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Magazine

A new target? The future of monetary policy

Second Issue Spring 2013 The euro crisis Why being a turkey before thanksgiving is not a good idea Financial leverage and capital structure Managing emerging markets Careers in Norges Bank


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Editor Amaar Malik post@equilibriummagazine.no Writers

Alexander Albert Louisa Brandt Morten Fylkesnes Even Comfort Hvinden Fabian Harang Farzad Khoshnoud Petter Kongslie Amaar Malik Kjetil Stiansen

Layout & graphics Lasse André Lyngaas post@lasseal.no ONLINE equilibriummagazine.no Publisher Equilibrium Magazine FLI c/o Økonomisk institutt Postboks 1095 Blindern 0317 Oslo Cover photo Adam Fagen [ 2 ] 

''Inflation, if anything, is a little bit too low.'' – Ben Bernanke

Photo: Federal Reserve

M ACRO Nominal issues  4 The euro crisis  8 Guest article: Misconceptions of wages and unemployment10 FINANCE Why being a turkey before thanksgiving is not a good idea  Financial leverage and capital structure  Financial derivatives  Alternative marketplaces 

15 18 22 25

INTER NATIONAL EXPERIENCE Managing emerging markets 

29

Car eers Norges Bank 

32


Continuing to build on our success It is with great excitement our editorial staff is releasing the second issue of Equilibrium Magazine. We are delighted to currently be distributing at nine universities and colleges in Norway as well as attracting readers from eight additional countries on three continents. We are looking forward to contribute with more ideas, views and theories in this issue as we seek to inspire the broader student community to take the economic and financial debate outside the lecture halls. When we established this magazine, our main goal was to carry out high-quality economic and financial research as well as creating a platform for students from all over the world to come together and participate in the debate. Bearing in mind our goals, we have omitted interviews with academics and industry practitioners in this issue as we have received numerous applications from students who want to contribute with editorial content. Hence, we have focused on gathering students together to write about highly relevant economic and financial topics that we believe will influence economic policymaking in the time to come. This issue consists of discussions on macroeconomic topics such as monetary policy and economic challenges in the

euro-area while also highlighting financial topics covering financial risk management, corporate finance and alternative marketplaces. Our academically founded views on these topics encompass theories ranging from neo-Keynesian economics to Austrian perspectives as we aim to enable students to critically assess economic and financial theories. We also want to encourage you to perceive this magazine as active learning. Please do not only read, but do also digest and analyse the content as well as ultimately participating in the economic and financial debate by writing a guest column. In this ubiquitous economic environment that is characterised by new unorthodox policymaking and changing regulations, we hope you enjoy our analysis of both the current situation and the key opportunities going forward.

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Amaar Malik, Editor-in-Chief Economics, University of Oslo

  [3]


◆ Macro  ◆ Finance  ◆ International Experience  ◆ Careers

Nominal issues ✎ Kjetil Stiansen



Photo: U.S. Department of the Treasury

Replacing the inflation target? cus from returning the economy to full Central bankers have become super- employment, giving inflation an unwarstars. As the financial crisis and Europe’s ranted amount of attention, as if by dedebt crisis unfolded, central banks took fault. Rather than looking at the economy the stage, using conventional and uncon- through the lens of inflation, countries ventional means to stave off disaster and might be better served with a central bank return the world to prosperity. While the that targets the level of economic output influence and power of central banks have directly. The time may have come for reexpanded rapidly, they are still subject to placing the inflation target with a target for rules. The rules come in the form of mon- nominal GDP. etary policy regimes, given by politicians, which govern what central banks are al- What is NGDP-targeting, lowed to do and which economic variables monetary policy targets? they should be targeting. Governments leave the issue of conInflation targeting, which is the mone- trolling monetary policy to an independent tary policy regime adopted by most cen- central bank due to issues of time incontral banks in the developed world, has sistency. According to standard macrosucceeded in bringing stable inflation and economic theory, there exists a trade-off stable growth for several years. However, between inflation and unemployment in during the crisis, it has increasingly shown the short run but not in the long run. A itself to be a distraction, diverting fo- democratically elected government will [ 4 ] 

have problems taking the long-term view, essentially because it faces re-election and will thus have incentives to pursue an expansionary policy, sacrificing price stability (which is regarded as a good thing) for temporary low unemployment. In other words, the short term preference of lower unemployment is inconsistent with long term preferences for price stability. As long as unemployment is kept below its equilibrium rate (also known as the natural rate, the rate at which inflation is constant), inflation will rise as people revise their inflation expectations. In the end the government will have to accept a rise in unemployment back to the equilibrium rate to avoid inflation skyrocketing. Thus the economy has been saddled with higher inflation without any permanent gain in lower unemployment. Giving an independent central bank the responsibility of


NGDP-targeting would provide a better paradigm for expectations management keeping inflation at a predetermined target, which is the essence of inflation targeting, should thus anchor inflation expectations and keep unemployment at its equilibrium level. Targeting nominal GDP (NGDPtargeting) means that the central bank picks a “normal year” with unemployment at its equilibrium rate and sets a target for the growth path of nominal GDP (GDP not adjusted for inflation). For example, if trend growth is projected at 3 %, and the favoured inflation rate is 2 %, then a NGDPtarget would be 5 % growth per year. Also, since the central bank is targeting a growth path, lower than expected NGDP growth one year, e.g. at 4 %, would mean it should target NGDP growth of 6 % the next year, to catch up. Managing expectations The current economic climate is best characterised by the standard Keynesian liquidity trap. In the liquidity trap, production has fallen due to a powerful negative demand shock, such as a large increase in desired private savings, with a corresponding increase in unemployment. To counteract this, the central bank has lowered rates all the way to zero as a way to expand the economy. However, even a zero interest rate policy is insufficient to return the economy to full employment. Because the rate is already at zero, cutting it further is not an option, as people would rather hold cash than pay banks to hold their money. Thus, the central bank is unable to affect the economy through changes in the interest rate; the trap is sprung. In the liquidity trap, the main weapon of the central bank becomes expectations

management, but the inflation target could make this more difficult. Consider the current US Federal Reserve policy of keeping monetary policy accommodative until the unemployment rate falls below 6.5 percent or inflation exceeds 2.5 percent. The goal of this policy is to influence people’s expectations about future growth: people and firms should be certain that the Fed won’t move to choke off the recovery, and should thus be more optimistic about their future income. This should in turn make them more willing to spend and invest today, feeling less of a need to save in order to sustain themselves in the coming years. However, in the current situation, the inflation target acts as an unhelpful distraction. Unemployment at 6,5 percent is still well above the equilibrium rate, which is estimated to be between 5 and 6 percent, and there is virtually no reason to expect inflation to run wild with unemployment above its equilibrium rate. Also, the apparent unwillingness to allow inflation to run temporarily above 2.5 percent creates unnecessary uncertainty: would the Federal Reserve for instance move to tighten policy in the face of a supply side inflation shock such as an oil price surge? It probably wouldn’t, but it would come under political pressure to do so, and the uncertainty is unnecessary. In an economic environment where focus should be directed at returning the economy to full employment the current monetary policy regime may grant inflation an undeserved amount of attention. NGDP-targeting would provide a better paradigm for expectations management. A central bank with an NGDP target would not be forced to evaluate all its actions in

light of an inflation target, which could help make promises of accommodative policy more credible and easier to understand. Currently, GDP (nominal as well as real) is well below the level it would have been at if the economy had continued growing along the trend it was on before the financial crisis. An NGDP mandate would in this situation call for substantive catch up growth to return the economy to its target growth path. Following such a mandate, the central bank would commit to keeping monetary policy accommodative for as long as necessary to return the economy to the growth path. The message in this scenario is simple and lacks the reservations and contradictions of the current messages from central banks in both Europe and the US. More inflating Far from dangerous, moderate inflation would be helpful in the current economic environment by reducing long term real rates. With high levels of private debt, and with interest rates pressed against the zero lower bound, standard macroeconomic theory points to moderate inflation as being helpful. Moderately higher inflation would help in two main ways: most obviously it would help erode the real value of debt. Also, in a country that issues debt in its own currency, such as the US, long term interest rates will basically be an average of expected future short term rates. As such, higher expected inflation decreases real long term interest rates, something which should help boost economic activity today. The Japanese experience provides a case in point here. The Japanese economy has been stuck in the liquidity trap for   [5]


◆ Macro  ◆ Finance  ◆ International Experience  ◆ Careers

over a decade, with nominal interest rates to gain much traction. By the same token, rather reaffirm their commitment to bring essentially at zero. Long term interest rates raising the inflation target to, for instance, nominal income back on track. As long as have, however, been positive, as they are 4 %, while economically sound, is probably nominal income remained below its taran average of expected short rates, which politically unfeasible. This makes it diffi- get path, the central bank would be uncan only go up, being already at zero. The cult for the central bank to alter inflation der pressure to get it back on track, rather recent message from Japanese policy mak- expectations: the central bank often finds than have their every policy decision ers has been one of targeting higher infla- itself under pressure from politicians and scrutinised in light of the inflation target. tion, and markets seem to have responded. the public when the inflation exceeds the Even under a regime such as that of the US, Expected inflation (which can be mea- target, but rarely when it dips below. It thus where there is a double mandate to target sured by looking at so called breakeven both unemployment and inflation, policy rates, which are the spread between nomhas arguably been biased towards moderatinal and inflation indexed bond yields) ing inflation. Either way, the inflation tarhave increased, with no increase in interest get acts as an anchor in the debate, and in rates; in other words long term real interan environment such as now, the distracest rates have fallen. Lower long term real tion it creates is damaging. interest rates means higher future real income and lower costs of managing new A fittingly imperfect policy debt (as real interest payments would be “Monetary policy is not a panacea”. lower). This should make households more The US Federal Reserve Chairman, Ben willing to spend, and firms more willing to Bernanke’s warning to US policy makers invest today, expecting higher income and goes for all forms of monetary policy meademand, respectively, in the future. sures and its regimes, including NGDP targeting. However, as Christina and David It’s (still) the politics, stupid! Romer of Berkeley argue in a recent paper, In principle, there is nothing preventing being overly pessimistic about the power policy makers from pursuing the policies of monetary policy, even in the face of maoutlined above within the framework of jor challenges, can be dangerous, having an inflation target, but the politics are difresulted in limited and slow response to ferent. First of all: people tend to dislike both the current and past crises. A good inflation, and policies that are perceived monetary policy regime is one that ento increase inflation tend to be unpopuables the central bank to credibly commit lar. Completely rational agents shouldn’t to whichever policy it deems appropriate be too concerned with this, as prices nor- becomes hard to make promises (or threats, for the current situation. An NGDP target mally move in response to wages, leaving depending on your position) of higher in- could help enhance central bank credibilmost people no worse off. However, peo- flation credible. (In econspeak: inflation ity, even in instances when what is needed ple arguably judge the benefits of inflation expectations are too well anchored.) is a dose of monetary recklessness. While in relation to their current, nominal inThe politics of NGDP-targeting would be politicians remain hard at work squabbling come, perceiving inflation as something substantially simpler, as well as easier to over structural reforms, budget deficits that erodes their standard of living. As understand. In response to a slump, poli- and other “real issues”, there may be somesuch, announcements by the central bank cymakers would not have to sell a message thing to gain by considering the nominal calling for higher inflation are unlikely of targeting higher inflation explicitly, but ones.

