[MUSIC PLAYING] The Netherlands, Ajax, Amsterdam: a football club with a long tradition. Large clubs go public as companies. The obligation to disclose financial information to shareholders and the public, structure of the balance sheet and techniques in financial statement analysis. Switzerland, the telecommunication service provider, Swisscom: a large company in dynamic markets. The interaction of the flow of funds from the operational business, investments and financing. The need for cash flow analysis and cash management. Tunisia, an investment project in a tourist region. Building a new luxury hotel. Weighing out profit and risk. Financial techniques to evaluate an investment project. In any company, capital from a wide range of sources is tied up in various assets. The balance sheet is a momentary record of these financial structures. However, the balance sheet needs to be correctly interpreted in order to obtain sound information concerning the financial situation of a company. The world of football fills millions of people with enthusiasm, and football has long ceased to be merely a sport. Behind the big matches and the major media events there is a huge corporate effort. Large clubs, such as Ajax, Amsterdam, run their operations as commercial enterprises with their shares increasingly being listed on the stock exchange. The financial public, they read a different paper than the sports public, OK? And we have shareholders from both sides. So the football shareholders will look, very much, at the results of the club. The financial shareholders will look at both, but they will have more focus on the financial picture, of course. They will say are you a healthy club? Are you making the right investments? Are you not selling out? Are you doing this? The balance sheets, in general, for every company, means that it gives you an insight in the position. Where does the company stand? I mean, what is the assets that they have in possession and how are these assets financed? In what way are they financed by equity? By, let's say, your own money, to say it bluntly. And what part is financed by going to banks or find third-parties that will finance those assets for you? The traditional format of a corporate balance sheet reflects the symbol of scales in balance because the sum of existing assets in which the company has invested corresponds to the sum of the capital used to finance them. Outside capital, like bank loans, is placed at the disposal of the company, risk-free, for a fixed time, and at a fixed interest rate. Whereas, capital placed at the disposal of the company on a continuous basis by the owners is subject to risk, and the interest that it yields is dependent on the company's success. This capital structure of outside and equity capital is shown on the liability side of the balance sheet. Assets are primarily categorize as current assets, such as liquid funds, or assets that can be converted into cash at short notice, and long-lived assets binding capital in the long-term, such as real estate or a stake in the stadium. The players under contract, however, also represent a balance sheet asset because they can be sold to other clubs for a transfer fee. This book value is lost when the player's contract expires. He has, in the end, a value of zero because if nothing happens and the contract runs to an end, the player is free to go wherever he wants and you don't get any revenue from the sale of that player. This means the players have to be written off by the time that their contracts expire, which results in the reduction of the balance sheet assets. However, it is also possible to increase the balance sheet total in the same way, for example, by developing talented new players. If they become more attractive to other clubs, and their market value increases in the form of the transfer fees that they can bring in, the balance sheet assets of the club also increase. However, individual balance sheet items only present a limited insight into a company's financial situation and development. More in-depth information is obtained by applying the methods of financial statement analysis. [SPEAKING ITALIAN] The analysts calculate ratios or indices. This means they connect individual items from the balance sheet with other items from the profit and loss statement to enable them to interpret the company's development over the years. [SPEAKING ITALIAN] These ratios clarify the company's situation with regard to its liquidity, the solidity of its financing, and its profitability. [SPEAKING ITALIAN] Liquidity means the ability of a company to pay off debts at short notice. The most simple method to measure liquidity is the current ratio. This establishes a ratio between the liquid funds and the short-term liabilities of a company. Liquid assets ratios can vary depending on whether only real cash items, or also items which can be converted into cash on short notice, are taken into account. [SPEAKING ITALIAN] Clearly, when the liquid funds are higher than the short-term, outside capital, the company has a strong ability to pay regarding short-term debts. [SPEAKING ITALIAN] To analyze how financially sound a company is, it is necessary to examine its capital structure by looking at its debt/equity ratio, also financing ratio, for example. We had an equity of 230 million on a balance sheet total of about 300 million, which means that you have an equity ratio against debt on the total of the balance sheet of about 78% equity. This means, from an equity base, we are very, very healthy. When evaluating the soundness of a company, the fixed assets to net worth ratios are particularly important. They show the ratio between fixed assets and equity capital, or capitol placed at the company's disposal