I read quite a bit, though my interest is highly concentrated in history, finance, current events, and derivations on those three subjects. I usually go through 1-2 books a week depending on my reading load for classes, and one of the challenges is remembering what the key points that I learn in each book. Since I've been a lazy blogger, I'll start trying to do a quick synopsis of each book here.
I recently finished Obama's Wars by Bob Woodward. For those of you who don't know the name, he's one of the more famous investigative journalists of our era and was at the center of the Watergate scandal. The book is a narrative of the national security council's actions/thought process as they develop Obama's strategy for Afghanistan which was later announced in a speech at West Point on 01 December 2009.
As with any Woodward book, Obama's War does not seek to do more than simply record what happened. There's little analysis by the author, which may be just as well considering the subject matter. The most astonishing aspect of the Afghanistan saga is the degree of petty behavior exhibited among those who should represent the best of their respective fields. In every one of Woodward's books, senior military officers and Pentagon officials appear to consider their duty to country a distant second to their own parochial interests. General Petraeus, the former commander of CENTCOM and current commander of the fight in Afghanistan, as well as Admiral Mullen appear to brazenly defy the President's wishes on a number of key strategic issues, not least of which is providing neutral advise.
The difficulty in evaluating in the actions of individuals within the story is that Woodward is well known for playing favorites. Certain individuals receive very complimentary portrayals based upon what appears to be their assistance to Mr. Woodward. That Petraeus is viewed in a less than positive light in this most recent book after Woodward's glowing reviews in four previous books should tell you something about the current administration's view of the general.
A new Chairman of the Joint Chiefs of Staff will be nominated this summer, I sincerely doubt that General Petraeus will be the one taped by the administration for the job. Far more likely it seems is the promotion of the current Vice-Chairman, Marine General James Cartwright. The only reason I would see this not occurring is that it would interrupt the otherwise steady rotation of the chairman's office from service to service, see here.
All in all, a good read. But if you're a current service member, this is yet another example of why the wars we fight seem to be run by a pack of schizophrenics.
Tuesday, March 29, 2011
Friday, March 25, 2011
What was getting out of the Army worth?
For the past 9 months I've been telling myself that I should do a financial analysis of my decision to leave the active duty Army to enter a full-time MBA program. This afternoon I finally sat down and finished it. The number was fairly astonishing. Leaving the Army for a career in the private sector is worth a minimum of several million dollars over the rest of my life. While I won't share the specifics or the excel model, it was a good exercise to at least do.
For those who are interested, I basically assumed that I would enjoy a fairly typical military career. Promotions would happen on schedule and I would retire after 25 years of service. After retiring I would begin a second career before retiring completely at age 60.
To estimate the civilian option I used my current job offer and some widely published statistics on post-MBA pay (see here). The chart presented is probably not a good representation of actual salaries, as MBA graduates tend to become quickly segregated into income brackets which vary considerably. The sample size and methodology that Bloomberg Businessweek used is dubious at best, but represents a good starting point.
I did this exercise for a couple reasons:
1. Many people see to make education choices with little analytical thought. While I'll perhaps write more on this later, I fundamentally believe that too many young people attend college/university and receive no financial benefit.
2. When I was resigning from the Army, my supervisors asserted (falsely) that it was a mistake financially. I believed then that this was a fallacious argument supported by some extremely naive assumptions around the value of a military pension. Unfortunately it's difficult to understand what your opportunity cost is when you haven't received a civilian job offer.
All that being said, money isn't everything. I know a great many peers who are still serving on active duty who would not leave their profession for any amount of money. There's certainly something to be said for being part of a profession with a noble calling.
For those who are interested, I basically assumed that I would enjoy a fairly typical military career. Promotions would happen on schedule and I would retire after 25 years of service. After retiring I would begin a second career before retiring completely at age 60.
To estimate the civilian option I used my current job offer and some widely published statistics on post-MBA pay (see here). The chart presented is probably not a good representation of actual salaries, as MBA graduates tend to become quickly segregated into income brackets which vary considerably. The sample size and methodology that Bloomberg Businessweek used is dubious at best, but represents a good starting point.