Inflation expectations are too well anchored

[ 6 ] 


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The euro crisis:

Far from over ✎ Even Comfort Hvinden The medium term prospects for a successful resolution are becoming bleaker as the ongoing crisis exacerbates the between country asymmetries that form part of the euro’s Original Sin. Much can be said about flaws and perverse incentives in the construction of the common currency and its institutions. One of these is the issue of asymmetry, understood as the economic incompatibility of the constituent nations in forming the common currency area. The countries comprising the euro zone differ fundamentally in the structure, scope, scales and composition of their economies, explaining differences in competitiveness and productivity and ultimately the countries' real income level. When asymmetry (figure ❶) is represented as differences in macro indicators such as GDP per capita and the current account balance they ultimately reflect these relative fundamentals. At the same time, a common currency, free flows of capital and trade, and a central bank with an inflation targeting regime ensures that there is one rate of interest and one exchange rate. If the fundamentals of the euro zone countries differ, what are the consequences of the onesize-fits-all solution? Writing on optimal currency areas, R .A Mundell (1961) stated that “[…] a region is an economic unit while a currency domain is partly an expression of national sovereignty […] the argument for a common currency area works best if each nation (and currency) has internal factor mobility and external factor immobility.” Given that the euro zone is characterised by low internal factor-mobility, describing the semi-rigid Bretton Woods system, R. A. Mundell is ironically prophetic when stating “[it] is patently obvious that periodic balance-of-payments will remain an integral [ 8 ] 

feature of the economic system as long as fixed exchange rates and rigid wage and price levels prevent the terms of trade from fulfilling a natural role in the adjustment process.” Two alternatives thus exist for the euro zone one-size-fits-allcurrency to work. One is convergence, which requires Greeks to become more like Germans. The second is a transfer union: German taxpayers treating the Greeks as if they were German. With the latter option being politically impossible, the creation of the euro was based on the assumption that the former would hold. Thus, the Maastricht Treaty stipulated a number of convergence criteria, goals for macro indicators such as inflation, deficits and debt to GDP ratios that individual countries had to fulfill to be eligible for euro zone membership. And indeed, during the 1990s, convergence appeared to happen. There are two problems with the Maastricht criteria. Firstly, they are at best proxies for convergence as they do not contain information on fundamentals. Second, the numbers were achieved for a short time period and with national currencies. Therefore the actual medium term feasibility of convergence would be tested after the creation of the currency area (figure ❷). The traditional strategy of currency devaluation followed by export growth is explicitly impossible under the current policy scheme and is aggravated by the fact that the euro zone countries trade mostly with each other. Prolonged high unemployment is guaranteed as peripheral countries deleverage their debts with low domestic demand. Meanwhile, the damage being wrought on the peripheral economies reduces their medium to long term potential and the euro zone becomes ever more suboptimal as a currency area.


150 140 Italy Portugal Spain Greece

130 120 110

Germany 100 90 80

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Figure ① : Asymmetry? Unit Labour cost. Index: 2000 = 100

2011

Source: ECB

120 Sweden 115 Germany

110 105

Italy

100 95 90

Ireland

85 80 75

Greece 2007

2008

2009

Figure ② : Falling apart. GDP index: Q1 2007 = 100

2010

2011

2012

Source: ECB

  [9]


◆ Macro  ◆ Finance  ◆ International Experience  ◆ Careers

Misconceptions of wages and unemployment ✎ Alexander Albert

(Guest Writer)

In the aftermath of the last decade’s economic crisis, most western nations are struggling with massive problems. One of the most urgent problems, especially in the majority of European nations, is unemployment. Governments, politicians and economists are proposing solutions. Underpinning their policies is that they advocate increased government control and regulation, in order to create opportunities. Do the problems we are facing require such policies, or could there be a much simpler answer? Could the solution be found in the complete opposite direction; less state intervention? In this article, I will discuss wages and unemployment. I will try to establish a solid understanding of what factors are causing unemployment. I will not be technical, but rather I will ask simple questions. At the end, I will discuss the future and what to expect. What are wages? Common opinion seems to be that workers are paid too little and executives too much. People also tend to think of wages as something “sacred”. Most people think of their jobs as one of the most important parts of their lives. We depend on it to survive, thus personal feelings have a tendency to blur discussions about wages. Is it so, that wages are any different from other prices? Labour is a scarce factor of production. Hence, it is bought and sold on the market [ 10 ] 

like any other commodity. It is unfortunate that wages should be differentiated from other prices in the language of economics. The price of labour is simply just a price. In addition to the fact that labour is a factor of production, it is also the source of disutility. Workers do not value work only in regards to the immediate satisfaction received in the form of a pay check, they must also take into consideration the cost of forgone leisure. Workers may, however, overcome this disutility in several ways. They could justify the disutility with working for a higher power, for the “common good”, or simply because it might make their minds and bodies strong. As stated above, a wage is nothing more than a price, the price for which workers are willing to sell their precious time and skills. Both workers and employers engage in voluntary mutual beneficial trade, trading value for value. People work for the sole reason that they want to reap the fruits of labour.

A wage is nothing more than a price

Determination of wages The most obvious and easy way for workers to compete is by the price they charge for their labour. Furthermore, workers can compete on efficiency or other attributes. Ultimately, all relates to the price paid. Based on the continuous competition between workers and employers, markets will ultimately determine the correct price. Each individual is special in its own sense and therefore employers will value each individual differently. It is the abundance of a certain skill or attributes, that plays the most important part in the determination of wage rates. Consider the simple example of a film production; the actor obviously adds more value to the overall production than the cameraman, as cameramen are more common than high quality actors. The sum of the prices an employer pays for the factors of production, must therefore at least equal the price of the product he sells. There are several factors which affect how this process works, and markets will determine the correct price. Important factors for capitalists are specialisation and division of labour. Specialised workers will lead to more efficient firms, and ultimately increase the overall wealth of society. Wage earners make up the majority of people in a society. It is ultimately wage earners who will determine the prices of goods and services. Wages in the respective industries will be determined


30%

26% 27%

25% 20% 15% 10% 5%

6% 5% 5% 5%

8% 8% 8% 8% 7% 7% 7% 7%

10% 10% 11%

11% 11% 11% 11%

12% 12% 13%

14% 14% 15%

16% 16%

ĂŁ Unemployment.

(*September 2012, **October 2012, ***Q 3 2012)

by the consumer. In a free market, wages across industries will tend to equal over time. Businessmen are under the necessity of producing what consumers ask for, and of selling goods at prices the consumers can afford and are willing to pay. It is human action working at its finest. This is one of the most important economic principles. This principle is, sadly enough, constantly violated by highly ranked economists. When the market determines wage rates it also sets the ceiling of wages. The ceiling of wages will be determined at the instant labour being bought and sold. It also rest on prices of all other complementary factors of production. In a changing economy, there are several factors affecting such relationships of prices. We have to take into consideration employers` and workers` time-preferences, and also their outlooks for the future. In addition, wages depend on the workers ability and motivation for moving, acquiring new set of skills, gaining education and their personal value of leisure. Unemployment and what it means Following the principle of supply and demand, unemployment tells us that the supply is greater than the demand. The demand for a commodity is usually low when the price is unsatisfactory. A producer would usually lower the price on his products if he observes that the demand for his

products is decreasing. The same principle holds for workers, it works, however, in the opposite direction. Workers would offer their labour at a lower price in order to attract employers to demand their services. The truth about unemployment As the chart above shows, unemployment rates vary from 4.5 % to as high as 27 %. The situation is quite bleak and utterly disturbing. The implications such levels of unemployment have on Europe, and societies in general, are disastrous. Moreover, all income that is derived from taxation

The public sector is detached from the private sector's requirement of profitability. Therefore, the public sector leads to large inefficiencies

* ES

EL

IE PT

C LV Y ** * SK

LT

IT EA 17 BG

PL EU 27 H U **

FR

**

SI

EE

FI SE

K

D

CZ U K*

M T BE

E N L RO

D

LU

AT

0%

Source: EUROSTAT

and used in the public sector should be regarded as extremely non-productive for society. The reason is simple: The public sector is detached from the private sector's requirement of profitability. Therefore, the public sector leads to large inefficiencies. This will lead to a waste of society`s resources. To measure real unemployment one only needs to examine who are the producers in the economy and subtract the number of people who are able and willing to produce but who are not employed. Hence, current official unemployment rates deceive the real situation in the labour markets. What could cause unemployment to reach such levels? If we assume that people need to work to be able to live and prosper, every person able and willing to work would be employed in a free market. Hence, real unemployment rates would tend to get close to zero. The current situation tells us that something is not working properly. The root to the problem can be traced back to several features in the economy. The main one is regulation of labour markets. We start by looking at the most popular of them all: Minimum wage laws. A good intended policy with outcomes opposite of their intentions. A minimum wage law is essentially a law making it illegal to hire someone at a rate lower than what is set by the   [ 11 ]