long-term. [SPEAKING ITALIAN] It tells us how strongly the company is financed by equity or outside capital, or what the ratio is between fixed assets and equity capital to reveal how many of the company's long-term investments are financed in an equally long-term way. The analysis of the financial statement also takes a close look at profitability. The most important revenue items include earnings from merchandising and sales of the numerous fan items, revenue from match tickets as well as revenue from sponsoring and from TV broadcasting rights. On the outgoing side, in addition to the normal operating expenses, the main item is payroll costs, clearly, because of the well above-average salaries the soccer stars receive. The overall company results, seen as the result of all expenses and revenues, is considered in relation to the various balance sheet items to clarify the performance capacity of the company from different points of view. [SPEAKING ITALIAN] Profitability is probably the most interesting aspect. There are many different concepts of profitability. Those mostly used are return on assets, which considers the ratio of profit to the total amount of assets. Return on sales establishes the ratio of profit to turnover. Maybe even more important is the return on equity, which looks at the amount of profit compared to shareholder's equity. This return on equity also depends on the capital structure. If a company achieves a 20% return on its overall capital and outside capital costs only amount to 10%, higher debts result in an over proportional increase in the return on equity despite the increasing interest load. [SPEAKING ITALIAN] Taking on more debts can generate stronger earning power but also entails higher risks and increased vulnerability. [SPEAKING ITALIAN] The balance sheet analysis is essential when drawing up a financial evaluation of a company. However, many aspects that are decisive can, frequently, not be measured in figures and, therefore, cannot be reported on the balance sheet. An asset which is really the most important one, which for Ajax has been a capability to develop players. So that's almost like intellectual capital that we have experience, processes, systems, facilities, really to scout players, to find the best talent. The balance sheet presents the assets and capital structure as a particular moment in time. The calculation of ratios makes it possible to analyze the company with regard to its liquidity, soundness and profitability. Still, you can only make plans and purchase and forecast. The result is down on that field. Club interest, of course, has been and always will be first the sport and second the business. The amount of cash flowing in and out of companies varies. The movement of funds is caused by business activities, financing activities, and investment activities. To see a company safely into the future, this movement of funds needs to be kept under constant control. The instrument used is the cash flow analysis. Swisscom, the Swiss telecommunication services provider, has a turnover that goes into billions. But even large, profitable companies can encounter a temporary shortage of liquid funds if they fail to monitor their cash flow closely enough. [SPEAKING GERMAN] It is possible for companies to generate negative cash flow even when they are making a profit. In such cases, neglecting their cash flow and failing to analyze it can even cause a company to slip into a state of insolvency. Ever or not, sufficient liquid funds available at all times to cover overhead, such as salaries or energy, or to pay suppliers, sooner or later the company will face huge problems independent of its size or its earnings position. This means that maintaining solvency is a [FOREIGN PHRASE] for every company. Companies have three different types of cash flow. Operative cash flow refers to the cash flow from business activities. Investing cash flow covers cash paid out for investments and money coming into the company from disinvestments, while financing cash flow encompasses funds coming in that are related to company financing. The cash flow is positive or negative depending on whether more money is coming in or going out. [SPEAKING GERMAN] Operative cash flow records the difference between the overall cash flow that we receive from our clients during the year and payments made to suppliers. As a rule, this cash flow should be positive. In other words, the company should generate positive cash flow from its current business. [SPEAKING GERMAN] The flow of funds from investment activities refers to the funds required for the acquisition of installations or participation in other companies. [SPEAKING GERMAN] This is usually negative. The difference between cash flow from business activities and from investment activities has to be filled by the third measurement, financing activities. [SPEAKING GERMAN] In this sense, filling means taking out a bank loan or raising money from the shareholders. Or if, as can also be the case, the entire cash flow is positive, money can be repaid to the bank or distributed to the shareholders in the form of dividends. [SPEAKING GERMAN] The sum of all funds from business, investment, and financing activities produces the company's cash assets or liquid funds. These cash assets must always be high enough to cover the current operating costs. Longer term liquid funds must also be available for investments, to meet interest payments, and to pay dividends arising from financing activities. The ideal situation is when all expenses can be covered by funds from the operative cash flow, which obviously means that it must be positive in the first place. Cash requirements need to be forecast in detail to make it possible to raise any additional