I did this exercise for a couple reasons:
1. Many people see to make education choices with little analytical thought. While I'll perhaps write more on this later, I fundamentally believe that too many young people attend college/university and receive no financial benefit.
2. When I was resigning from the Army, my supervisors asserted (falsely) that it was a mistake financially. I believed then that this was a fallacious argument supported by some extremely naive assumptions around the value of a military pension. Unfortunately it's difficult to understand what your opportunity cost is when you haven't received a civilian job offer.
All that being said, money isn't everything. I know a great many peers who are still serving on active duty who would not leave their profession for any amount of money. There's certainly something to be said for being part of a profession with a noble calling.
Thursday, March 10, 2011
Black-Scholes - Will they have to give back their Nobel Prize someday?
I've been delinquent in writing posts, mostly because I'm lazy. As a 2nd year MBA with a job offer in hand, my life is not that much different from an unemployed beach bum, much to my wife's chagrin.
Fischer Black, Myron Scholes, and Robert Merton are economists who developed a formula, now known as Black-Scholes, to value European style options. A European style option gives you the right to buy or sell (known as exercising) a financial instrument at a fixed point in the future for a fixed price. Normally you must pay an upfront fee for this right, and Black-Scholes is what is used to calculate that fee. To keep this at a level which is understandable to the lay person, Black-Scholes uses the past prices of the asset, amount of time for which the option is available, and current borrowing rates to establish the price of the option. Black-Scholes makes a number of assumptions about each of these variables and a few others, and has been widely adopted by the finance community as the preferred method for valuing options. Scholes and Merton won a Nobel Prize for their work in 1997, Black was unfortunately dead and therefore ineligible for the honor.
Both Scholes and Merton were part of an infamous hedge fund called Long-Term Capital Management, or LTCM. For those of you who are curious about a disaster that nearly became a prominent part of American history, you should read this book that details the story. I find it riveting, though you may find it a good way to fall asleep after a busy or stressful day. On a side note, many of the characters in the book came back to haunt us in this most recent financial crisis. The short story of LTCM is that they used many of the concepts that Black-Scholes developed, primarily the role of historical pricing in estimating future prices. LTCM failed miserably in 1998 when the Russian and East Asian financial crises occurred.
When I first heard about Black-Scholes as undergraduate economics major at West Point I considered it to be a intellectual gimmick. The difficulty is that Nobel Prize winners are likely to ask for your better idea when you point out that theirs is rubbish. Modern finance has spun this idea of using historical assets prices (or more accurately, volatility in those asset prices) to predict future prices into a frightening swirl of bullshit. While it may or may not be accurate in the very short term, in any period longer than a few weeks or months the validity of the model becomes questionable. A company's future profits are dependent on a myriad of factors, not least of which are the overall economy, individual market served, and company's operations. None of these factors are stagnant, rather they constantly evolve such that it is extraordinarily unlikely that the same set of variables which existed in the spring of 2011 may ever again exist. If these variables are not static, it becomes very difficult (I would say impossible) to use them in predicting future prices or volatility.
The recent financial crisis has put a bulls-eye on the back of adherents to this theory. It also raised very serious concerns about modern portfolio theory and the efficient market hypothesis which are the fundamental reasons that most Americans use something called index funds to invest for retirement. I don't believe that markets are efficient in the short or medium term or that index funds represent the best way to invest for retirement. That, however, does not translate to recommending that disinterested investors abandon their index funds. For most individuals, identifying market pricing failures is a task too difficult or boring to engage in and an index fund is the best option.
I've written this long-winded explanation as a lead-in to some interesting comments made by Warren Buffet. In his most recent letter to shareholders he made the following statement, "Both Charlie and I believe that Black-Scholes produces wildly inappropriate values when applied to long-dated options...More tangibly, we put our money where our mouth was by entering into our equity put contracts. By doing so, we implicitly asserted that the Black-Scholes calculations used by our counterparties or their customers were faulty." (paragraph 6, page 20, here).