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[ 12 ] 

Employers would then compete on hiring productive workers and this would determine the fair wage. If the minimum wage is such a great tool for increasing workers’ well being, why stop at a certain rate? Why not set the rate to 50 or 100 euros per hour? Wage Rate

government. The worst part of such laws is that it can deprive man of the ability to work. Most importantly, it hurts the group of people the minimum wage law is intended to help, namely the unskilled and the young. The main sources of acquiring important and highly valuable skills are by getting work experience. This will allow workers to gain highly valuable skills, making them more attractive for future employers. If minimum wages are set above the unhampered market rate, unemployment will follow. As you can see (figure ❶), a minimum wage set above the equilibrium rate will cause unemployment. I do not consider this graph to hold for an economy as a whole, but rather as industry specific. Workers are willing to supply more labour at the new rate, but employers` demand for labour decreases. I will not discuss all kinds of regulations on labour for the sake of simplicity. The reason for this is that other regulations, may it be taxes on hiring, or minimum hours per week; they all have the same results. It increases the risks and costs of hiring, making it more difficult for businesses to grow and prosper. Businesses should be able to hire as many people possible at whatever rate and conditions the two parties voluntarily agree upon. What is often misunderstood is that minimum wages do not help the workers on the expense of the employers. What it does is that it helps the most productive on the expense of the less productive. Workers who create value above the given minimum wage rate will not be laid off, and their wage would obviously increase to the new rate set by the government. The sad part is that the most productive workers usually do not require the minimum wage law, simply because they are creating significant value to employers and thus would be able to bid their wages up over time regardless of such policies.

Figure ① Supply of Labour

£4,20 £3,80 Demand for Labour

cies advocated by most western nations over the last decades. These easy money policies lead to abnormal misallocation of resources. This happens because by printing money, or easing credit, the business cycle and people's time preference gets distorted due to the change in interest rates. Instead of dealing with their misdoings right away, they continue to inflate at even higher rates in order to solve the problem. This strategy delays the onset of a recession, but guarantees a more severe and protracted one. For further reading on these matters, I recommend studying the Austrian Business Cycle Theory and the great works of Ludwig von Mises and F. A. Hayek.

750 1000 Number of Workers

At the end of this article there is a map (figure ❷) portraying statuary minimum wages in Europe. Countries painted in grey, such as Norway, Germany and Italy do not have any statuary minimum wage. Minimum wages are however negotiated in various collectively bargained agreements. The minimum wage is from there automatically applied to all employees in those occupations. The high unemployment rates do not come as a surprise using the microeconomic principles discussed above. However, when unemployment rates reach levels as high as 26 % and over 50 % among people aged 15-24, it is evident that we are dealing with a large and structural problem. Minimum wages would most likely not have such adverse effects, even though it is technically possible. Regulation on labour markets is definitely one of the sources to this structural problem, but we have to combine it with other factors, such as taxes and other kinds of regulations. The main source to the problems discussed can be traced back to the inflationary monetary poli-

What will the future look like? Even if the problems are severe and highly complex, I still believe that simply deregulating the labour market would be beneficial. The positive results will not be evident in the short run, but in order for the conditions to get better, it has to be done. One of the reasons why I am in favour of deregulating the labour market is that in order to achieve a reduction in prices and for the economy to stabilise, and most importantly to let people understand the consequences of years of misdoings, there must be a reduction in wages. When countries experience high unemployment rates, it would make it easier for businesses to thrive if the wheels would spin with less friction. In a situation like the one today, what the economy needs is a cold shower. We have come to this point due to the misdoings of politicians, and they are therefore responsible for cleaning up the mess. Unpopular decisions have to be made and that quickly. Sadly, politicians will most likely never impose strategies as I have discussed above, and the reason for that is simple: Politicians buy votes with advocating more of what people want.


290 287 232

680

1462 1456

1244

353 1472 312

1801

327 323

1426 763

157

371 148 412

566

748 684 No statuary minimum wage

< 500

500 - 1,000

Figure â&#x2018;Ą : Minimum wages in European countries as of July 2012.

The common man does not usually understand economics, and therefore to vote for someone who wants to cut their wages or the like, is not probable. If a politician was to advocate such strategies he would commit political suicide. Elected representatives are only temporary care-takers and therefore their only goal is to maximise their short-term goals. The cost of their actions can easily be passed on to future generations. If nothing as discussed above is done in the near future, I think we will have a significant price to pay. One of the reasons why I am not overly optimistic is because of today`s situation with large budget defi-

cits and government debt combined with unsustainable unemployment rates. If wages decrease it would lead to lower tax income. Lower tax income results in even larger public deficits, and if there is something governments does not want when they currently can't service their debt loads, it is less tax income! Years of misallocation of resources caused by central banksâ&#x20AC;&#x2122; inflationary policies need to be reversed. Instead, central banks continue to engage in easy-money policies, the same kind of policies which led us here in the first place. Einstein`s definition of insanity is hereby satisfied. Hopefully I have been able to give

> 1,000

No data available

Source: EUROSTAT

you a better sense of why we are where we are today. Even though it would help noticeably to deregulate labour markets, much more has to be done in order to have long lasting prosperity. Keep in mind that the root of the problem is simple; Governments have grown to unsustainable levels. Debt is what is causing governments to further lead their economies towards a halt. The more debt they have, the more tax income they need, and the more they levy on the people, the more inefficiency we will experience. Actions have to be taken. If else, the outlook for the future is not even slightly entertaining. â&#x20AC;&#x201A; [ 13 ]


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Why being a turkey before Thanksgiving is

not a good idea ✎ Morten Fylkesnes

Currently Apple Inc., the world’s largest listed company by duced, hopefully offering some mind-tinkering revelations that market capitalisation, has 54 analysts tracking their performance. should be helpful to anyone investing capital in the markets. Ever since the late mastermind Steve Jobs introduced the i-products to the market, analysts’ estimates for the company Why we suck at probabilities performance have gone higher every quarter, without looking A rather fair assumption in the wake of the late 2008 crisis is down. Until recently. For the last five months the share price has that the financial sphere includes a population who, indeed, has seen a near 40% collapse since its 52-week high, just south of $700. a lot of confidence in their own abilities. Alas (and perhaps more Apple still continue to bleed from its “bombshell” quarterly re- surprisingly) in the same population, a somewhat innumeracy is sults, just below market expectations. The last time Apple missed also rather common. Suppose the weather forecaster on T V pretheir estimate for a second successive quarter was ten years ago, dicts (say, with 80% probability) a clear sky tomorrow because of in 2003. Yet, with a growth estimate of around 60% last year such little wind and increased pressure (air density). The next morning a high price (relative to earnings) could be considered reason- you arrive at work soaking wet, cursing a certain anchor-man’s inable. However, what has happened over the autumn and winter competence for not suggesting taking the umbrella. Concluding is a classic play of market irrationality or humans behaving like hu- that the forecaster is unreliable based on a single instance is the mans. By mid-August last year, analysts had slashed their growth “data beats your lying eyes”-fallacy; forgetting that an 80% probaestimates for this year’s EPS growth by two-thirds. Nonetheless, bility of something happening also implies a 20% chance of it not while the price was tumbling over the next nine weeks in a row, happening, i.e. no reason to feel surprised by rain, unfortunately. all you could hear on Bloomberg, FT or any other financial re- Similarly, as will be introduced throughout this article, the hulated news-provider was analysts literally every day telling us man mind prefer heuristics or comprehensible stories, and are (eshow cheap Apple was at 650, then 600, then 550 and so on. So, one pecially) prone to overlooking logic when it comes to probabilimight wonder why the guys who actually makes the estimates ties and decision-making with stakes (risks) included. It turns out in the first place, after cutting the growth rates from 60% to 20%, that even if you are the CEO of a Fortune 500 company, an elite were on T V telling you to keep buying the stock? equity analyst or a graduate trading your precious savings, when One does not need a Harvard degree to work out the relation- faced with choices and assessments involving risk and probabiliship between a decline in growth and what is going to happen to ties, your decisions will often be based on heuristics, and not the the share price of a company, yet today there are still 39 analysts “rational optimal choice”. Heuristics are everyday simple menrecommending buying A APL shares. Whereas the analysts are tal “shortcuts”, possibly deviating from logic, which people base watching Apple more carefully than ever, this article is going to (complex) decisions on. In an economic framework, the most turn the tables and direct its attention on the market and to the promising ideas come from what is called prospect theory, introanalyst themselves. As introduced above, understanding why you duced in the late 1970’s by Daniel Kahneman and Amos Tversky. should be very critical about any estimate or forecast is rather es- Their seminal work on behavioural finance, also later awarded the sential to any investment-related action. Furthermore, in the fol- Nobel Memorial Prize in Economic Science (2002), offers some lowing sections, several human behaviour phenomena are intro- interesting contrasts from the conventional textbook alter  [ 15 ]


