the unrealized gains/losses as you so choose. To find the total profit/loss, then, just add the two. For the rate of return calculation, you will need to estimate your unrealized gains/losses, but for the realized portion it is not necessary.
To compute realized gains/losses, you need to know how much you have paid for a security. At first, this may seem like a nightmare, as you may have purchased different amounts at different prices, making some sort of odd average seem very difficult. However, if we just use some Excel commands, we can easily compute the total number of shares held along with how much was paid for them.
Here is a spreadsheet with some transactions (all made-up) for the month of December. Apologies to any companies whose tickers I used inadvertently. I've only got 8 transactions in there to keep life simple, so that readers can check my formulas without too much trouble if need be. I've also listed the beginning and ending balances for the month. The bolded portion of the worksheet represents the part that comes straight off of the download from CapEx - everything else I've added. (Note that because the CapEx format lists cash flows from sells as negative and buys as positive, you must subtract the sum of those cash flows rather than adding them to your beginning balance.)
You'll have to do some scrolling to see the full worksheet. What I've done is separate out the buys and the sells so that I can add them more easily later. I've put buys on the left and sells on the right, and done it for both the cash value traded, as well as the number of shares traded. IF() statements are very useful for doing this quickly.
In Excel, there is a very nice command called SUMIF, which takes the following arguments: SUMIF(lookup_range,condition,sum_range). "lookup_range" refers to the range where the condition is located. "sum_range" is then the corresponding range to sum if the condition is met. For my purposes, the ticker symbol is a nice condition to sum on. Using SUMIF, you get the small chart I have at the bottom-right.
I want to go over the formula I have in the "realized gains/(losses)" cell, however. It reads:
ROUND(Cash_In - Cash_Out * (Shares_Sold / Shares_Bought), 2)
What I'm doing is averaging what your price paid for the stock was, and what you sold it for. All of this is on average. Cash_In is fine as is - you get 100% (less commission) of your sale price as a gain. The Cash_Out, on the other hand, may have been for more shares than you sold. Say you wanted to reduce your holdings in a company. You may still hang on to some shares, but you may have realized a profit on the ones that you did sell. Because of this, I'm multiplying the Cash_Out by the percentage of your shares that you sold. In the line detailing ABC, for example, the investor sold 80% of the holdings, so only 80% of the Cash_Out is applied to the Cash_In when computing these gains/losses.
The final cell calculates a basis for the remaining shares, although not complete in the strict, IRS sense of the word. However, it will provide a nice way for you to track shares carried over from month-to-month using that as your price.
In my happy example, the investor has realized L$103.79 in gains.
A few final comments:
- I am not an accountant. Any accountants out there who would like to critique my methods, please do so.
- I realize you all cannot view the formulas and that may be less than helpful if you don't have much experience with Excel. If you would like an Excel copy of this spreadsheet, email me at guardian.market@gmail.com.
- My First Life job requires me to be pretty disciplined at Excel, but nevertheless I do make mistakes. (Every once in awhile, Excel makes mistakes, too!) Always check at least a few parts of your calculations by hand or calculator when making spreadsheets.
Sunday, December 23, 2007
IPO Hesitations
Sometimes when a new initial public offering (IPO) comes out in the Second Life capital markets, I may read the prospectus and then decide that this company is a worthwhile investment, with a good business plan and solid management. Other times, I have reservations about buying an IPO for various reasons, some of which have become more common and so I thought I would list here. Maybe I'm off-base with my hesitations, or maybe I haven't seen something I should have. Read on, and let me know what you think of my reasons, and maybe add some of your own.
1. Big IPO with a Long Duration
In short, if I think this IPO will take a long time coming to the trading room, I won't buy it. At least not until it's much closer to selling out, and probably not even then. (A good current example of this is the ACE IPO on the Ancapistan Capital Exchange. 7,000,000 shares, with the majority of shares owned by the massive BNT? I think that will take awhile to sell out.)
The reason is because when an IPO takes a long time to sell out, investors who bought in early get nervous. Maybe First Life situations create a demand for cash from Second Life, maybe they find better investments they wish to try, but whatever happens, they suddenly have an urge to trade their shares for cash. This often causes long-standing IPOs who move to the trading room to drop below their IPO price almost instantly. Therefore, the prudent investor looking to maximize returns will wait until that price drops and buy at 90%, 80%, 50% of the IPO price.
2. Existing Businesses Suddenly Becoming Generous
"We've been in Second Life for 3 years and now we want to share the wealth!" Uh-huh. Sure you do. When I read this I think to myself that this is either a business in serious trouble or an outright "poof" scam (the CEO goes "poof" with all the money). Neither is good for my ROI, so I'll stay away from these.
3. Banks
When I see a bank IPO, a huge, flying, shimmering red flag goes up in my mind. Unless there is some major project requiring capital expansion, this screams "I can't pay my interest" to me. That's not my type of investment.
There has been some discussion as to whether or not JTF will IPO on the SLCapEx forums. Should JTF IPO, I will reduce my cash and stock holdings significantly within JTF in anticipation of its failure. The reason is because I don't think JTF needs money to IPO. They're already huge - why would they need another L$1, 5, 10 million to expand when they have somewhere in the neighborhood of L$80 million on deposit, last I heard? That doesn't make sense, and therefore taking JTF public would be a major sign of insecurity to me. Once again, readers, please comment if you have a different analysis.
4. Multiple Companies under one CEO or Brand
While this could be perfectly legitimate, it also runs the risk of "robbing Peter to pay Paul." This is a criticism I have of the LNL brand, as well as the BNT brand and (basically) it's spin-off, ACE. I would have added the Delicious brand to that list, but they recently combined their tickers into the DDE ticker on the WSE.
I would rather see one conglomeration than two or more separate and distinct companies building into the same brand. For one, bookkeeping costs (or time spent bookkeeping) is likely to be significantly less under one ticker symbol than two or more. Secondly, if the businesses are combined, then divisions doing well can help divisions which need more capital infused into them to succeed.
Also, remember that Jasper Tizzy controlled three tickers at the time of his departure, and it has since been discovered that he used the deposits of the bank (one ticker, AVC I believe) to pay for the land purchases of another (CGI). I am not accusing IntLibber or Lindsay of these dishonest actions, but I simply ask investors to be wary of the possibility and to do their homework when dealing with these companies (which they should be doing anyway).
5. Incompetent Management
If you're really hoping to hold on to this security for a few months (long-term in Second Life), then chat/talk with the CEO before purchasing. Ask them questions. Hard questions. Ask them where the money is going, what it is going to be used for, how much they expect to bring in, low estimates, high estimates, share price targets, "what ifs," etc. If they can't at least attempt to handle your questions, or worse yet blow you off, then run away fast. So long as you ask in a respectful manner, they should respond likewise.
Every company I own I've either contacted the CEO or read enough of their blog to know they're competent. One of my biggest hints that Tao Group Bonds (formerly WSE:TGB) was going to fail was that Chao Mu, the former CEO, became rather frustrated with my questions and started giving sarcastic responses. That was a big red flag to me, and I sold before my money got completely "WTFed."