I find the second part of the statement particularly amusing. Scholes and Merton received about $1 million and the undying love of their fellow academia's for their formula. Buffet is betting billions of dollars that they are full of it, and he's winning.
I've decided over the past year that my future investments will include a number of LEAPS. They are certainly risky, in most instances you must invest $1000s in each option and run the risk of the investment becoming worthless. You must be willing to lose on the vast majority of these bets, but one winner can make your year. I also love the risk, it's not unlike doubling down at the blackjack table if your two card total is 11. It doesn't matter what
Fischer Black, Myron Scholes, and Robert Merton are economists who developed a formula, now known as Black-Scholes, to value European style options. A European style option gives you the right to buy or sell (known as exercising) a financial instrument at a fixed point in the future for a fixed price. Normally you must pay an upfront fee for this right, and Black-Scholes is what is used to calculate that fee. To keep this at a level which is understandable to the lay person, Black-Scholes uses the past prices of the asset, amount of time for which the option is available, and current borrowing rates to establish the price of the option. Black-Scholes makes a number of assumptions about each of these variables and a few others, and has been widely adopted by the finance community as the preferred method for valuing options. Scholes and Merton won a Nobel Prize for their work in 1997, Black was unfortunately dead and therefore ineligible for the honor.
Both Scholes and Merton were part of an infamous hedge fund called Long-Term Capital Management, or LTCM. For those of you who are curious about a disaster that nearly became a prominent part of American history, you should read this book that details the story. I find it riveting, though you may find it a good way to fall asleep after a busy or stressful day. On a side note, many of the characters in the book came back to haunt us in this most recent financial crisis. The short story of LTCM is that they used many of the concepts that Black-Scholes developed, primarily the role of historical pricing in estimating future prices. LTCM failed miserably in 1998 when the Russian and East Asian financial crises occurred.
When I first heard about Black-Scholes as undergraduate economics major at West Point I considered it to be a intellectual gimmick. The difficulty is that Nobel Prize winners are likely to ask for your better idea when you point out that theirs is rubbish. Modern finance has spun this idea of using historical assets prices (or more accurately, volatility in those asset prices) to predict future prices into a frightening swirl of bullshit. While it may or may not be accurate in the very short term, in any period longer than a few weeks or months the validity of the model becomes questionable. A company's future profits are dependent on a myriad of factors, not least of which are the overall economy, individual market served, and company's operations. None of these factors are stagnant, rather they constantly evolve such that it is extraordinarily unlikely that the same set of variables which existed in the spring of 2011 may ever again exist. If these variables are not static, it becomes very difficult (I would say impossible) to use them in predicting future prices or volatility.
The recent financial crisis has put a bulls-eye on the back of adherents to this theory. It also raised very serious concerns about modern portfolio theory and the efficient market hypothesis which are the fundamental reasons that most Americans use something called index funds to invest for retirement. I don't believe that markets are efficient in the short or medium term or that index funds represent the best way to invest for retirement. That, however, does not translate to recommending that disinterested investors abandon their index funds. For most individuals, identifying market pricing failures is a task too difficult or boring to engage in and an index fund is the best option.
I've written this long-winded explanation as a lead-in to some interesting comments made by Warren Buffet. In his most recent letter to shareholders he made the following statement, "Both Charlie and I believe that Black-Scholes produces wildly inappropriate values when applied to long-dated options...More tangibly, we put our money where our mouth was by entering into our equity put contracts. By doing so, we implicitly asserted that the Black-Scholes calculations used by our counterparties or their customers were faulty." (paragraph 6, page 20, here).
I find the second part of the statement particularly amusing. Scholes and Merton received about $1 million and the undying love of their fellow academia's for their formula. Buffet is betting billions of dollars that they are full of it, and he's winning.
I've decided over the past year that my future investments will include a number of LEAPS. They are certainly risky, in most instances you must invest $1000s in each option and run the risk of the investment becoming worthless. You must be willing to lose on the vast majority of these bets, but one winner can make your year. I also love the risk, it's not unlike doubling down at the blackjack table if your two card total is 11. It doesn't matter what
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