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native; expected utility theory – where the rational agent operates however, is the incentive to not be worse than the other analysts regardless of the reference point. (E.g. with a 98% probability to and not hurting the overhead-business (i.e. banking and mergers win, would you bet $10 to win $100? What if it was $1,000,000 to and acquisitions activity with the respective company), rather win $10,000,000? If you are indifferent between the two bets, you than being correct. Specifically, it hurts an analyst a lot more are likely either very rich or poor with numbers, possibly both). to be completely off (blowing his reputation and possibly being Another phenomenon, particularly found in social science and replaced), then it yields him credibility to be in line with othfields with unexpected and ambiguous events occurring, is the ers (keeps the job). Why take the risk? One of the killer trades “narrative fallacy”; a preference for stories to data. Events does not last decade would have been shorting Lehman Brothers in 2008. always go down the road as we had anticipated in the first place. Surely, someone following the financial sector and in particular Therefore, we are often trying to explain history by evolving a Lehman would spotted some forthcoming gloom and doom, and story around what happened or fitting history neatly into recommend a sell? Turns out, in the beginning of the year, a predetermined story (cherry picking) – or both. there were 17 analysts covering Lehman. The breakHowever, the financial market is an organic down was nine had "hold," five at "buy" and two creature by humans and not an exact prehad "strong buy" and by headcount, only one dictable science. For that reason, dealing had sell (although, this recommendation effectively within such a context requires came not of fear of collapse but because it the acceptance of randomness and its was seen as overvalued). In fact, a paper influence (which cannot a-priori be inby Pablo Fernández López, and Javier cluded in a story). Aguirreamalloa Arízaga published last Irrespective of model and theory, year, confirms the herd mentality, beating the market has never been easy. As introduced in the previous “Indeed, only one out of a total of passage, most investors prefer coun106 (emphasis mine) reports issued selling analysts, online forums, bankers, by analysts between January and Google search engine, etc. rather than September of that year recommended looking at the facts (empirically) when selling Lehman stock.” making investment decisions. Even if you do not believe in technical analysis (forecasting Another human behaviour effect enlightened by price levels by charting), why argue with the market? P hoto: Dennis Skley prospect theory is anchoring – When estimating a numDon’t listen to the analyst (or anyone) on Bloomberg telling you ber (say, a distance, a percentage, a stock index level or a share to buy Apple when the price, P/E, EPS and so on is telling you price) people tend to start from an offered (but not necessarily otherwise. Let the market tell you the direction. In 99 out of a 100 applicable) available number. I.e. is the kilometres of road in the cases, an analyst (even if he works for Goldman Sachs) does not U.S more or less than 150,000,000 km? By the same fallacy, when know something the market doesn’t know. Don’t play the sucker’s dealing with confidence intervals, say, asked to estimate a 98% game, at least get the odds in your favour: the trend is your friend, range, people still miss the correct answer 30-40% of the time, until it bends. lacking enough deviation around their best estimate. (Try make a 98% upper and lower boundary for the question in italic above. Curb your enthusiasm The answer is found at the bottom of this page). For many market participants, certainly agents relying on foreForecasts and estimates may give you a ball park clue of where a cast models, uncertainty and volatility means bad news. In the particular stock or index could be heading, but even if being a hissmooth linear narrative world, surprises are usually on the down- torical, statistical or educated estimate, it is still just an estimate, side, e.g. when things are not “in line with consensus or expec- if the market disagrees, you’re in trouble. Again, and sadly for tations”. Such a system is very fragile and must be handled with investors, the same anomaly described above applies to brokers care. “hot stock” or best picks of the year, those usually covering finanLet’s turn back to our 54 Apple analysts. The earnings game is cial front pages in January. A short backtesting done by The Wall all about accuracy, right? Analysts generally make a living of fore- Street Journal in 2011, looked at the performance of the 10 most casting company earnings four times a year, plus recommending cherished (with most buy recommendations) and most loathed some market over-performers in-between. The delinquent part stocks of Wall Street analysts for the impending year. For (Correct answer, U.S .road length 6,550,030.08 kilometres or 4.07 million miles.)

[ 16 ] 


2010 and 2009 the favourite 10 returned 24% (13%) and 22% (26%) percent respectively, with the index return in parenthesis. Not bad, but here’s the caveat, including the -10- most hated stocks in your portfolio had yielded you 32% and 70% (!) over the same two years (going back to the crisis year 2008, the numbers are about equal for all three portfolios). The lessons here is that as humans we are comfortable being almost right most of the time, forgetting about those 5% - 2% probability of, say, rain, missing an earnings estimate, or a Greek default. The issue is easily transferable to other domains that might help for amplification. Consider a doctor or surgeon. Even if he has the remedies for your everyday ailments (infections, headache, allergies, stitching, cosmetic surgery etc.), his usefulness ultimately comes down to detecting (and curing) the low-probability but high impact illnesses, (think cancer, heart diseases or other complex/emergency interventions). Same applies to driving, most of the time driving without a seatbelt would not harm you, except that one time. These are areas where the downside is typically very large (perhaps the largest) and upside is limited (status quo). Fortunately, in financial markets, we have the same asymmetrical options, but also to the upside. The final section offers a primer in unpredictability and how uncertainty and shocks plays an underappreciated important role in our lives. The Black Swan theory and the turkey 500 years ago, an elite called Renaissance Men were the go-to guys for pretty much anything challenging. Boasting expertise in several different subjects, gentlemen such as Newton, Galilei, Da Vinci, Leibniz, were the so-called polymaths (leading experts in many scientific fields). And in 16th century, there were still many unsolved mysteries (spherical Earth, algebra, exploration and so on). Some questions and happenings where thought of as not feasible or impossible, even for polymaths, and sometimes coined as black swans, something that was yet to be seen in the Old World (Europe) at that time. However, since the Dutch explorer Willem de Vlamingh discovered black swans in Australia in the 17th century, the term has been used with regards to falsification of a proposition and debunking alleged beliefs (via negativa). In 2004 Nassim Nicholas Taleb introduced the Black Swan Theory in his book, Fooled by Randomness. Taleb, a senior derivatives trader turned scholar, applied this metaphor to the financial domain and extended it to other areas in his 2007 book The Black Swan. Despite presented with two books on the subject, people are still struggling to understand the fundamental idea behind it. A 2007 assertion from Taleb in the New York Times may very well serve as illumination for our purpose too,

"What we call here a Black Swan (and capitalise it) is an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme 'impact'. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable." "I stop and summarise the triplet: rarity, extreme 'impact', and retrospective (though not prospective) predictability. A small number of Black Swans explains almost everything in our world, from the success of ideas and religions, to the dynamics of historical events, to elements of our own personal lives." Pay close attention here, by definition we are not able to predict or model these Black Swans (the first attribute) or their impact (second), but we often think otherwise (third, particularly applies for finance and especially equity analysts in January). But as humans and with heuristics as our decision-making tool, a neat story, some nice charts and an analyst (or two) on the phone claiming that Apple has not failed on earnings in the last 10 years, often convince us to think that it’s not going to happen this time either and commit capital accordingly. Many turkeys currently residing in (but not restricted to) North America are fed by their butcher every day. And each day the butcher comes over handing them nourishment, the turkeys become more and more convinced that all is well and the butcher is just being nice, giving them a free lunch (although this should ring a bell). After a thousand days, say, the morning of November 24 (a.k.a. T-2), the butcher comes over for a special occasion, Thanksgiving. The turkey’s statistical assurance that the butcher was never going to hurt him, was hit by a Black Swan Event (from the turkey’s point of view). Throughout this article we have been acquainted with several heuristics and fallacies that humans often have a habit of using. Although these are part of our natural behaviour as humans and can often be both precise and effective, it turns out they are not particularly fruitful for investing purposes. The key take-away lesson is, a narrative cause and effect approach, be it as an analyst, investor or a turkey, is often unjustified and ill-advised (possibly dangerous), especially in a capital market setting. As Taleb puts it, “You are worse off relying on misleading information than on not having any information at all. If you give a pilot an altimeter that is sometimes defective he will crash the plane. Give him nothing and he will look out the window.”   [ 17 ]


◆ Macro  ◆ Finance  ◆ International Experience  ◆ Careers

Financial leverage and capital structure

✎ Amaar Malik

In aftermath of the Lehman Brothers collapse and the subsequent economic turmoil, the economic environment has been characterised by ongoing challenges and changing regulations. On the one hand, the Basel III requirements, which advocate for stronger equity ratios and lower levels of debt financing, have been implemented. On the other hand, major investment banks such as Goldman Sachs are currently advising their clients to ‘’borrow as much as they can for as long as they can.’’ Thus, the problem many banks are facing today is measuring the risk trade-off between equity and debt financing as they seek to find an optimal capital structure in an environment with excess liquidity and low interest rates. Recent market developments Firms that want to raise capital have three main choices. They can issue shares, take on debt (issue bonds and take out bank loans) or retain a bigger portion of their profits (increasing the plowback ratio). Most companies’ capital structure consists of a mix of debt (20 %), equity (10 %) and plowback (70 %). After the financial meltdown of 2008, however, the following economic turmoil in Europe triggered activity in the corporate bond markets. As interest rates were historically low, investor demand for corporate bonds had increased due to low government bond yields. In 2013, continued accommodative monetary policy, higher equity valuations, a pickup in inflation expectations and stronger M&A activity have led to a reversal of this trend as equity inflows for the first time since 2008 have surpassed fixed-income inflows. [ 18 ] 

Equity versus debt financing Conventional thought among regulators and policymakers to date has been that lowering the level of debt financing reduces a firm’s exposure to risk. Hence, policymakers have for the last five years been urging entities to raise more capital, improve equity ratios and deleverage balance sheets. According to the OECD the global GDP will shrink by .15-.5 % when the Basel III requirements kick in as banks will reduce lending in order to strengthen their capital buffers. This process has already started as equity and reserves as a percentage of assets in the euro zone banking sector has risen since last summer. The question as to whether the benefits of this industry restructuring outweigh the potential costs on global GDP is worth analysing. In corporate finance, the management’s main goal is to maximise their shareholders value by creating rates of return that exceed their cost of capital. The restraint is to maximise the share price while also designing an effective capital structure to support the corporation’s strategy and minimise the risk of financial distress. Assume a world without taxes, transaction costs, bankruptcy risks and differences in borrowing costs. There are two firms whereas one of them is unlevered (i.e. financed by equity only) and the other one is levered. Both firms deliver the same operating income. The investor can adopt an investing strategy that is as follows: buy 10 % of the shares of the unlevered firm, and be entitled to 10 % of the firm’s profits. For the leveraged firm the investor can buy the exact same fraction of both the debt and


equity. The payoff will be the same for both firms. Given efficient markets where both strategies yield the same pay off, they must also have the same cost. Thus, given perfect markets where everybody can borrow at the same interest rate, investors can cancel out the effect of changes in a firm’s capital structure. This is the main argument in the Modigliani and Miller theorem that states that the market value of any firm is independent of its capital structure. The most common measure to quantify a company’s cost of capital is the Weighted Average Cost of Capital (WACC) that increases if a company’s cost of equity or cost of debt increases as higher risk leads to a decrease in valuation. WACC =

E D * Re + * Rd * (1 − Tc) V V

E = equity D = debt V = D+E

WACC EXCLUDING TA X ES Cost of Equity

30 % 20 %

WACC

10 %

Cost of Debt

00 %

0

0.5

1.5

2

2.5

Debt Ratio

This chart shows that the cost of capital is unaffected by the firm’s debt and equity mix.