These are my principal reasons why I do not participate in a new IPO on an exchange. Certainly I have missed some opportunities from my caution, but I feel that prudence is the better part of valor, and I know I've also saved myself some Lindens with these rules of thumb. As always, comments are welcome here or in-world.
1. Big IPO with a Long Duration
In short, if I think this IPO will take a long time coming to the trading room, I won't buy it. At least not until it's much closer to selling out, and probably not even then. (A good current example of this is the ACE IPO on the Ancapistan Capital Exchange. 7,000,000 shares, with the majority of shares owned by the massive BNT? I think that will take awhile to sell out.)
The reason is because when an IPO takes a long time to sell out, investors who bought in early get nervous. Maybe First Life situations create a demand for cash from Second Life, maybe they find better investments they wish to try, but whatever happens, they suddenly have an urge to trade their shares for cash. This often causes long-standing IPOs who move to the trading room to drop below their IPO price almost instantly. Therefore, the prudent investor looking to maximize returns will wait until that price drops and buy at 90%, 80%, 50% of the IPO price.
2. Existing Businesses Suddenly Becoming Generous
"We've been in Second Life for 3 years and now we want to share the wealth!" Uh-huh. Sure you do. When I read this I think to myself that this is either a business in serious trouble or an outright "poof" scam (the CEO goes "poof" with all the money). Neither is good for my ROI, so I'll stay away from these.
3. Banks
When I see a bank IPO, a huge, flying, shimmering red flag goes up in my mind. Unless there is some major project requiring capital expansion, this screams "I can't pay my interest" to me. That's not my type of investment.
There has been some discussion as to whether or not JTF will IPO on the SLCapEx forums. Should JTF IPO, I will reduce my cash and stock holdings significantly within JTF in anticipation of its failure. The reason is because I don't think JTF needs money to IPO. They're already huge - why would they need another L$1, 5, 10 million to expand when they have somewhere in the neighborhood of L$80 million on deposit, last I heard? That doesn't make sense, and therefore taking JTF public would be a major sign of insecurity to me. Once again, readers, please comment if you have a different analysis.
4. Multiple Companies under one CEO or Brand
While this could be perfectly legitimate, it also runs the risk of "robbing Peter to pay Paul." This is a criticism I have of the LNL brand, as well as the BNT brand and (basically) it's spin-off, ACE. I would have added the Delicious brand to that list, but they recently combined their tickers into the DDE ticker on the WSE.
I would rather see one conglomeration than two or more separate and distinct companies building into the same brand. For one, bookkeeping costs (or time spent bookkeeping) is likely to be significantly less under one ticker symbol than two or more. Secondly, if the businesses are combined, then divisions doing well can help divisions which need more capital infused into them to succeed.
Also, remember that Jasper Tizzy controlled three tickers at the time of his departure, and it has since been discovered that he used the deposits of the bank (one ticker, AVC I believe) to pay for the land purchases of another (CGI). I am not accusing IntLibber or Lindsay of these dishonest actions, but I simply ask investors to be wary of the possibility and to do their homework when dealing with these companies (which they should be doing anyway).
5. Incompetent Management
If you're really hoping to hold on to this security for a few months (long-term in Second Life), then chat/talk with the CEO before purchasing. Ask them questions. Hard questions. Ask them where the money is going, what it is going to be used for, how much they expect to bring in, low estimates, high estimates, share price targets, "what ifs," etc. If they can't at least attempt to handle your questions, or worse yet blow you off, then run away fast. So long as you ask in a respectful manner, they should respond likewise.
Every company I own I've either contacted the CEO or read enough of their blog to know they're competent. One of my biggest hints that Tao Group Bonds (formerly WSE:TGB) was going to fail was that Chao Mu, the former CEO, became rather frustrated with my questions and started giving sarcastic responses. That was a big red flag to me, and I sold before my money got completely "WTFed."
These are my principal reasons why I do not participate in a new IPO on an exchange. Certainly I have missed some opportunities from my caution, but I feel that prudence is the better part of valor, and I know I've also saved myself some Lindens with these rules of thumb. As always, comments are welcome here or in-world.
Saturday, December 22, 2007
Security Regulation in Second Life
Guardian's Note: This was also published at SLReports.net
By Samantha Goldflake and Guardian Market
The transcript of the 12/12/2007 meeting of the Second Life Exchange Commission (SLEC) is not very encouraging. It shows an organization struggling with its own identity, leadership, and purpose in the virtual world, all the while public voices are growing increasingly critical of the abilities of the SLEC, as well as the conflicts of interest which reside with its leadership. Two different schools of thought appear to be forming within the SLEC - one which looks at a system of punishment for companies and markets not compliant with the SLEC's regulation, the other which argues for rewarding the companies and markets which are compliant.
The first idea, that of punishment, is a natural one to strive for. It is, after all, how governmental regulatory bodies operate. If a company does not comply with their rules, they can fine, imprison, or seize assets as justified. However, in Second Life this is simply impractical. Although some systems have been constructed to incorporate this system of punishment into the mixture (such as ACE requiring that its companies who own land use BNT land, so that that asset may be seized if necessary), it simply does not carry the same weight that it does in First Life. The bottom line is that even if you do everything you can to an avatar: take their money, land, inventory, maybe even ban them from Second Life - it simply does not carry as much weight as any one of those actions would in First Life.
The second idea, that of a reward system, also has many examples in First Life. Some examples include Underwriters Laboratories (UL), The American Institute of Certified Public Accountants (AICPA), The American Academy of Actuaries and numerous others all over the world. Each of these organizations has a set of rules and standards by which membership may be granted. In exchange for abiding by these rules and keeping in good standing with the organization, a designation is awarded. For example, the AICPA awards the Certified Public Accountant (CPA) designation, which is widely recognized throughout the United States. The only form of "punishment" which the AICPA can offer is to take away the right to use that designation, and yet this is punishment enough to keep the entire organization membership in line because of how well-respected (and valuable) that designation is.
This idea, the idea of awarding a designation to those who (voluntarily) follow the set standards, is indeed practical within Second Life. What standards, how the designation is awarded, and what the designation looks like is the concern of the marketing department of the organization awarding it. The World Wide Web Consortium (W3), for example, gives links or icons to be placed on well-constructed websites which then link back to the W3 explaining what the designation means and why the website is using it. When visiting a site displaying one of those icons, then, the user knows that the designer has taken the time to make their site compliant with the W3's standards (and this usually indicates a careful and advanced web programmer as well). A similar system could be put in place for the SLEC or other investor protection entity.
The concept of a regulatory body in Second Life is impractical. However, the concept of an organization which publishes well-founded standards, evaluates applications, and awards designation(s) to those who adhere to the standards published is entirely practical within Second Life. Such an organization could earn the trust and respect of investors, as well as gain publicity through publishing said designations. This method of honoring those who abide by their standards, rather than criticizing those who do not adhere to them, could (in time) grow to be an effective method of market regulation, support, and education.
So far so good, but one should always look at the whole picture. The aforementioned theoretical organization should be formed by people with a relevant First Life background, not by self-certified or wannabe public accountants. Also it should be unbiased and not partial. Is this an obvious statement? It sure is, however it's a good thing to recall this concept, as it's a good thing to recall that actual, apparent and even perceived (by the general public) conflicts of interests should be avoided at all costs.