funds necessary in time, or to invest funds that are temporarily not required on the capital market. [SPEAKING GERMAN] Cash is, on the one hand, very, very important for a company. But on the other hand, it is a variable which is very difficult to budget. This means that there are three main requirements. First, cash planning must be extremely precise, and the closer in the future we plan, the more precise it must be. Why? The more precisely we plan, the better we are protected against unexpected developments in cash flow or unexpected cash deficits. The planning of the movement of funds is based on the parameters of strategic management. The financial situation of a company, however, in turn, imposes certain restrictions on strategic goals. [SPEAKING GERMAN] Strategic planning is the basis for budgetary planning. Strategic management monitors whether the budgetary planning will be achieved, whether the goals of the strategic planning will be met. This means that if certain variances are observed, appropriate corrective action needs to be taken for the current business activities, or the budgetary planning has to be adjusted. [SPEAKING GERMAN] Second, it follows that the company must have optimum cash management. Optimum cash management means that the cash a company has at its disposal is controlled as carefully as possible, employed as efficiently as possible, and yields the highest possible level of interest. [SPEAKING GERMAN] It also requires the regular and strict examination of the cash flow to ensure that there are always adequate liquid funds to cover the financing requirements of the company, thus, safeguarding the company's standby liquidity. The cash flow analysis is the basis for budgetary planning, and cash management is the daily implementation of budgetary planning. If a company does not monitor its cash flow closely enough, it may have more cash available than planned or less. [SPEAKING GERMAN] The result could be problems in the company's ability to pay. In other words, we may have too little money to finance our current business activities or our investment activities. [SPEAKING GERMAN] A consequence of this could be a temporary postponement of our investments and this could, in turn, mean that we are too late getting innovative products on the market. [SPEAKING GERMAN] As a countermeasure, we could establish cash reserves in the sense of setting aside a percentage of the funds from business activities, of the funds required to meet interest payments, and funds that we want to invest. [SPEAKING GERMAN] To avoid the risk of a liquidity squeeze, attention must be paid, for example, to the maturity of funds when planning and financing investments. [SPEAKING GERMAN] This would naturally pose a serious problem if the bank could call in a loan on short notice forcing us to find new funding for this investment. [SPEAKING GERMAN] This means we try to align the maturity of investments with financing resources. There's a simple reason for this. We don't want to run the risk that funds that can be called in at short notice may threaten a long-term investment. [SPEAKING GERMAN] The amount of a company's disposable cash is highly volatile. To ensure that the strategic goals can be achieved, the cash flows must be planned and monitored precisely. [SPEAKING GERMAN] Investors expect a certain continuity, A, in the financial management of the company and, B, in the return they receive from a company. Investments increase the economic performance potential. Building new production facilities or founding completely new companies are the key to economic growth. But how are investment decisions taken on the level of individual companies? Tozeur, an oasis town in the southern part of Tunisia. The boom in the tourism industry was already extended this far into the desert where numerous new hotels have been built. One of them is the five star hotel, Dar Cherait. It is a family-run business. [SPEAKING ARABIC] Southern Tunisia is virtually new ground. Those investing in this region have the advantage of being pioneers. It is easier to make an impression in a region if you discover virgin terrain, if you have a good idea and a good project. [SPEAKING ARABIC] Regardless of whether you are talking about individual capital goods or an entire new hotel, an investment project is always characterized by long-term considerations. Capital is tied up long-term and bad investments are virtually impossible to reverse. Moreover, fixed costs accumulate irrespective of the actual capacity utilization. Evaluating an investment project is, indeed, a complex task. [SPEAKING ITALIAN] The main characteristics of investment projects are the high initial outflow of liquid funds and the fact that the, usually, positive cash flow they generate is often only achieved after many years. [SPEAKING ITALIAN] In this context, the future cash flow is hard to predict both with regards to time and the actual revenue. [SPEAKING ITALIAN] To evaluate an investment project, all the revenue and expenses generated by the project must be compared with one another. In this context, it is primarily the cash flow that is relevant rather than the profit. [SPEAKING ITALIAN] The most complex aspect is forecasting the cash flow. For a hotel, your forecast will depend on the season, the success of the region, the number of guests, occupancies, and meals sold. What is required is a forecast. To make forecasts, you have to analyze the competition, for example. Who are your competitors? And how much market share can be gained? You also have to analyze the general market trends. The more growth the market is showing, the more optimistic the project evaluation will be. [SPEAKING ARABIC] Ten years ago, a mere 3,000 beds were available in Southern