Re = cost of equity Rd = cost of debt Tc = tax rate

This equation shows that three variables can change a company’s cost of capital, i.e. cost of equity, cost of debt and taxes. The cost of equity is calculated by the CAPM model, where we assume that only the beta can change by a company’s behaviour (as we assume that the risk free rate and the market risk premium is given by the market). The cost of debt is measured by the company’s credit rating and we assume rational investors that require higher returns on risky investments. Excluding taxes from the equation, we observe that a firm can create financial leverage by undertaking extensive borrowing and thus create higher returns (as the interest rates are fixed). However, this additional return comes at a price, which is the increase in risk and thus an increase in the return required by shareholders (cost of equity). According to the Modigliani and Miller theorem, these two effects will exactly offset each other and ensure that the WACC remains constant (figure ❶). According to the Modigliani and Miller theorem a change in the debt/equity ratio leads to a change in the expected return and cost of the securities, but not any change in the company’s cost of capital (WACC). Introducing a constant tax rate, however, we observe that debt financing offers a tax benefit (because the debt side of the equation is multiplied by (1-Tc) and we assume 0 < t < 1). Thus, the WACC declines because debt interest is tax-deductible (figure ❷). The Modigliani and Miller theorem fails to take into account the reality as most of its assumptions are violated. In the real world, there are taxes, transaction costs, bankruptcy risks and

1

WACC INCLUDING TA X ES Cost of Equity

30 % 20 %

WACC Cost of Debt

10 % 00 %

0

0.5

1

1.5

2

2.5

Debt Ratio

As this chart shows, a company can strengthen its financial position by taking on debt and drive down its cost of capital.

M A R K ET VA LUE 400mn

PV (Financial Distress) PV (Tax Shield)

300mn 200mn

Value of Equity

100mn 0

0

0.5

1

1.5

2

2.5

3

Debt Ratio

This chart shows that this firm’s optimal debt ratio is 2, which maximises the company’s market value.

  [ 19 ]


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Banks generally benefit from higher debt ratios than other firms differences in borrowing costs. Gathering all of those variables in the parameter PV (Financial Distress) the value of the firm can be broken into the sum of three parts (figure ❸): Value = Equity + PV (Tax shield) + PV (Cost of financial distress)

do, might squeeze out the smaller players in the banking sector in a time regulators are trying to reduce the systemic risk by breaking up the ‘’too big to fail’’ institutions. Thus, smaller players will suffer as their profitability takes a hit (as lending out becomes relatively more expensive) and they face the risk of being acquired by the bigger banks. Implementing such reforms in an environment where banks’ profitability has been slashed and the industry is characterised by job cuts, bonus stops and smaller shareholder returns has historically led to banks engaging in risk-taking in their search for yield as they are under pressure to generate a return on equity that exceed their cost of capital (WACC). Moreover, there are indications of the re-emergence of shadow-banking and risky off balance sheet activities as banks look to cut how much it sets aside to cover defaults, while also keeping assets such as loans on their balance sheets. Ultimately, what we already are seeing is that banks are announcing to specialise in only their niche areas and thus undermine their economies of scale benefit, which has been described as the only advantage of ‘’too big to fail’’ institutions by economists such as Paul Krugman.

Although, the cost of financial distress varies heavily from firm to firm, and is difficult to estimate, the theoretical simplification provides some valuable insight. Given that the Modigliani and Miller theorem’s assumptions do not hold, the main point is that the cost of debt is not linear. As a firm's debt level increases, the costs connected to financial distress and the total cost of capital increases too. The optimal debt ratio is given at the level of the present value of the tax shield of further borrowing is exactly offset by the increase in the present value of the cost of financial distress. Hence, a firm can find its optimal capital structure, and can maximise its market value by choosing an optimal debt/equity mix. A vital point is that the debt/equity ratio differs from firm to firm. Companies with tangible assets and a large amount of taxable income, such as ExxonMobil, usually have high debt ratios. Companies like Facebook, which are characterised by risky and Summary intangible assets have lower debt ratios and rely more on equity Debt financing enables banks to leverage their balance sheets financing. As the banks’ main assets are financial assets such as and create higher returns on equity as the WACC declines. As government bonds, and they also generate a large taxable income banks hold a limited number of intangible assets and generate to shield, banks generally benefit from higher debt ratios than a large taxable income to shield, banks generally benefit from other firms. higher debt ratios than other firms. Although, borrowing seems beneficial in this environment with record-low interest rates, Implications of new regulation banks might not be able to take advantage of it as they are adaptIntroducing new capital requirements such as the Basel III ing to new regulations and building capital strength. Thus, policymight lead to a deviation from the banks’ optimal capital struc- makers have to ensure they do not become too aggressive impletures. This can lead to further mispricing in a market where menting new capital requirements as banks might be tempted to Goldman Sachs, JPMorgan Chase, Morgan Stanley, Credit engage in risk-taking in their search for yield. As banks are seekSuisse and Deutsche Bank all have price/book ratios that are be- ing to generate a return on capital that exceeds the cost of capital low one (which implies that the market prices their assets lower (WACC), capital restraints may force significant deviations from than their accountants). Furthermore, introducing one-size-fits- the banks’ optimal capital structures. all capital requirements, which the Basel III requirements aim to [ 20 ] 


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Financial derivatives: A historical perspective ✎

Fabian Harang

Derivatives are mystified instruments, which combined with but not the obligation, to sell an underlying asset at an agreed their central role in the financial crisis of 2008, have resulted in price, at some agreed time in the future. Today, there exist numermassive attention. Some people endorse them, while others hate ous types of options with the two most common types being the them. Warren Buffett referred to them as ''Financial weapons of European option and the American option. The European may mass destruction'' in his annual report for Berkshire Hathaway in only be exercised on expiration of the contract, but the American 2002. There is now a debate going on as to whether derivatives are option can be exercised at any time until expiration. beneficial for the economy as a whole or not. This article will give a historical perspective on derivatives, as well as explaining some Some highlights from the history of derivatives. basic concepts. In the book of genesis, chapter 29, Jacob was interested in marThe general definition of a derivative from Wikipedia is: “A de- rying Laban's daughter, Rachel. He agreed with Laban to work rivative is a term that refers to a wide variety of financial instru- for seven years to get the right to marry Rachel. This can be seen ments or contract whose value is derived from the performance as the first purchase of an option. The option premium being of underlying market factors, such as market securities or indices, the seven years of labor, and the underlying good being Laban’s interest rates, currency exchange rates, and commodity, credit, daughter, to which Jacob received the right, but was not obliged, and equity prices.” to marry. The seller of the option was Rachel’s father Laban. This One of the most basic derivatives is called a forward contract. incident, which apparently took place around 1700 BC, is not only A forward contract is an agreement to buy a certain good (com- seen as the first option like agreement that we know of, but also modities, equities, interest rates etc.), at an agreed price, at some the first default on such. At settlement date, Laban required time in the future. One example could be a farmer selling the Jacob to marry his older daughter Leah, as it was custom to give grain he will harvest in six months, today. The advantage of such away the youngest daughter first. Jacob did marry Leah, but bea contract is that the seller of a forward contract secures his future cause he still loved Rachel, he bought another option to marry income, and the buyer secures his future payment, at an agreed Rachel, again, costing him seven years of labor. As bigamy was price. Another important feature with forward contracts, and allowed at the time, Jacob ended up with two wives, and twelve most derivatives, is that the contract itself can be traded in the sons. The debate among finance academics still goes on whether secondary market. This is probably one of the main reasons why the contract Jacob purchased from Laban was a forward contract such contracts occurred in the first place, as we will examine later or an option; whether he was obliged to marry the daughter or if on. he had a choice, after working for seven years. Another very important derivative is the option contract. An Another interesting story is from the first book of ''Politics'' by option is a contract where the buyer pays an amount for the right, Aristotle in 350 BC. In par XI he tells about Thales of Miletus. [ 22 ] 


Feb 3

200 Dec 12 150

100

Nov 25

Feb 5 Feb 9

Dec 1

50 Nov 12

ã Tulip price index (1636-37)

May 1

Source: Earl A. Thompson in Thompson, Earl (2007), "The tulipmania: Fact or artifact?"

Thales was a poor man that was skilled in reading the stars. One rice traders started trading rice on future prices. At the rice winter he saw that there would be a great harvest of olives in the market in Osaka, they arranged standardised contracts to trade upcoming summer. Having little money, he gave deposits for on different delivery months. These contracts looked a lot like the use of the olive-presses in Chios and Miletus. As no one bid todays futures contracts, in their standardised form, although against him, he won the auction at a bargain. When harvest time it is unclear whether or not the contracts were marked to marcame, and many people wanted to use the presses, he could rent ket. The agreements were kept in a book at a clearinghouse, and them out for any rate he wanted. Thales made a lot of money by in- were settled within the contract periods. The contracts were setvesting in something that could give a payoff in the future, a sort tled in cash, and the counterpart had to pay or receive the differof a forward contract. ence between the spot price in the market and the agreed future If you look closely in the history books you can probably find price. All future trades were done through the clearinghouse, so many stories like this, people agreeing on exchanging goods at if one trader defaulted, the clearinghouse was responsible for the some fixed “price” at some time in the future. payment. The clearinghouse operated with strict credit lines and Around the 17th century the first forward contracts, in the way margin requirement and had to adjust their risk. This type of rice we know them today, were traded in the Netherlands. The traded trading was operating until 1937. contracts were for tulip bulds, an asset that was considered to be In the beginning of the 19th century, the city of Chicago grew worth ten times the average annual income. People borrowed larger and larger, becoming a trade center for many commodities. money to purchase and speculate in the tulip bulbs. In 1637, the In 1848, The Chicago Board of Trade (CBOT) was established. bubble burst and the price of tulip bulbs was in free fall. Many The trading at the exchange worked much like it had done cenpeople lost all their money. This was not only one of the first fi- turies earlier. The traders made forward-like agreements, and nancial crises but also the first crisis involving derivatives. settled when the agreements where due. The big problem was the Hundred years later, on the other side of the world, Japanese risk of the counterpart backing out of the agreement if the   [ 23 ]