An award is as good as the reputation of the awarding organization. Of course everybody has to start somewhere and public trust isn't earned overnight, so at the beginning the life of an organization dealing with accounting and business standards could be hard. However, by following some guidelines problems should be greatly reduced. The organization:
That given, then everything is possible. After all, it's a matter of business ethics. An ethical organization will be able to win the hearts of both SL financial institutions and the general public.
The idea of an organization publishing standards and assigning designations to those who adhere to those standards is admirable and achievable. There is a big problem, however: that organization must really be unbiased and independent. It must also earn public trust. In the SL financial world we see pretty much the same faces everywhere. If not those faces, we see their friends. Are there people we can trust to form an unbiased and independent organization? Time will tell if the SLEC will be that organization, or if another must be formed to accomplish that end.
By Samantha Goldflake and Guardian Market
The transcript of the 12/12/2007 meeting of the Second Life Exchange Commission (SLEC) is not very encouraging. It shows an organization struggling with its own identity, leadership, and purpose in the virtual world, all the while public voices are growing increasingly critical of the abilities of the SLEC, as well as the conflicts of interest which reside with its leadership. Two different schools of thought appear to be forming within the SLEC - one which looks at a system of punishment for companies and markets not compliant with the SLEC's regulation, the other which argues for rewarding the companies and markets which are compliant.
The first idea, that of punishment, is a natural one to strive for. It is, after all, how governmental regulatory bodies operate. If a company does not comply with their rules, they can fine, imprison, or seize assets as justified. However, in Second Life this is simply impractical. Although some systems have been constructed to incorporate this system of punishment into the mixture (such as ACE requiring that its companies who own land use BNT land, so that that asset may be seized if necessary), it simply does not carry the same weight that it does in First Life. The bottom line is that even if you do everything you can to an avatar: take their money, land, inventory, maybe even ban them from Second Life - it simply does not carry as much weight as any one of those actions would in First Life.
The second idea, that of a reward system, also has many examples in First Life. Some examples include Underwriters Laboratories (UL), The American Institute of Certified Public Accountants (AICPA), The American Academy of Actuaries and numerous others all over the world. Each of these organizations has a set of rules and standards by which membership may be granted. In exchange for abiding by these rules and keeping in good standing with the organization, a designation is awarded. For example, the AICPA awards the Certified Public Accountant (CPA) designation, which is widely recognized throughout the United States. The only form of "punishment" which the AICPA can offer is to take away the right to use that designation, and yet this is punishment enough to keep the entire organization membership in line because of how well-respected (and valuable) that designation is.
This idea, the idea of awarding a designation to those who (voluntarily) follow the set standards, is indeed practical within Second Life. What standards, how the designation is awarded, and what the designation looks like is the concern of the marketing department of the organization awarding it. The World Wide Web Consortium (W3), for example, gives links or icons to be placed on well-constructed websites which then link back to the W3 explaining what the designation means and why the website is using it. When visiting a site displaying one of those icons, then, the user knows that the designer has taken the time to make their site compliant with the W3's standards (and this usually indicates a careful and advanced web programmer as well). A similar system could be put in place for the SLEC or other investor protection entity.
The concept of a regulatory body in Second Life is impractical. However, the concept of an organization which publishes well-founded standards, evaluates applications, and awards designation(s) to those who adhere to the standards published is entirely practical within Second Life. Such an organization could earn the trust and respect of investors, as well as gain publicity through publishing said designations. This method of honoring those who abide by their standards, rather than criticizing those who do not adhere to them, could (in time) grow to be an effective method of market regulation, support, and education.
So far so good, but one should always look at the whole picture. The aforementioned theoretical organization should be formed by people with a relevant First Life background, not by self-certified or wannabe public accountants. Also it should be unbiased and not partial. Is this an obvious statement? It sure is, however it's a good thing to recall this concept, as it's a good thing to recall that actual, apparent and even perceived (by the general public) conflicts of interests should be avoided at all costs.
An award is as good as the reputation of the awarding organization. Of course everybody has to start somewhere and public trust isn't earned overnight, so at the beginning the life of an organization dealing with accounting and business standards could be hard. However, by following some guidelines problems should be greatly reduced. The organization:
- must be formed by people with relevant First Life backgrounds and enough SL experience (there are differences between the two)
- must be unbiased and not partial to any SL financial institution
- must keep at any time open communication channels with SL financial institution and the general public
- must pursue at any time consistent, coherent and continued communication about its mission, acts, targets and such
- must strive to earn and keep SL financial institutions and the general public trust
- and, its members must avoid any actual, apparent or perceived conflicts of interests.
That given, then everything is possible. After all, it's a matter of business ethics. An ethical organization will be able to win the hearts of both SL financial institutions and the general public.
The idea of an organization publishing standards and assigning designations to those who adhere to those standards is admirable and achievable. There is a big problem, however: that organization must really be unbiased and independent. It must also earn public trust. In the SL financial world we see pretty much the same faces everywhere. If not those faces, we see their friends. Are there people we can trust to form an unbiased and independent organization? Time will tell if the SLEC will be that organization, or if another must be formed to accomplish that end.
Wednesday, December 19, 2007
So, you're in the trading room...
Let's say you're the "Oompa Loompa Duffo Inc. SL" CEO. Your virtual company has recently gone public and you had your IPO on a Second Life stock exchange.
You did your homework and you followed the guidelines to the point; your IPO has been an outstanding success or, even if you failed to achieve that, you raised a nice amount of money and now your company has a solid foundation to build up from.
This blog post isn't about what you're gonna do with your money, anyway. This post is about you should deal with investors, present and future.
Working for a virtual stock exchange as I do can be pretty interesting. I see everything the general public can see and a lot of the things "behind the curtains" and in my 4 months (more or less) service for the VSTEX I observed some common trends.
Most CEOs will be very proactive about their IPO, but usually their excitement will tone down once they are in the trading room. It's been a month or more (in the worst cases several months) since the IPO and the company prospectus hasn't changed a word, except for the financial data (eventually). The business plan is still a few lines long and there isn't an in depth risk analysis.
Your last news item on the stock exchange website dates to a month ago, or to several months ago; and let's be honest: your last news weren't that great, short and with abundant exclamation marks.
I believe that one of the issues behind stock prices dropping to ridiculous levels (0.1x L$ per share) is lack of proper and regular communication with the investors and the traders.
You may argue that nor you as a CEO, nor your company, earns anything from people buying and selling your company shares. While that's quite true, that's only the minor part of the picture.
First, would you like the CEO of a "0.1x company?". I certainly would not, as I wouldn't be happy to be the CEO of a company who had a successful IPO and in just a month is trading at values 5, 6 times lower than the original IPO price (can you say "unhappy investors"?).
Second, your share value is part of your company (and sometimes personal) reputation. An healthy share price is perceived as the result of an healthy, well run company. It makes people want to buy your shares and your investors are maybe the first in line to buy your products or services.
Third, being perceived as a "valued company" helps you stand out from the crowd. Gets your name in the news, people look at you. And it's free advertising.