Tunisia. Today, there are 10,000 beds in Tozeur alone. Including the up-market hotels, there are about 75 luxury hotels in this tourist region. This has led to excellent results because the region has continued to develop year-after-year. [SPEAKING ARABIC] To make a financial forecast for a project development, various techniques can be applied. [SPEAKING ITALIAN] The most usual technique, but not necessarily the most simple, based on simulations which take various scenarios as a starting point. An optimistic scenario in the case of the hotel, for example, would be to assume that it will have an occupancy rate of 80% to 90% on opening, and then you take medium and pessimistic scenarios. For every probable scenario regarding the occupancy rate trends for the hotel, a detailed pre-investment analysis is conducted. The variables of a pre-investment analysis are, first of all, the investment amount, which encompasses all expenses incurred by the project. The benefit is the forecast revenue, which extends over the planned effective life. After expiration of the latter, it is usually possible to realize liquidation proceeds which, like the imputed rate of interest on the face capital, also have to be taken into account. To draw up a financial evaluation, there are static techniques available. [SPEAKING ITALIAN] The most simple is the payback technique. This takes into account the initial investment and the inflow of cash that is predicted from the investments made. If I were to invest ITL 10 billion into a hotel, and this investment produced a return of ITL 2 billion a year, I would regain my initial investment within five years. [SPEAKING ITALIAN] This very simple method can serve as a rough guide to determine whether a project's amortization period is reasonable. [SPEAKING ITALIAN] A second indicator that is still quite elementary is to calculate the average accounting rate of return. Here you need to recalculate the earnings ratio as the quotient of the average annual revenues over the average annual expenses. [SPEAKING ITALIAN] These static techniques, however, do not enable you to reach a precise result because they do not take into account the current value of money. The value of $1,000 in two year's time will be less than it is today. [SPEAKING ITALIAN] If I get $1,000 today, I can invest it for two years and also get interest on it. If I just have the $1,000 paid back to me in two years time, I miss out on the interest. The dynamic techniques of pre-investment analysis take the current value of money into account. The current outflow of funds and the future inflow of funds due to investments can only be compared in a precise way if both are compared with identical current values. This means that the cash flow must be discounted at its current value. The higher the required rate of return chosen, the lower this actual current value will be. [SPEAKING ITALIAN] Determining the rate of interest to discount the cash flow is probably the decisive element of this technique. It is very difficult to determine and it basically reflects the, so called, opportunity costs of the investments. [SPEAKING ITALIAN] Instead of building a hotel, the entrepreneur could just as well put his money in fixed interest investments on the capital market. The increased financial risk must, therefore, result in a higher return for the entrepreneur and reflect a risk bonus. [SPEAKING ITALIAN] This will be the discount rate I use to update the flow. The rate must reflect the degree of the risk. In order to evaluate investment projects, the entire flow of funds resulting from the project must be compared at the same current value. The prevailing interest rate takes into account both the opportunity costs and the investment risk. [SPEAKING ITALIAN] I think, in the case of a hotel, the extent of a financial commitment at the site of the investor is clear. [MUSIC PLAYING] Everyone is familiar with the real world of economy. You see it at work every day, in our smoking factories, transported goods, and glittering shop windows. It's tangible, concrete, and intelligible. We're at ease with it. Financial markets, on the other hand, are quite a different matter. Although money circulates through them at the speed of light and on a worldwide scale, these markets remain, to the average person, incomprehensible, elusive, unreal almost. The most well-known amongst them are the equity markets-- the stock markets and the foreign exchange markets. But there are a great many more-- the energy commodity markets, the bond markets, the derivatives markets, the metal markets, the foodstuffs markets, the futures markets. The list is as long and as varied as the imagination of the financiers. All these markets are, of course, interdependent. The Polish zloty drops, and the Warsaw Stock Market becomes erratic. The copper market catches cold in Chicago, and the one in London will be sneezing within the next few minutes. It's like a vast plumbing installation, with horizontal links within each country and vertical ones between the countries of the world. Hence, the temptation to take a look at the inner workings of this intricate network. What sort of people navigate in these uncertain waters? How do they manage to hold their course and forecast future weather conditions? What strange compass guides their movements? Or more simply, how can they, or we, manage to make any sense out of it all? The financial markets have their own glittering shop window, which twinkles with the lights of hundreds of monitor screens-- the trading room. [SPEAKING FRENCH] Here, we're on the second floor of the trading room. This is where the funds of the Credit Agricole Group are going to be managed. The financial markets are perfect illustration of the proverb, "From little acorns, great oaks grow." Funds collected in 1,000 different ways accumulate here. The modest savings of private individuals to the vast capital reserves of American retirement funds and foreign currencies that circulate through international commerce. All these different amounts of money merge together, build up, to be finally lent out or borrowed through a simple phone call or click of a mouse. And all in the space of a few seconds by spoken word and by very young people. 