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prices moved too much. CBOT lacked a very important ingredient to make the trading efficient and secure to investors; the clearinghouse. The reformation of CBOT came in 1864. Over 50 different standardised forward contracts were made with the exchange as counterpart to transfer the counterpart risk from investors to the exchange. This was very similar to what the Japanese did over 100 years earlier. In 1919, the Chicago butter and egg board, a spin-off of the CBOT, changed its name to Chicago Mercantile Exchange (CME) and allowed members to trade futures. CME and CBOT have been the leading exchanges for derivatives and commodities to this day.

right way to eliminate risk and replicate an option's pay-off. The model changed the financial world. It was easy to use, and seemed to give accurate prices. The traders endorsed the formula immediately, and the volume in options trading took off. In 2008, the notional amount of all outstanding positions in the futures and options market traded at an exchange was $81 trillion according to the Bank of International Settlements (BIS). The notional value of the over-the-counter derivatives was $615tn in 2009 according to BIS. Now, 40 years after Black-Scholes, we recently had a financial crisis that many say was caused by financial derivatives, in particular credit derivatives. Collateralised-debt-obligations (CDO) and Credit-default-swaps (CDS) are both seen as heavy contributors to the recent crisis. Derivatives often have complex features that are hard to understand and thus difficult to price right. The models can be misleading, and the skepticism among politician, regulators, investors and common people to these instruments is profound. Still the benefit that companies and individuals achieve from using these instruments is huge. One thing history has shown is the importance of the ability to store future value and hedge unwanted risk. In 2010 the Dodd-Frank act was signed by President Barack Obama. This act is the most significant change in financial regulation, since the great depression of the 1930s. It was legislated to enhance consumer protection, transparency and market efficiency. Still some people argue that the regulation can cause inefficiency in some market places because of its complicated nature and uncertainty. Financial regulation will increase financial innovation, and financial innovation will increase financial regulation. This spiral will certainly go in to the future. What we will see in the future is highly uncertain, but it will hopefully bring more transparency and efficiency while we get more instruments that are tailored for different purposes.

The benefit that companies and individuals achieve from using derivatives is huge

The Midas formula The next evolution in derivatives trading came through mathematics. The big question was, how can you set a price on a right, but not an obligation to buy something in the future? The first person to find a sensible answer to this question was the French mahematician Louis Bachelier. In his Ph.D. thesis, “The theory of speculation” published in year 1900, he used stochastic processes and Brownian motion to model random behaviour in the markets. The theory was not well received in academia at that time. In the 1950’s, economist Paul Samuelson, a highly influential economist, discovered Bachelier’s work. The word spread, and in a couple of years, everyone was using geometric Brownian motion in their models on stock prices. Many people tried to calculate the value of the option by looking at the expected discounted pay-off, all of them using different discount rates. Often the discount rate was non observable, and would not serve well in real market situations. In 1973, Fischer Black and Myron Scholes derived what has been one of the most influential formulas in financial history, the Black-Scholes model. By using stochastic calculus, they derived a formula only dependent on actual observable data. The formula was based on the idea of perfectly hedging the option by buying or selling the underlying asset and a bond in the [ 24 ] 


Alternative marketplaces â&#x153;&#x17D;

Petter Kongslie

Approximately a quarter of all stock the main drivers of the growth in alterna- electronic marketplaces were created. The trading in Norwegian shares is now tive marketplaces we have seen in recent shares of the largest and most liquid comthrough alternative marketplaces. Cost, years. It had not been basis for all the new panies on the Oslo Stock Exchange are efficiency, infrastructure, latency and ano- platforms without a rapid development in now traded on several markets in Europe, nymity are the main advantages of trading technology" says Per Eikrem, a press con- most of which are located in London. through such marketplaces. The increas- tact and senior vice president of corporate This internationalisation has enabled alingly competitive nature of the market- communications at Oslo Stock Exchange. gorithms to function simultaneously on place has contributed to a higher degree of multiple marketplaces, and thus take adfragmentation in trading. A typical agent Algorithmic trading vantage of time delays and mispricing on may trade the same security on many difAlgorithmic trading is carried out by different marketplaces for the same secuferent platforms as she seeks to avoid mov- the usage of computers in order to place rity. ing markets when carrying out big volume orders on stocks and other securities. The There are many reasons why algorithtransactions. software's settings dictate the circum- mic trading has become more widespread. Regulatory authorities are losing track stances that must be present for an order The most important ones, however, is the of financial markets as markets are becom- to be executed. These settings may include mathematical accuracy and cost-efficiency ing fragmented. Traditionally, big volume absolute values that refer to time, price, or such pre-programmed algorithms offer. transactions were carried out under regu- quantity. Once this pre-programmed cri- Furthermore, this service also offers inlated and transparent terms. Proliferation terion is fulfilled, the algorithm will place vestors more options in terms of risk diof alternative trading markets, however, the order automatically. Due to the tech- versification of trades. Some people argue has impaired market efficiency and raised nological development, the increase in use that the rise in pre-programmed algorithissues concerned with transparency. In re- of algorithms has been a natural develop- mic trading is a natural development as cent years, less than half of the total trad- ment in the global markets. the increased sophistication in computer ing in Norwegian equities have been carThe European Markets in Financial softwares has led to automation in several ried out on the Oslo Stock Exchange, while Instruments Directive (MIFID) was im- other industries as well. Furthermore, supas much as 25 % of the trades have been plemented in 2007 and lead to increased porters of algorithmic trading have also carried out in the dark. "Technological de- competition in securities trading. As a highlighted the fact that their presence velopment and new regulations have been result, a number of establishments of new promotes efficiency by exploiting â&#x20AC;&#x201A; [ 25 ]


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"Even the exchanges' revenues have declined as a result of the increased competition and lower volumes in the markets after the financial crisis of 2008" Per Eikrem

market imperfections and short-term fluc- kers, regulators and trade systems. The tuations in valuation. OTC market is not as strictly regulated as "It is also challenging for firms to offer an exchange, which allows smaller compabest execution for their customers as this nies to attract capital easier in this market. requires that they must have lightning Unlisted companies that make their entry fast technology that can follow the order here is often in their early stages, and the books (algorithms) of multiple markets si- risk is higher than for companies listed multaneously. This has resulted in signifi- on exchanges. In addition to small busicant investments in networks and technol- ness start-ups, one may also find compaogy, while the revenues have been under nies that have fallen out of the exchange. pressure due to increased competition" is Investors in the OTC market want returns Eikrem`s verdict on the current situation. proportionate to the risk, so that the reHigh Frequency Trading (HFT) dif- turn is often higher than on the exchange. fer from traditional algorithmic trading Contracts and negotiations take place dias these algorithms perform a very large rectly in the market, so anonymity is not a number of orders and transactions in a top priority here, but the lack of reporting short time. There may be several thousand on trade has created concerns for governorders, changes and transactions within ments. seconds. These algorithms’ main goal is to “European governments are now workmake small low-risk profits several thou- ing on a new Directive (MIFID II), which sand times a day. among other things will address the im"Even the exchanges' revenues have de- perfections of MIFID. This includes the clined as a result of the increased compe- opportunity to monitor trades as well as tition and lower volumes in the markets shifting the trades towards regulated exafter the financial crisis of 2008," says changes”, Eikrem comments. Eikrem. Alternative Trading Systems (ATS) OTC In recent years, the number of trades Over-the-Counter (OTC) market is an that has taken place outside regulated exalternative to stock trading as it encom- changes has risen, which has forced many passes trading in unlisted companies. exchanges to merge in order to recapitalise Trade is conducted among investors who on their market share. The U.S. stock marmeet directly for trading. This market has ket has undergone a significant growth five players: companies, investors, bro- and innovation in trading platforms in re[ 26 ] 

cent years. Electronic markets have grown rapidly and become more diverse. The willingness to trade securities without the help of intermediaries has increased. The biggest factors driving these changes have been new technology, new infrastructure, new investors, new laws, new regulations and new products. A distinction is often made between two fragmented markets: Electronic Communications Networks (ECN) and Alternative Trading Systems (ATS). ECN is bid and offer run, while ATS as Crossing Networks and Dark Pools, order-driven. The way they compete with other exchanges is to offer lower latency and fees. The difference between ATS and the stock market is that the ATS creates additional value for investors by providing anonymous trading, reduced transaction costs and access to new markets globally. The first alternative system, crossing network, was developed in 1987 and marked the beginning of the ATS revolution. Crossing networks Crossing networks are markets outside the exchange developed by institutional investors. Buyers and sellers are directly connected with each other and large orders are intersected. This multinational trading platform matches buy and sell orders, for example, to the last transaction price in another large market. Buy and sell limit orders are held until there is a


"A typical agent may trade the same security on many different platforms" Per Eikrem

match. There is no price discovery as this market relies on other market prices. This attracts large institutions because they can execute large orders without moving the public market prices. If a large order is sent to an exchange, the order can be split up into smaller parts so that the price is influenced along the way. Dark pools Dark pools are private crossing networks with the difference being that investors are offered anonymity. There are no bids and offers involved, and they do not need to publish the order handling rules to the public, nor provide trading volume or the number of orders that are traded internally. Vendors cannot see listed prices, but they can place orders. Once the order is executed, it must be reported to the market. Investors who participate in dark pools are always at risk, both in terms of orders that are not carried out and sensitive inside information which may be leaked. If an investor does not get rid of her order, it can be passed on to a stock exchange to be executed. If an investor places purchase orders in dark pools that are not executed, it will mean that there are more buyers than sellers for that particular security. This leads to an increase in the price of the security. Trading in dark pools is therefore best suited for high liquid securities. This is because we find the most likely buyers

may trade the same security on many different platforms”, Eikrem comments. The SEC has recently charged the dark pool operator Pipeline Trading Systems (PTS). The charge is that they have not been honest with their customers about how they execute orders. This case will possibly allow the SEC to look back at previous regulations in such markets. It may cause new laws that the markets have to deal with in order to ensure that there is no confusion about what information should be made public. Dark pools have evolved a lot over the years and are now using systems that contribute to high frequency trading (HFT). Investors who have access to dark pools can now execute trades extremely fast. This implies that liquidity and transparency in the traditional market is reduced to smaller investors. A reduction of liquidity may result in fewer opPhoto: Oslo børs portunities to improve prices, which may ã Per Eikrem lead to the dispersion and the execution of and sellers with low price volatility. The orders becoming more expensive. A trend other risk is that information might be among some exchanges has been that they leaked from operators that govern trade have developed dark pools themselves in in dark pools. There is nothing to suggest order to not lose market share to the ATS, that they will never use the information to which is regarded as a major threat. their advantage, which implies that inves“There is still a very small share of the tors must blindly assume that everything total trades that are executed through is correct. dark pools. We also have the functional"Users are not necessarily superior to ity of the trading system of the Oslo Stock the new platforms, but they have more op- Exchange that is equivalent with dark tions to utilise. A typical agent (broker) pools", Eikrem concludes.   [ 27 ]