I could go on for miles on this subject, but I think I told you the most important things. When writing, you don't have to be telegraphic (unless you're writing a newsflash or a telegram), but you don't have to flood your readers with words too (unless you're writing a novel or a poem).
You did your homework and you followed the guidelines to the point; your IPO has been an outstanding success or, even if you failed to achieve that, you raised a nice amount of money and now your company has a solid foundation to build up from.
This blog post isn't about what you're gonna do with your money, anyway. This post is about you should deal with investors, present and future.
Working for a virtual stock exchange as I do can be pretty interesting. I see everything the general public can see and a lot of the things "behind the curtains" and in my 4 months (more or less) service for the VSTEX I observed some common trends.
Most CEOs will be very proactive about their IPO, but usually their excitement will tone down once they are in the trading room. It's been a month or more (in the worst cases several months) since the IPO and the company prospectus hasn't changed a word, except for the financial data (eventually). The business plan is still a few lines long and there isn't an in depth risk analysis.
Your last news item on the stock exchange website dates to a month ago, or to several months ago; and let's be honest: your last news weren't that great, short and with abundant exclamation marks.
I believe that one of the issues behind stock prices dropping to ridiculous levels (0.1x L$ per share) is lack of proper and regular communication with the investors and the traders.
You may argue that nor you as a CEO, nor your company, earns anything from people buying and selling your company shares. While that's quite true, that's only the minor part of the picture.
First, would you like the CEO of a "0.1x company?". I certainly would not, as I wouldn't be happy to be the CEO of a company who had a successful IPO and in just a month is trading at values 5, 6 times lower than the original IPO price (can you say "unhappy investors"?).
Second, your share value is part of your company (and sometimes personal) reputation. An healthy share price is perceived as the result of an healthy, well run company. It makes people want to buy your shares and your investors are maybe the first in line to buy your products or services.
Third, being perceived as a "valued company" helps you stand out from the crowd. Gets your name in the news, people look at you. And it's free advertising.
I could go on for miles on this subject, but I think I told you the most important things. When writing, you don't have to be telegraphic (unless you're writing a newsflash or a telegram), but you don't have to flood your readers with words too (unless you're writing a novel or a poem).
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Sunday, December 16, 2007
Lessons in FM: Part IV - Equivalent Portfolios
Note: This is a continuation of the series Lessons in Financial Mathematics. Reading previous posts about this topic may aid in your understanding of this article, but shouldn't be necessary for this one.
The last time I had checked, the Big Six and Big Eight bets had all but disappeared from modern craps tables on the Las Vegas strip. The reason is because no one was betting them. The Big Six and Big Eight bets paid even money (1:1) for a payout, but there was another bet, called "Place Six" or "Place Eight" which paid better odds (7:6) and hit at the exact same time that the Big Six and Big Eight bets did. Because of this, bettors learned that it was smarter to use the place bets rather than the large, Big Six or Big Eight bets on the corners. (To try these out for yourself, you can find a nice craps flash game, no real money used, here.)
The Big Six and Big Eight bets violated a fundamental rule of financial mathematics:
The concept is simple enough - portfolios of investments that provide the exact amount of reward, in exchange for the exact amount of risk, will sell for the same value. If not, the market will buy the more advantageous one and sell the less advantageous other one until the prices come to equilibrium. Note that once again, this is economic argument and not mathematical proof. However, once mathematicians accept this argument, they get their (very powerful) equals sign back and begin to work their magic.
It's very difficult to frame this article in the context of Second Life finances because many of the tools used to bring this principle into practice don't exist there. Short selling, options, futures, etc. all don't exist in Second Life (yet - I'm still holding out hope), and so these strategies likely will not work there. Instead, then, venture with me into First Life and the world of financial derivatives. First, some quick definitions (with links for better explanations):
Long Buy - This is the stock transaction we're all used to: buying a stock and selling it at a later date.
Short Sell - This is selling a stock you do not own with the promise to pay it back later. You are liable for any dividends, splits, etc. that the stock undergoes while you are shorting it.
Calls - This is an option which gives the holder the right, but not the obligation, to purchase a specified security by a specific time at a specific price, all of which are spelled out in the details of the call contract.
Put - The opposite of a call, this is an option which gives the holder the right, but not the obligation, to sell a specified security by a specific time at a specific price, all of which are spelled out in the details of the put contract.
In the put and call articles of those Wikipedia links above, the authors have provided a graph on which the vertical axis shows the payout (or profit with the dashed line) and the horizontal axis shows the underlying security's price. If you sell the call or put instead of buying it, you simply invert those lines over the horizontal axis to get your new payoff/profit graph. These are shown below the first graphs.
The payoff graph for a long buy is an upward-sloping line (with slope 1). For each unit the underlying security (the stock) goes up, you get another unit of payoff and profit. As I mentioned above, if you happen to short the stock, then the line slopes down (slope = -1) and for each unit the stock goes up, you lose another unit of payoff and profit.
There is also some consideration to be given to interest in this matter. Options take place in the future, and so you have to compensate the investor for giving up their money for a period of time. This is usually done at the risk-free rate.
Out of all these graphs and rates, you can push, pull, bend, and tweak various portfolios to have the exact same payouts, even though on the face they look very different. Some of these portfolios will make even the most seasoned investor's head spin, but because of financial mathematical principles, the price can be easily calculated.
A good example of this is the put-call parity formula. This formula tells how the price of a put, call, the underlying stock, and the interest rate all depend on each other. Given any three of those, you can solve for the fourth.
Let's get an example here. At the time of this writing, the price of 3M Corporation (NYSE:MMM) was $85.93. A January 2009 call for $90 is selling for $8.42, and a January 2009 put at $90 is selling for $9.40. Using the put-call parity formula, we can calculate what the interest rate must be in order for these prices to be in line. From the article (with symbols properly translated):
Investors in the 3M Corporation believe that they must receive exactly 9.3% interest between now and January 16, 2009 (8.28% annually) in order to make these prices work. Note, however, that the put-call parity formula assumes no transactions costs. Your 9.3% rate of return would be offset by these transactions costs. Still, if you happen to be looking for a decent rate of return (and don't mind making your broker sweat in order to get it), this is something to consider.
Questions? Comments? To me, this is one of the most fascinating concepts in financial mathematics, because it allows you to construct new portfolios, new investments, new ways of moving money around and still have a good idea of what the price should be. It also allows for you to more easily see arbitrage opportunities, and exploit them if they happen to exist.
I have no idea what the next Lesson in FM topic will be. Suggestions, anyone? It doesn't have to be overly complex - if a reader would like me to take a stab at explaining a concept, I'll do my best. Just leave your thoughts in a comment here, and it'll find its way back to me.
The last time I had checked, the Big Six and Big Eight bets had all but disappeared from modern craps tables on the Las Vegas strip. The reason is because no one was betting them. The Big Six and Big Eight bets paid even money (1:1) for a payout, but there was another bet, called "Place Six" or "Place Eight" which paid better odds (7:6) and hit at the exact same time that the Big Six and Big Eight bets did. Because of this, bettors learned that it was smarter to use the place bets rather than the large, Big Six or Big Eight bets on the corners. (To try these out for yourself, you can find a nice craps flash game, no real money used, here.)