2 billion, 100 million. 2 billion, 100 million what? 2 billion, 100 million euros. That's our cash balance. It has to be cleared within the next hour and a half or so. In other words, the Credit Agricole traders we see here have a vast reserve of money to lend. The voices on the telephone are colleagues from other banks throughout the world who want to borrow. [SPEAKING FRENCH] The discussions concern the interest rate percentage, the duration, but also the size of the loan. And what size, please? The bigger, the better. Could you do more? I don't think so. Could you do 100? No. [SPEAKING FRENCH] We have to invest the 2 billion, 100 million either with some of our clients, who are themselves borrowers, or with banks, who are in the opposite situation to ourselves. That is, they are short. They need liquidity. So we're going to lend this liquidity in such a way as to make a return on the money that's lying idle in our accounts. [SPEAKING FRENCH] And all that in an hour and a half. It has to be completed before 5 o'clock. [SPEAKING FRENCH] The strange language spoken here is a mixture of English, French, and in-trade abbreviations. [SPEAKING FRENCH] For example, when the traders negotiate an interest rate, only the third and fourth decimals of the percentage are mentioned. The other figures are assumed to be known by everyone. OK. Yours at 17 and a 1/2. Yours. Hang on. [SPEAKING FRENCH] Yours. [SPEAKING FRENCH] When we say "yours," it means we're lending. It's either "mine," I'm borrowing, or "yours," I'm lending. We use the English terms. The unit used for counting is the million-- millions of dollars or euros. [SPEAKING FRENCH] What behind? I'm waiting to see where the market's going to position itself, because it looks like it wants to climb very high. So I'm not going to sell off. I think it might climb a bit higher. How much do you have left now after half an hour? We have something like one billion two left. To lend? Yeah. So that means you've already lent out about a billion in half an hour. That's right. We started out at 3 and 1/2, but half an hour ago, it was even lower, 335. So you see in half an hour, from 335 we're now at 3/4, 375. That's 40-something. A percentage point gained in one night on an amount of 2 billion, 100 million euros means an extra 400,000 francs in the bank's safe the next morning. [SPEAKING FRENCH] Yeah, we heard there was a bank paying 4%, so we're calling to tell them we have the money and can help them out. [SPEAKING FRENCH] We know that anyone who is in need of liquidity has to go and look for it. So by definition, they're ready to pay, even if it's 10 or 15 centimes higher. It doesn't matter, because they really need the cash. It seems exactly like the sort of bargaining that goes on between normal commercial traders. It is. However sophisticated or complex the tools, we inevitably have to apply the usual market strategy. That's why it's called the trading room. Of course, I'm going to try to get them to think that I'm going in one direction, while in fact, I may have a very big transaction lined up in the opposite direction. It's like bluffing in poker. [SPEAKING FRENCH] Before closing a deal, the traders first have to check through their information system that the potential borrower hasn't reached the borrowing ceiling granted him. [SPEAKING FRENCH] It's not accepted? No. [SPEAKING FRENCH] The lines of credit are granted according to the ratings of the various banks. And as we're making loans here to other counterparts, we have to make sure that we have authorization from the risk committee to lend this money. [SPEAKING FRENCH] In traders' language, it's called checking the quality of a signature. It's exactly as in everyday life. The richer and healthier you are, the more easily you'll obtain loans. [SPEAKING FRENCH] You're giving yourself another quarter of an hour? Another quarter of an hour, even though our balance today has gone down considerably. At the worst, we can always lend this money to the European Central Bank, which has a marginal deposit rate of 2%. Which means that if we haven't managed to lend our money by this evening, then we'll lend at 2% instead of the present 3.5%. [SPEAKING FRENCH] Finding one's way in this complicated universe is something that can be learned. Here, for example, at the Sloan Business School, a department of the highly-renowned Massachusetts Institute of Technology. The classroom here is, in fact, a simulated trading room, where the traders of tomorrow learn the basics of their future profession. As for the teacher, he has 40 years of Wall Street behind him. Every generation in history has a group of people who are traders. Jesus threw the moneychangers from the temple, and it's the second-oldest profession in the world. It's like in Monopoly. Each students starts out with 200 stocks in two fictitious companies plus $10,000 cash-- also fictitious, of course. Quite often traders, when they start in the real world, they make terrible mistakes, and they get fired. They lose money, and then they could become depressed. In this case, we put a lot of pressure on them, so they are in as close to a real world situation as possible without the risk of losing real money. Here, the students work with the same electronic transaction