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Managing

Emerging markets How multinationals should shape their emerging markets strategies â&#x153;&#x17D; Louisa Brandt and Farzad Khoshnoud (Emerging Markets Team at Capital Magazine) Creating a powerful emerging-market strategy has moved to the top of the growth agendas of many multinational companies. 15 years from now, 57 percent of the nearly one billion households with earnings greater than US$ 20,000 a year will live in the developing world. Seven emerging economiesâ&#x20AC;&#x201D;China, India, Brazil, Mexico, Russia, Turkey, and Indonesia are expected to contribute about 45 percent of global GDP growth in the coming decade. Figures like these create a real sense of urgency among many multinationals (MNCs), which recognise that they are not currently tapping into those growth opportunities with sufficient speed or scale. Even China, forecasted to create over half of all GDP growth in those seven developing economies, remains a relatively small market for most multinational corporations: ranging between 5 to 10 percent of global sales; often less in profits. We have identified six core practices that the next generation of business leaders need to adopt in order to be successful in realising the business potential that emerging markets offer. These are: innovation, talent management, global corporate culture and values, risk awareness and mitigation, transparency, and ability to implement business strategies based on a more granular level.

do not always translate into maximised profits in emerging markets. Even if the consumer needs of a product would be the same in all markets, a company needs to supply a similar product at a very low price in a low-income economy because of the price sensitivity of the consumers. An example of this kind of cost-differential executed very well are the various global telecommunication service providers that offer similar services in their developed markets and in their emerging markets, but at a fraction of the price. However, most multinational companies struggle to reach the level of innovation necessary to truly experience success in emerging markets. When big firms try to innovate they tend to be slower than their local competitors due to organisational structures not being flexible enough and because of the sheer size of the firm. Another dilemma is that as soon as a firm have successfully innovated and brought a product to a local market, it is very tempting to believe that all emerging markets are homogeneous, and thus export the concept to another emerging market. Whilst this might work well, the product is possibly not capturing the full potential of the market. For any company, it is important to weigh relative advantages. Using innovation to adapt to local markets On one hand, it is beneficial for multinational companies to build Product standardisation is the possibility for a firm to offer a strong global brands with standardised products. On the other product with uniform characteristics that matches the needs of hand, they want to develop products targeted for local markets consumers in all markets. For a firm that strives to break into and with specific consumer demand. An interesting example of a develop their business in emerging economies, product standard- company who has succeeded in developing a product that works isation poses a problem because there are significant differences well in an emerging market is multinational brewer SA BMiller. in consumer needs, income, and literacy to name a few factors. The company struggled with supplying a low-priced beer that Hence, products that are targeted and sold in developed markets could attract additional consumers who would not be able to â&#x20AC;&#x201A; [ 29 ]


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Emerging markets will have a significant impact on multinationals' growth prospects afford the conventional but relatively expensive SA BMiller beer. For emerging markets, the company was able to produce beer from cassava, which is a local root crop that in Africa is taxed at a lower rate than conventional crops used for beer production. The result was an affordable beer that the local consumers enjoyed.

Equally important is to look over incentive schemes to make sure that they adequately motivate employees in emerging markets. If incentives are designed so that pay is aligned to a firm’s global performance, emerging markets that outgrowsthe global growth rate of the company will be de-motivated due to low payouts. A company could hence reallocate theglobal bonus pool to raise payouts in high-performing emerging markets. It is also crucial to recognise cultural differences when it comes to the various kinds of incentives that employees value. In some cultures, workers would for example value high salaries and prestigious titles instead of long-term compensation packages such as pensions and stock options. Naturally, a good understanding of local compensation preferences is key when trying to attract the best local talent.

Identifying and retaining local talents At a new market, multinationals tend to struggle to get the right people at the right place within the organisation. There is often a deficit of local leaders who have the skills needed to work both locally and globally and who understand both the local market and also the global operations of the firm. Often there is also a shortage of senior leaders, both home and abroad, with a truly global mindset, an understanding and experience of entering new undeveloped markets. A company faces strong competition for talent at all levels of seniority from both local and global competitors who compete Creating a globally coherent for competent employees. Hence, it is difficult to find employees corporate culture and values at all levels, and retaining them might be even harder. Successful To function across different cultures can be a challenge for executives in emerging markets might not be content working for multinational corporations as cultural differences must be adthe local branch of a global company and they might find other dressed. Strong corporate values that truly guide the everyday more attractive opportunities at local companies as these firms function of the enterprise can act as glue that holds a global comgrow global. It does not matter if an executive leaves because he or pany together, speeds up decision-making processes, and imshe sees little possibility of upward mobility at the local branch or proves employee attraction and retention. When the company if he or she is poached by local competitors- the result is the same: values are communicated clearly by top management, behaving a shortage of competent staff at the top. in accordance with these values will become intuitive even in reIn order to combat this problem, companies need to make sure mote locations far from the corporate headquarters. that there are multiple ways for local leaders to develop and move The company values must also resonate with the personal up in the organisation. One approach is to invest in training and values of the employees and the values therefore need to guide development of local leaders and make sure to make the most use hiring decisions at all levels. To become cemented in the organiof them in the global organisation. One way of achieving this is sation's culture, everyone must be held accountable for living up to use expat programs where potentials from emerging markets is to and demonstrating the company’s values in their day-to-day stationed at the global headquarter. The expat programs can vary work. Because of this, values need to be incorporated intocomin length. pensation and promotion decisions. A company could also shift more responsibilities to functional or geographical hubs in emerging markets instead of man- Assessing and mitigating relevant risks aging those markets from the head office. An example of this is Emerging market investments are exposed to additional the Cisco Globalization Center East in Bangalore. The leaders risk compared to developed markets, including accelerated trained in Bangalore will account for 20% of Cisco’s senior leader- inflation, exchange rate fluctuations, adverse repatriation ship team in emerging markets. laws and fiscal measures, and macroeconomic and [ 30 ] 


political distress. These elementsclearly call for a differentap- the difficulties from the beginning, adopt a transparent business proach to investment decisions. model, and be consistent and defend their policy of not acceptUnfortunately, the perception of the elevated risk leads com- ing bribery. By doing so, it may provide long-term sustainability panies to reject good investment opportunities and to underes- as the organisational values are protected and corporate scandals timate the performance of existing businesses. What should be may be avoided. a clinical evaluation of a company’s many investment decisions become distorted, affecting even the analyses used to evalu- Go beyond country-level and build ate a project’s risk-and-return profile. As a result, analysts and strategy at a granular level business managers overestimate the risk premium, assigning it A massive wave of urbanisation is propelling growth across the to levels that even substantial underlying risk would not justify. emerging world. This urbanisation wave is shifting the world’s Addressing these risks correctly may therefore lead to better in- economic balance toward the east and south at unprecedented vestment decisions for the multinational corporation. speed and scale. It will create an over-four-billion-strong global “consumer class” by 2025, up from around one billion in 1990. Creating credibility through transparency Moreover, nearly two billion people will be living in emerging This scenario plays out all too often in emerging markets: A market cities. These cities will inject nearly US$ 25 trillion into company wants to get a new facility up and running as quickly as the global economy through a combination of consumption and possible and assigns a manager to deal with regulatory obstacles. investments. The manager meets with a local official that makes it clear that for In order to accelerate growth in China, India, Brazil, and other $500 certain obstacles will be “resolved” and the project can move large emerging markets, it is not enough, as many multinationals forward quickly. The payment would be illegal, but the company do, to develop a country-specific strategy. Opportunities in these will gain millions in revenue by opening the facility sooner and markets are also rapidly moving beyond the largest cities, which the manager has thousands of dollars in bonuses riding on the often are the focus of many multinational companies. For sure, project’s success. What should he or she do? the top cities are important: by 2030, Mumbai’s economy, for exUnfortunately, bribery is not uncommon in emerging mar- ample, is expected to be larger than Malaysia’s economy today. Even kets. New York Times reported that a 2005 internal investiga- so, Mumbai would in that year represent only 5 percent of India’s tion at Walmart found evidence that executives in the company’s economy, and the country’s 14 largest cities will be 24 percent. Mexican subsidiary paid more than US$ 24 million in bribes to China has roughly 150 cities with at least one million inhabitants. officials in “virtually every corner of the country” to clear the way The emerging markets cities’ population and income characterfor the rapid expansion of the retail empire. Consequently, there istics are so different and changing so rapidly that consumption are two factors that are in work. Firstly, local officials can tell of a given product category is forecasted, over the next five or ten when a foreign company is in a hurry to get things done, which years by mckinsey, to range from a drop in sales to growth of five they naturally leverage. Secondly, local competitors may be “ac- times the national average. Understanding such variability can customed” to paying bribes, which gives a competitive disadvan- help business leaders to invest more shrewdly and ahead of the tage for multinational corporations (which wants to be bribe- competition rather than following others into the fiercest battlefree). The question remains, how can business leaders tackle this fields. problem? Emerging markets will have a significant impact on multinaBusiness leaders need to accept certain facts, e.g. that it takes tionals’ growth prospects. The six core competencies as stated time to set-up new facilities, projects, and businesses in emerging above will prove important for future business leaders who wish markets. Providing bonus rewards for quick delivery creates in- to capture these growth opportunities successfully, and lead their centives for bribery. Instead, business leaders may want to accept corporations in tomorrow’s business landscape.   [ 31 ]


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Careers in

Norges Bank Interview with Petter Meyer

✎ Norges Bank is Norway’s central bank and aims to promote economic stability in Norway. Norges Bank is responsible for conducting monetary policy and ensuring financial stability. In addition, they manage the country’s foreign exchange reserves and the Government Pension Fund Global. Norges Bank’s headquarters are located in Oslo with additional offices in London, New York, Shanghai and Singapore.