The Big Six and Big Eight bets violated a fundamental rule of financial mathematics:
Portfolios with equivalent payouts will have the same price at all points in time.
The concept is simple enough - portfolios of investments that provide the exact amount of reward, in exchange for the exact amount of risk, will sell for the same value. If not, the market will buy the more advantageous one and sell the less advantageous other one until the prices come to equilibrium. Note that once again, this is economic argument and not mathematical proof. However, once mathematicians accept this argument, they get their (very powerful) equals sign back and begin to work their magic.
It's very difficult to frame this article in the context of Second Life finances because many of the tools used to bring this principle into practice don't exist there. Short selling, options, futures, etc. all don't exist in Second Life (yet - I'm still holding out hope), and so these strategies likely will not work there. Instead, then, venture with me into First Life and the world of financial derivatives. First, some quick definitions (with links for better explanations):
Long Buy - This is the stock transaction we're all used to: buying a stock and selling it at a later date.
Short Sell - This is selling a stock you do not own with the promise to pay it back later. You are liable for any dividends, splits, etc. that the stock undergoes while you are shorting it.
Calls - This is an option which gives the holder the right, but not the obligation, to purchase a specified security by a specific time at a specific price, all of which are spelled out in the details of the call contract.
Put - The opposite of a call, this is an option which gives the holder the right, but not the obligation, to sell a specified security by a specific time at a specific price, all of which are spelled out in the details of the put contract.
In the put and call articles of those Wikipedia links above, the authors have provided a graph on which the vertical axis shows the payout (or profit with the dashed line) and the horizontal axis shows the underlying security's price. If you sell the call or put instead of buying it, you simply invert those lines over the horizontal axis to get your new payoff/profit graph. These are shown below the first graphs.
The payoff graph for a long buy is an upward-sloping line (with slope 1). For each unit the underlying security (the stock) goes up, you get another unit of payoff and profit. As I mentioned above, if you happen to short the stock, then the line slopes down (slope = -1) and for each unit the stock goes up, you lose another unit of payoff and profit.
There is also some consideration to be given to interest in this matter. Options take place in the future, and so you have to compensate the investor for giving up their money for a period of time. This is usually done at the risk-free rate.
Out of all these graphs and rates, you can push, pull, bend, and tweak various portfolios to have the exact same payouts, even though on the face they look very different. Some of these portfolios will make even the most seasoned investor's head spin, but because of financial mathematical principles, the price can be easily calculated.
A good example of this is the put-call parity formula. This formula tells how the price of a put, call, the underlying stock, and the interest rate all depend on each other. Given any three of those, you can solve for the fourth.
Let's get an example here. At the time of this writing, the price of 3M Corporation (NYSE:MMM) was $85.93. A January 2009 call for $90 is selling for $8.42, and a January 2009 put at $90 is selling for $9.40. Using the put-call parity formula, we can calculate what the interest rate must be in order for these prices to be in line. From the article (with symbols properly translated):
Call Price + (Strike Price)/(1+i) = Put Price + Asset Price
8.42 + 95/(1 + i) = 9.40 + 85.93
i = 9.3%
8.42 + 95/(1 + i) = 9.40 + 85.93
i = 9.3%
Investors in the 3M Corporation believe that they must receive exactly 9.3% interest between now and January 16, 2009 (8.28% annually) in order to make these prices work. Note, however, that the put-call parity formula assumes no transactions costs. Your 9.3% rate of return would be offset by these transactions costs. Still, if you happen to be looking for a decent rate of return (and don't mind making your broker sweat in order to get it), this is something to consider.
Questions? Comments? To me, this is one of the most fascinating concepts in financial mathematics, because it allows you to construct new portfolios, new investments, new ways of moving money around and still have a good idea of what the price should be. It also allows for you to more easily see arbitrage opportunities, and exploit them if they happen to exist.
I have no idea what the next Lesson in FM topic will be. Suggestions, anyone? It doesn't have to be overly complex - if a reader would like me to take a stab at explaining a concept, I'll do my best. Just leave your thoughts in a comment here, and it'll find its way back to me.
Friday, December 14, 2007
How to Make a Stock Index
There are, as I now count, six capital exchanges in Second Life. Yet only two of them (the ISE and VSTEX) have indices to measure that exchanges performance. There is also a service which provides indices and stock graphs, SL Quotes, available for public viewing. However, none of these aforementioned indices detail their methodology for how they produce this index (nor have I tried to replicate it). I thought, therefore, that it might be illustrative for readers to think about how a stock index is constructed and administered.
First, let's think about what a stock index should and should not do. We DO want it to
For Second Life, I'm going to alter that definition slightly because of some companies who have a LARGE volume of outstanding shares, but only a small portion of which is actually being traded, or in float:
A market capitalization gives you an idea of how large a company is on the stock market. A company with 1,000 shares trading at L$100 is smaller than a company with 1,000,000 shares trading at L$0.50, even though the L$100 stock price is higher. This is a very important concept when constructing an index, because it demonstrates that you should not form an index by simply constructing a portfolio of one share of each stock, because larger prices can give disproportionately higher representation to smaller companies. (Such an index, by the way, is called a price-weighted index.)
You can make price-weighted indices that function well (the link I used cites the Dow Jones Industrial Average as one), butI think it gives, or could give, disproportionate weight to companies that aren't actually affecting the market that much .
In contrast to this, a market-weighted index will weight each company by its market capitalization, thus giving the larger companies more say in how much the index swings.
So how does one actually construct such an index? Well, one way to do it would simply be to add up all the SLMCAPs and leave it at that. Mathematically:
However, this number is likely to be quite large and cumbersome, so instead, you need to divide it by some divisor D.
This divisor is very important, because it also allows the flexibility to adjust for buybacks, new entrants, secondary offers, dividends, and removals. You'll notice that I did not mention stock splits in the above. This is because (theoretically) a stock split does not affect market capitalization (ex: 2:1 stock split. Shares double, price halves, market cap stays the same). However, any of those other events would require a change in the divisor. To do this, you simply look at all values at time t, and solve:
For Dnew, using all the new SLMCAPs with the change incorporated into them.
How about an example? Assume you had a new entrant into the market (a new IPO). First, you find the current index value the normal way:
Then, you take that index value, and include the new company in the calculation, and solve for Dnew (I've bolded the new company for emphasis):
You can disregard the previous D at after you calculate the new value, and go forward using the new value of D until another event occurs such that you need to change it again.
Any questions? I don't know how difficult it would be for exchange programmers to incorporate such a system into their operations. And, as mentioned above, I have no idea how SLQuotes or VSTEX or the ISE calculate their indices. However, I think that each exchange should have some sort of index following it so that investors can more easily get an understanding of how the market has changed.
