Friday, February 8, 2008

An Interesting tidbit

MBIA insures corporate bonds, gov. bonds etc. Right now MBIA and AMBAC, the two biggest players in the bond insurance field, are the worry on Wall Street (see previous post on counter party risk i.e. bond insurers are a counter party). Yesterday MBIA's market value was approx $1.8 Billion, today the same company is worth $3 Billion (link). WOW! you might say their stock price must have gone up, up, up (the market value of a company is the (stock price) * (# of floating shares) ). But no, the value of the shares declined. How does this compute? Well to raise cash to keep its all important AAA credit rating, MBIA needed more cash "in the bank", so it decided to sell more shares (link). A secondary type stock offering usually has a higher cost of capital so this points to a possible shortage of borrowing opportunities for MBIA. This shortage is something to remember if MBIA needs more cash in the future. The amount of new shares sold increases the float by approx. 67% (from 123M shares to 205M shares). This is a huge number to increase the float by for a mature company. According to age old supply/demand as the supply of an item increases the value/price of that item drops. When the market (efficient or not) values a company at one level and the next day that level has increased by $1.2 Billion with no known fundamental changes to the business, then the (price of the shares)*(float) must eventually come down near the previous company value. The only way for that to happen is for the stock price to decline.

So what does all this mean? It means that MBIA increased its value by increasing the dilution of existing shareholders. Increasing the number of shares should eventually push the stock price lower and thus the market value of the company.

So what does this mean part II? Well if you believe this hypothesis, then the stock price of MBIA will decline (right now the AAA credit rating means more to MBIA than the price of the stock). You can profit from this by shorting MBIA. Of course with all their latest problems MBIA already shows a short position of approx %25 of its shares, so this option may not be the best. You could short AMBAC, but again their short position already is large. You could also join the revolution and use derivatives (the same things that got MBIA in trouble in the first place in a round about way) , more specifically put options on MBIA or AMBAC stock. But with all the volatility in the market and the companies in particular, the option premiums will be high. There are other things you could do, but I'm trying to lead people into finding more about this on their own and keeping my posts shorter (selling call options !!!!dangerous!!!!).

Until next time.

Friday, February 1, 2008

What I'm Reading Now

Traders, Guns & Money: Knowns and unknowns in the dazzling world of derivatives








Traders, Guns & Money: Knowns and unknowns in the dazzling world of derivatives

by: Satyajit Das