Amaar Malik

year were the employer of choice amongst organisations in the public sector.

Norges Bank How is Norges Bank organised? Norges Bank is organised into four different parts headed by a governor appointed by the King. In addition to Norges Bank Investment Management (NBIM), the Central Bank is divided in Human Relations three main divisions: Financial stability, Monetary policy, and What is your job role in a nutshell? Markets and Bank Services. My job is a combination of recruitment and employer brandWere there any changes in Norges Bank after the financial crisis? ing. In the employer branding part, my main responsibility is to In the past couple of months, we have observed that monepromote Norges Bank as the employer of choice for clever mac- tary policy and financial stability have many things in common. roeconomists. We try to showcase Norges Bank as an attractive I think Norges Bank is the first Central Bank in the world that workplace for both young professionals and seasoned candidates. has combined the two documents that explain monetary policy In the recruitment part, we motivate and pick the best candidates and financial stability in one report. We had a press conference a that have the potential to help us reach Norges Bank’s goals and month ago and the market response was positive. drive the organisation forward. We are at all times curious about how to set up the organisation How has recruitment in Norges Bank changed over the past in the best possible way to support our employees in their work few years? putting our strategies into action. When I first started working here a couWhat is your culture like? Petter meyer ple of years ago, we had job postings in Norges Bank is in a transition now. 15•• Head of recruitment and talent managenewspapers like Aftenposten and Dagens 20 years ago, a lot of the employees workment at the Central Bank of Norway Næringsliv, and recruitment was all about ing here were not highly educated econ•• Has held several posts within executive picking the most suited applicants for an omists, but rather security guards and search and selection interview. Now, there is more competition money-counters with their key respon•• Holds a degree in organisation and manin the marketplace to hire the best macrosibilities being transporting and producagement development from the University economists, especially after the financial ing money. The organisation has been of Oslo crisis. We are proud to say that we also this slimmed down as the headcount has [ 32 ] 


â&#x20AC;&#x201A; [ 33 ]

PHOTO: Norges bank


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been reduced from 1200 to 320 during the past years. The reason letter as we encourage our employees to go to such schools. for that is that we are not doing the same tasks as we were doing What is the Phd grant you offer? 15 years ago. Today, we are more like a financial institution that Norges Bank would like to expand the field of macroeconomics needs fewer people. The kind of people that work here now are for people who are connected to Norway. Thus, we have made a highly trained and educated. People, who have worked here for 30 list of sixteen top universities in the world for economics. If an years or more, would most likely say that the bank has changed as individual would like to apply for a Phd programme at these uniwe have become more academic in our approach and our people versities, we would be happy to help them with both the applicaare now coming from universities and top consultancy firms. tion process and a grant. Furthermore, there is no requirement to What is the message you want to convey to potential applicants? start working at Norges Bank upon completion of the programme. The main message is that Norges Bank is a great place to start The purpose of this initiative is to expand the field of macroecoyour career and a great place to stay for a couple of years as well. nomics in Norway, and we expect to give this grant to one or two By starting your career here you will get a lot of responsibilities people annually. early on. For instance, you can play a role in the team that influDo you offer any kind of training schemes for new employees? ences the interest rate and the current state of the Norwegian We offer basic courses and information, and on-the-job traineconomy. ing programmes, but not any fixed schemes. It is more likely that Secondly, our message is that we have a huge internamost divisions will assign you a peer or a mentor that tional focus. At Norges Bank you will have the poswill help you in the beginning. The purpose is that sibility to have an exchange programme at central you should be working on authentic tasks from banks such as the Bank of England, the Reserve day one. We think that the people we hire are Bank of New Zealand, the Bank of Canada and on an academic level that enables them to the Federal Reserve. It is also possible to take start working on real projects from the start. a Phd programme at top schools like Harvard or Columbia. Graduate recruitment Thus, Norges Bank is an organisation that What kind of educational backgrounds do invests a lot in its employees. you prefer? What is the international exchange programme The minimum requirement to work here is a like? master degree. Some years ago, we would only hire If you have been hired directly from University, you people with a macroeconomic background. However, Photo: Norges Bank might have to wait for one or two years before being eligible as most graduate programmes have evolved, the course for an exchange. However, if you inform your manager that you outlines are not as strict on macroeconomic specialisation as would like to exchange, we will discuss with the candidate what students have the opportunity to specialise in finance, microecokind of role they want to develop into and thus which central nomics or other related subjects. Thus, the distinction between bank is the most suitable for them. We have good relations with macroeconomists and micro-economists is not as strict as it used numerous central banks, especially with the Bank of England. to be. Norges Bank is therefore also interested in hiring people We do not have any particular quotas, but we would rather con- with backgrounds in business administration (siviløkonom). sider employees who want to exchange on a case-by-case basis. For more quantitative roles, do you hire people with more scientific If you choose to go to the Bank of England, Norges Bank will degrees such as mathematics, statistics or engineering? set you up with an apartment in London and pay your wages. In Norges Bank has a lot of different positions, and we have return, we would receive an employee with new perspectives and people with backgrounds in industrial economics (industriell a broader skill set. økonomi og teknologiledelse) from NTNU as well as physicists How flexible are you in terms of continuous education for and mathematicians. There is an increasing number of managers your employees? that demand people with strong quantitative backgrounds with We are very interested in people applying for the best schools mathematical and statistical knowledge rather than qualitative in the world. If you apply to the schools with the best economic backgrounds. I would recommend people to do modules such as programmes, it can be hard to get admitted. As the application mathematics, statistics and econometrics in order to build supeprocess is thorough, we would be happy to make the Governor of rior quantitative skills. the Central Bank, Øystein Olsen, write you a recommendation [ 34 ] 


How do people usually enter into Norges Bank? For the most part we hire young professional who have little or no work experience that will start as analysts and climb the career ladder. How is the career ladder at Norges Bank? We have two different ladders. First we have the managerial ladder, where we involve you in the broader part of the organisation. The second ladder enables you to go in-depth in one particular area of macroeconomics and specialise in a narrower part of the discipline. Which students are the internships primarily aimed towards? The internship is primarily for people on their last year of a bachelor degree or the first year of a master degree. We have two different internships, and the further you have reached in your studies, the greater your benefit and overall experience will be. The internship lasts for six weeks in the summer. We also have longer internships for students in their last year of a bachelor degree or first year of a master degree that can work here on 10-20% positions as analysts. We do also help students with writing their master thesis. How is the process going from an internship to landing a full-time offer? It depends on each candidate. Students who are clever, work hard and have the right motivation will increase their chances of getting a full-time offer should a position that is suited to them be available. There is no automatic fast-track process and every applicant is considered on an individual basis. What do you look for in a candidate? We want academically strong students with good grades and preferably an average of at least B (ECTS-scale). Furthermore, we want to see people with the right motivation that have a genuine interest to broaden their horizons in economics. We like people who are curious about understanding the dynamics of the international economy. You will also need the motivation to climb the career ladder at Norges Bank, and you can choose either progressing into managerial roles or specialising in one particular field. As a public organisation, we are more concerned about the field of macroeconomics in Norway rather than just our organisation. Therefore, we also hire people who believe that Norges Bank is a good place to start. Do you look for work experience and extracurricular activities or do you hire on the basis of academic achievement alone? Norges Bank has historically been focusing on attracting top academic talent. We are in the crossfire between the government, the industry and the academic field. We produce a lot of reports that are used by the government, the private sector as well as by individuals. A candidate should therefore possess communica-

tion skills and a good command of English. The ability to present difficult technicalities of economics in a coherent manner is also a good skill to have. These are usually the qualities we find in people with good academic achievements. Of course, a candidate should also have the right personality and manage to work in teams as well as communicating efficiently with colleagues. What kind of qualities do you need to succeed at Norges Bank? We have already talked a bit about curiosity, an interest to understand the international economy, communication skills and being a team player. Other qualities we would like to see are analytical skills. Our goal is to bring the macroeconomic field in Norway forward. Thus, what we want to see are people who can say whether a particular report can be written any better or whether a model can be improved. Such traits are examples of the kind of qualities that takes Norges Bank forward. What is the selection process like? The first part of the process consists of me and the HR manager discussing with the managers what kind of needs they have now and in the future. Norges Bank is constantly moving and the need for competence we had yesterday is not necessary the need for competence we will have tomorrow. On this basis, we will post the opening on both our website and social media. The next stage is to identify the most qualified applicants that are invited to a first round interview. The most suited candidates will be invited for a second round interview before we ultimately fill the position. We do not carry out any online testing. We do have personality tests, ability tests and some cases. Normally, we base our decision on interviews, recommendation letters and grades. What do the interviews consist of? During the first round, we would like the candidate to meet Norges Bank in order to feel the culture here. It is not only Norges Bank choosing an employee, but also the other way around as the competition for graduates is fierce. The last part of the interview will usually be with a manager asking technical questions in order to determine whether the candidate is on the level that we expect. Rather than looking for the ultimate right answer, we are more interested in the way the candidate communicates and what kind of approach the candidate has to the field of economics. What piece of advice would you give to students that could strengthen their candidacy to work at Norges Bank? If you would like to work at any top employer, you have to be a good student with good grades. We prefer a GPA of A or B, which means that candidates with C or D might find it difficult to get an offer from Norges Bank. And most importantly we are looking for those who really want to be a part of the Norges Bank team. â&#x20AC;&#x201A; [ 35 ]


What about starting your career at Norges Bank?

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Equilibrium issue 2  

Second issue of Norway's student-run journal in economics and finance

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