First, let's think about what a stock index should and should not do. We DO want it to
- Incorporate many securities (conceivably all of them from a given exchange)
- Adjust for new entrants and exits from the market, splits, and (probably) dividends
- Reflect market performance
- Be less volatile the least volatile stock, or more than the most volatile
- Spike or decline sharply just because of an entrance or exit by a security, split or dividend
Definition: MCAP = (Total outstanding shares) * (Price per share)
For Second Life, I'm going to alter that definition slightly because of some companies who have a LARGE volume of outstanding shares, but only a small portion of which is actually being traded, or in float:
Definition: SLMCAP = (Total shares in float) * (Price per share)
A market capitalization gives you an idea of how large a company is on the stock market. A company with 1,000 shares trading at L$100 is smaller than a company with 1,000,000 shares trading at L$0.50, even though the L$100 stock price is higher. This is a very important concept when constructing an index, because it demonstrates that you should not form an index by simply constructing a portfolio of one share of each stock, because larger prices can give disproportionately higher representation to smaller companies. (Such an index, by the way, is called a price-weighted index.)
You can make price-weighted indices that function well (the link I used cites the Dow Jones Industrial Average as one), but
In contrast to this, a market-weighted index will weight each company by its market capitalization, thus giving the larger companies more say in how much the index swings.
So how does one actually construct such an index? Well, one way to do it would simply be to add up all the SLMCAPs and leave it at that. Mathematically:
Index = SLMCAP1 + SLMCAP2 + ... + SLMCAPn
However, this number is likely to be quite large and cumbersome, so instead, you need to divide it by some divisor D.
Index = (SLMCAP1 + SLMCAP2 + ... + SLMCAPn)/D
This divisor is very important, because it also allows the flexibility to adjust for buybacks, new entrants, secondary offers, dividends, and removals. You'll notice that I did not mention stock splits in the above. This is because (theoretically) a stock split does not affect market capitalization (ex: 2:1 stock split. Shares double, price halves, market cap stays the same). However, any of those other events would require a change in the divisor. To do this, you simply look at all values at time t, and solve:
Indext = (SLMCAP1 + SLMCAP2 + ... + SLMCAPn)/Dnew
For Dnew, using all the new SLMCAPs with the change incorporated into them.
How about an example? Assume you had a new entrant into the market (a new IPO). First, you find the current index value the normal way:
Index = (SLMCAP1 + SLMCAP2 + ... + SLMCAPn)/D
Then, you take that index value, and include the new company in the calculation, and solve for Dnew (I've bolded the new company for emphasis):
Indext = (SLMCAP1 + SLMCAP2 + ... + SLMCAPn + SLMCAPn+1)/Dnew
You can disregard the previous D at after you calculate the new value, and go forward using the new value of D until another event occurs such that you need to change it again.
Any questions? I don't know how difficult it would be for exchange programmers to incorporate such a system into their operations. And, as mentioned above, I have no idea how SLQuotes or VSTEX or the ISE calculate their indices. However, I think that each exchange should have some sort of index following it so that investors can more easily get an understanding of how the market has changed.
Thursday, December 13, 2007
To SLEC or not to SLEC
Chances are good you know what the SLEC (Second Life Exchange Commission) is. I'm not linking to their website since they don't appear to have one at the moment, with the domain they used up to a while ago featuring a "parking page".
TraderJohn Susa, current SLEC president was kind enough to invite me to the December 12 SLEC open meeting. I was not impressed. The most noticeable thing was this statement from IntLibber Brautigan:
[18:05] IntLibber Brautigan: exchanges that refuse to be controlled
should be openly publicised as refusing to behave by accepted
practices, so as to inform the investor about the risks of doing
business there
So, according to Brautigan, if you are not blessed by the SLEC then you're automatically not reliable, or questionable. As far as I know, the SLEC has not a God given right to rule the SL financial world and tell who's good and who's bad, nor it's written anywhere that it has to be the only regulatory body.
I could go for miles here, but there's so much time I can lose in a day and my quota has been met already.
Cadence Juran, one of the few voices at that meeting, raised some valid points:
[18:29] Cadence Juran: what I am refering to
[18:29] Cadence Juran: is NO member of the SLEC shoudl ever come across as THE single voice
[18:29] Cadence Juran: or no member of the SLEC should ever engage in public spats
[18:30] Cadence Juran: its about always maintaing an appearance of objectivity
Apparently nobody bought into her theories. If you ask me, who spoke against them did not even understand what she meant. At this point, who where the protagonists?
The list is pretty short: TraderJohn Susa and the "Brautigan bunch". Cadence Juran, Nobody Fugazi later, did not change my impression of an overall boring meeting, where a group was following its own agenda.
At the end, I was asked if VSTEX was going to join the SLEC:
[20:17] IntLibber Brautigan: Samantha are you considering joining SLEC ?
[20:17] You: No.
[20:17] Cliff Eclipse: hahahhaha
[20:17] Cliff Eclipse: Sorry
[20:17] Cliff Eclipse: Can I ask why?
[20:18] You: Yes, you can. But at this point we're not gonna comment on this.
When I was asked that question it was past 05.00AM where I live in RL; many times I stated in public my opinions about the SLEC and that meeting did nothing to change them.
I passed the whole meeting transcript to Guardian Market. Maybe he'll find something interesting there.
That's all folks, I know this blog post is not something special and somehow messy, anyway I wanted to share my feelings with you.
TraderJohn Susa, current SLEC president was kind enough to invite me to the December 12 SLEC open meeting. I was not impressed. The most noticeable thing was this statement from IntLibber Brautigan:
[18:05] IntLibber Brautigan: exchanges that refuse to be controlled
should be openly publicised as refusing to behave by accepted
practices, so as to inform the investor about the risks of doing
business there
So, according to Brautigan, if you are not blessed by the SLEC then you're automatically not reliable, or questionable. As far as I know, the SLEC has not a God given right to rule the SL financial world and tell who's good and who's bad, nor it's written anywhere that it has to be the only regulatory body.
I could go for miles here, but there's so much time I can lose in a day and my quota has been met already.
Cadence Juran, one of the few voices at that meeting, raised some valid points:
[18:29] Cadence Juran: what I am refering to
[18:29] Cadence Juran: is NO member of the SLEC shoudl ever come across as THE single voice
[18:29] Cadence Juran: or no member of the SLEC should ever engage in public spats
[18:30] Cadence Juran: its about always maintaing an appearance of objectivity
Apparently nobody bought into her theories. If you ask me, who spoke against them did not even understand what she meant. At this point, who where the protagonists?
The list is pretty short: TraderJohn Susa and the "Brautigan bunch". Cadence Juran, Nobody Fugazi later, did not change my impression of an overall boring meeting, where a group was following its own agenda.
At the end, I was asked if VSTEX was going to join the SLEC:
[20:17] IntLibber Brautigan: Samantha are you considering joining SLEC ?
[20:17] You: No.
[20:17] Cliff Eclipse: hahahhaha
[20:17] Cliff Eclipse: Sorry
[20:17] Cliff Eclipse: Can I ask why?
[20:18] You: Yes, you can. But at this point we're not gonna comment on this.
When I was asked that question it was past 05.00AM where I live in RL; many times I stated in public my opinions about the SLEC and that meeting did nothing to change them.
I passed the whole meeting transcript to Guardian Market. Maybe he'll find something interesting there.
That's all folks, I know this blog post is not something special and somehow messy, anyway I wanted to share my feelings with you.
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Sunday, December 9, 2007
Lessons in FM: Part III - Risk
Note: This is a continuation of the series Lessons in Financial Mathematics. Please read Part I - Present Value and Part II - Annuities if you have not already done so. They will aid greatly in your understanding of subsequent parts of the series. Although for this article, you can probably get along just fine without reading those if you really don't want to.
Risk. You've probably heard the term a lot in various contexts. Around the SL capital markets, you've likely heard of it as far as business risks, risks of default, and/or risks of de-listing. I know of one company which specializes in insurance in SL, The Rock Insurance, which is a tool used to mitigate risk. But has anyone ever defined risk for you? Beware, however, because this is a mathematical definition of risk. Finance professionals probably wouldn't accept my definition, or only grudgingly so, because of the consequences it brings. Here we go, though:
That's it. Anticlimactic, I know. Mathematically speaking, we measure risk through standard deviation (or variance, the square of standard deviation), which can usually be estimated. Please note that this means that risk occurs regardless of whether the security in question goes up or down. Obviously most investors would rather have the risk only go one direction, up, but such is life.
In order to accurately gauge risk, we need a measure of earnings without any risk. In my classes, we defined a risk-free asset, usually United States Treasury Bills (T-bills), to be the risk-free assets earning the risk-free rate of return. Take a look at what they're currently earning here. Note that these are annualized yields - you don't really earn 2.98% in 4 weeks' time.
Anything above that risk-free rate is defined to be a risky asset. How much investors need to be compensated in addition to the risk-free rate to invest in that asset is called the risk premium, and can be computed as follows:
Note that I've used the notation for expected value (E(X)) here, because the return on the asset in question is risky - it will vary. By definition, the asset determining the risk-free rate of return has no risk.
So let's take a look at the risk premium for a typical bank deposit in Second Life. The SLCapEx is currently offering rates of 0.1% compounded daily. To make that an annualized rate, we take
or 44.025% return. But, we're not done here. The SLCapEx cash accounts are a risky asset, and there is some probability that they will not pay out. We've already seen several bank collapses in SL this year, and that's the probability I'm talking about. I'm going to assume, for illustrative purposes, that the SLCapEx has a 90% chance of paying that rate of return, and a 10% chance of paying zero. Therefore, we calculate the expected value of SLCapEx returns as:
The risk-free T-bill had a rate of return of 2.98%. Therefore, the risk premium on a SLCapEx cash account is 36.643%! That is pretty staggeringly high, and usually those risk premiums are found only on the Las Vegas Strip.
So why aren't hordes of billionaires coming into Second Life to take advantage of SLCapEx's great rate of return? They're afraid of the risk. To them, the risk of losing their capital (and they would use more sophisticated models than I assumed above) outweighs the potential return that they could get. They are (as are most investors) risk-averse, meaning that they prefer less risk to more risk. There are some who are risk-takers, that will choose a riskier asset to a less risky asset. The third option is being risk-neutral, which means you don't care about the risk and just look at the rate of return, and I believe it's the rarest case of the three.
At this point, some pictures might be helpful. What we need is a graph to help us understand the relationship between risk and return. Fortunately, one exists, and is called the efficient frontier. What you do is you graph risk (measured either by variance or standard deviation) on the x-axis and rates of return on the y-axis. Then, by economic argument (not mathematical proof, mind you) you only take the highest rates of return for given levels of risk. What you wind up with looks something like this:
Pretty, isn't it? That line represents the best that you can do in the market. The lower dots are ignored, because investors would choose the higher dots (securities with a greater rate of return for the same risk) instead. Think about it - if you had two banks, one with a savings account at 3% and the other at 5%, you'd probably go to the one with the 5% rate of return (ceteris paribus).
There are an infinite number of points on that curve, however. How do we decide which one to take? Well, that's where your individual preferences come in via something called utility curves (or indifference curves). Actually, these are multi-dimensional functions that are often projected onto two-dimensional graphs as curves. Anyway, these curves quantify how much return you must be compensated with in order to take on an additional unit of risk. You wind up with a picture that looks like this:
You should choose the portfolio that maximizes your utility and lies on the efficient frontier. Simple, right? Well, the mathematics gets messy, but ideally (economists would like to think) we do this every day without even thinking about it.
All of this stuff falls under the umbrella of modern portfolio theory, and I encourage those interested to do some exploring on Google to see the range of topics out there.
Next week - equivalent portfolios and their magic.
----
Just a quick note: I take requests here at Second Chaos. If there's some mathematical, financial, or economic topic you'd like me to explore, let me know. I might refuse topics that I feel are too far advanced for me, but I'll gladly make articles explaining standard deviation or variance or anything like that. Just FYI.
Risk. You've probably heard the term a lot in various contexts. Around the SL capital markets, you've likely heard of it as far as business risks, risks of default, and/or risks of de-listing. I know of one company which specializes in insurance in SL, The Rock Insurance, which is a tool used to mitigate risk. But has anyone ever defined risk for you? Beware, however, because this is a mathematical definition of risk. Finance professionals probably wouldn't accept my definition, or only grudgingly so, because of the consequences it brings. Here we go, though:
Risk = Standard Deviation(Returns)
That's it. Anticlimactic, I know. Mathematically speaking, we measure risk through standard deviation (or variance, the square of standard deviation), which can usually be estimated. Please note that this means that risk occurs regardless of whether the security in question goes up or down. Obviously most investors would rather have the risk only go one direction, up, but such is life.
In order to accurately gauge risk, we need a measure of earnings without any risk. In my classes, we defined a risk-free asset, usually United States Treasury Bills (T-bills), to be the risk-free assets earning the risk-free rate of return. Take a look at what they're currently earning here. Note that these are annualized yields - you don't really earn 2.98% in 4 weeks' time.
Anything above that risk-free rate is defined to be a risky asset. How much investors need to be compensated in addition to the risk-free rate to invest in that asset is called the risk premium, and can be computed as follows:
Risk Premium = E(Return of Asset) - (risk-free rate)
Note that I've used the notation for expected value (E(X)) here, because the return on the asset in question is risky - it will vary. By definition, the asset determining the risk-free rate of return has no risk.
So let's take a look at the risk premium for a typical bank deposit in Second Life. The SLCapEx is currently offering rates of 0.1% compounded daily. To make that an annualized rate, we take
[(1 + .001)365 - 1] = .44025
or 44.025% return. But, we're not done here. The SLCapEx cash accounts are a risky asset, and there is some probability that they will not pay out. We've already seen several bank collapses in SL this year, and that's the probability I'm talking about. I'm going to assume, for illustrative purposes, that the SLCapEx has a 90% chance of paying that rate of return, and a 10% chance of paying zero. Therefore, we calculate the expected value of SLCapEx returns as:
(.44025)*(.90) + 0*(.10) = .39623 = 39.623%
The risk-free T-bill had a rate of return of 2.98%. Therefore, the risk premium on a SLCapEx cash account is 36.643%! That is pretty staggeringly high, and usually those risk premiums are found only on the Las Vegas Strip.
So why aren't hordes of billionaires coming into Second Life to take advantage of SLCapEx's great rate of return? They're afraid of the risk. To them, the risk of losing their capital (and they would use more sophisticated models than I assumed above) outweighs the potential return that they could get. They are (as are most investors) risk-averse, meaning that they prefer less risk to more risk. There are some who are risk-takers, that will choose a riskier asset to a less risky asset. The third option is being risk-neutral, which means you don't care about the risk and just look at the rate of return, and I believe it's the rarest case of the three.
At this point, some pictures might be helpful. What we need is a graph to help us understand the relationship between risk and return. Fortunately, one exists, and is called the efficient frontier. What you do is you graph risk (measured either by variance or standard deviation) on the x-axis and rates of return on the y-axis. Then, by economic argument (not mathematical proof, mind you) you only take the highest rates of return for given levels of risk. What you wind up with looks something like this:
Pretty, isn't it? That line represents the best that you can do in the market. The lower dots are ignored, because investors would choose the higher dots (securities with a greater rate of return for the same risk) instead. Think about it - if you had two banks, one with a savings account at 3% and the other at 5%, you'd probably go to the one with the 5% rate of return (ceteris paribus).
There are an infinite number of points on that curve, however. How do we decide which one to take? Well, that's where your individual preferences come in via something called utility curves (or indifference curves). Actually, these are multi-dimensional functions that are often projected onto two-dimensional graphs as curves. Anyway, these curves quantify how much return you must be compensated with in order to take on an additional unit of risk. You wind up with a picture that looks like this:
You should choose the portfolio that maximizes your utility and lies on the efficient frontier. Simple, right? Well, the mathematics gets messy, but ideally (economists would like to think) we do this every day without even thinking about it.
All of this stuff falls under the umbrella of modern portfolio theory, and I encourage those interested to do some exploring on Google to see the range of topics out there.
Next week - equivalent portfolios and their magic.
----
Just a quick note: I take requests here at Second Chaos. If there's some mathematical, financial, or economic topic you'd like me to explore, let me know. I might refuse topics that I feel are too far advanced for me, but I'll gladly make articles explaining standard deviation or variance or anything like that. Just FYI.
Thursday, December 6, 2007
Ethics (or lack of)
For those of you thinking SL is a game, or a "3D chat", a post about ethics may seem totally unrelated, or misplaced.
Well, I believe that no matter your opinion of SL and how you "live" it, ethics (or talking of) definitely have a place, here or anywhere else.
Ethics (and lack of) are strictly inherent to us humans. Every day we act, talk, write; there are many instances where ethics are (or should be) involved.
Before I get carried away, I'll get to the point and I'll specify that I'll be dealing with business ethics in this post. As I wrote in my first post here, I am the Director of Communication and Public Relations for the VSTEX, a "community based virtual stock exchange".
I won't go over all the issues most of us have seen, either directly or not. Most of us know that the range of "bad things" goes from CEOs running away with the company treasury to all sorts of blackmail attempts.
Those are the things getting the attention of the press and the general public. Of course on the other side there are a lot of good businesses, but as it happens in real life, most of the times who just does his business the right way, doesn't get much press. You may or may not agree with me here, but that's how I feel.
Before joining the VSTEX team I have been a "virtual trader/investor" and a few times I have stumbled on unethical people. Being in my new office I said to myself "What should I focus on, now?".
First thing was to improve the exchange rules which they are far away from being perfect now, but any improvement is a good improvement if you ask me.
Then I started digging into business ethics and that led to the VSTEX Code of Ethics and the VSTEX Public Disclosure Policy .
Of course even the best codes and policies won't mean much if you don't live by them. A Code of Ethics should not be a collection of phylosophical mumbo-jumbo or marketing jargon and at all costs shouldn't be a trap to lure people into thinking you're all good and white.
I believe ethics to be a major factor in the competition equation. SL is a social environment, a good reputation will take you up to the stars, a bad or tarnished reputation may hinder you seriously. Who will prove to be an ethical business will have a definite advantage in the race for success.
You may be thinking "So let's get ethical now", but please stop a little before you run for your desk, to write the "Ultimate Code of Ethics".
You don't learn ethics, though by reading some good documents you may improve your ethical inclination/awareness. You must have an ethical DNA. If it isn't in you veins, in your heart, you may get close, but in the long run you may give up or fail to live by your own code.
I would encourage you to discuss ethics with your team, or fellow businesses, whomever. Look around you and ask yourself "How could I do it, in an ethical way?" or "Could I be more ethical?". Asking questions, even to yourself, is a great way to learn. Great human discoveries and inventions came out of more or less simple curiosity.
As for myself, I'll see what I can do over at the VSTEX where I found a management very incline to follow my calls and ideas. Future will tell and I'm looking forward to a bright one.
Well, I believe that no matter your opinion of SL and how you "live" it, ethics (or talking of) definitely have a place, here or anywhere else.
Ethics (and lack of) are strictly inherent to us humans. Every day we act, talk, write; there are many instances where ethics are (or should be) involved.
Before I get carried away, I'll get to the point and I'll specify that I'll be dealing with business ethics in this post. As I wrote in my first post here, I am the Director of Communication and Public Relations for the VSTEX, a "community based virtual stock exchange".
I won't go over all the issues most of us have seen, either directly or not. Most of us know that the range of "bad things" goes from CEOs running away with the company treasury to all sorts of blackmail attempts.
Those are the things getting the attention of the press and the general public. Of course on the other side there are a lot of good businesses, but as it happens in real life, most of the times who just does his business the right way, doesn't get much press. You may or may not agree with me here, but that's how I feel.
Before joining the VSTEX team I have been a "virtual trader/investor" and a few times I have stumbled on unethical people. Being in my new office I said to myself "What should I focus on, now?".
First thing was to improve the exchange rules which they are far away from being perfect now, but any improvement is a good improvement if you ask me.
Then I started digging into business ethics and that led to the VSTEX Code of Ethics and the VSTEX Public Disclosure Policy .
Of course even the best codes and policies won't mean much if you don't live by them. A Code of Ethics should not be a collection of phylosophical mumbo-jumbo or marketing jargon and at all costs shouldn't be a trap to lure people into thinking you're all good and white.
I believe ethics to be a major factor in the competition equation. SL is a social environment, a good reputation will take you up to the stars, a bad or tarnished reputation may hinder you seriously. Who will prove to be an ethical business will have a definite advantage in the race for success.
You may be thinking "So let's get ethical now", but please stop a little before you run for your desk, to write the "Ultimate Code of Ethics".
You don't learn ethics, though by reading some good documents you may improve your ethical inclination/awareness. You must have an ethical DNA. If it isn't in you veins, in your heart, you may get close, but in the long run you may give up or fail to live by your own code.
I would encourage you to discuss ethics with your team, or fellow businesses, whomever. Look around you and ask yourself "How could I do it, in an ethical way?" or "Could I be more ethical?". Asking questions, even to yourself, is a great way to learn. Great human discoveries and inventions came out of more or less simple curiosity.
As for myself, I'll see what I can do over at the VSTEX where I found a management very incline to follow my calls and ideas. Future will tell and I'm looking forward to a bright one.
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