systems that are used in the big financial markets all over the world. In order to sell their shares, the student traders indicate to the central computer in this window the price they want to obtain. It's the ask, that is, the selling price. Inversely, when they want to buy they indicate the price they're willing to pay. It's the bid, the buying offer. This is how it looks on a real-life scale. The Hong Kong Stock Exchange. More than 1,000 traders, each in front of his monitor. That's the basic principle. But what provides the challenge and difficulty to the professional trader is the way in which he reacts to the information he receives. In this game, there's a lot of people with really big positions. So the spreads on the winnings are gonna be much wider than before. So just as a pilot instructor programs an engine failure in a flight simulator, the teacher here introduces an element of complication. The cash brings in interest. The choice is between being in stocks or being in cash. And if I set the interest rates above the possible dividends, then they might as well sell all their stocks and be in cash. And so the risk now that interest rates will rise means that the stocks won't be quite so popular. And in order to make things more realistic, as in a real training room, the teacher employs the assertive tone of the professional analyst and comments the situation to one and all. The Chairman of the Federal Reserve has made a couple of speeches suggesting that he is concerned about the pickup in wages and prices. So there now is a risk that we will have higher interest rates in the second period than the first period. As a cautious economist, I will say 9%, but that may not be exactly the rate that comes out. Hoo. Gonna get hurt. Me too. Yeah, me too. Very bad. Very bad news. Bad, bad news. So you play Greenspan basically. Yes. It's more than Greenspan. You're playing God in this one. Because you talk about invisible hand. We are the visible hand in this case, because by setting the interest rate, then we change the terms under which they can trade stocks. Finally, an interest rate of 12%, and not 9%, is announced. 12% interest rate. 12%. Oh, no. That's bad. 12? I was expecting higher. Ugh! Who's bidding 29? God damn. God damn. A minute ago, you told them that it was going to be 9%. And so then, it's 12%. Economists, quite often, are wrong. They are not good forecasters. They have two hands. One hand says better. One hand says worse. So one of the things I'm training them, as an economist, I'm training them not always to listen to economists, even MIT economists. Well, no one's paying me anything good for my stock. So I'm just going to have to sit on it, and take it like a man. I'm sitting on cash. With 12%, it's good. Good feeling. So that day, it seemed more profitable just to sit on one's cash without trying to invest it. You won? Oh, I was above average, 6.9. The others were 6.3. Who's the winner? The winner is Tuchman, 1.6. Who's Tuchman? Where is he? Tuchman. Who's Tuchman? It's an opportunity to work in an environment where success is not subjective. Either you're smart, and you do well, and you're lucky. Or you think you're smart, and you don't do quite as well. That's the reason so few private individuals play the stock markets directly themselves. It's simply too complicated. Most people just go to their agency and subscribe for shares in SICAV, as it is called in France, or mutual funds, as they are called in the United States. But whatever its name, the principle is the same everywhere-- Have your capital managed by a professional. What's more, everything here is in line with the image of the trading rooms, from the fund manager's white shirt and tie to the photos of the guru star managers and the green, moving, display band of the stock exchange quotations. All the client has to do is sign his modest check, which will then take its place in the intricate circuit of the financial markets. If the client is willing to take a few risks, his money may well wind up here at Firebird, a hedge fund or risk investment fund. Fireside manages a little over $400 million, all of it invested in Eastern European countries, including Russia. Sasha the strategy consultant, Constance the economic analyst, and Bob the manager have a difficult decision to make. I mean, I think the last time you expressed a concern, it was at a higher level. And if we had acted immediately, we would have gotten out before it had moved down to this level. So it's going to now take another move down. Let's just get out immediately. Yeah. Knowing that Poland is undergoing an economic crisis, should they keep the $3 million of shares they own in a Polish telecommunication society or not? Can't it just be weak? The zloty has been weaker against the euro, and that's the concern. I mean, obviously, for our purposes it is a concern it gets weaker against the dollar, because we're dollar-based investors. It seems like it's going to be the focus of Poland's stock market effort. OK. Well, let me get on looking into it, and I'll get back to you this afternoon. The decision is going to be made in less than an hour right here in this New York office, 8,000 kilometers away from Warsaw. What I'm trying to sort of ascertain right now is, what is this pressure on the currency. What is it going to develop into? Are we better off, will we make more money, if we sell now and take that cash and the profits we've made on our position and wait and see what happens? This is the stock. Now, we can get information about the company. Constance has logged on to the Bloomberg online financial data service, which displays in real time the balance sheets and quotations of all the companies listed on any stock exchange in the world. The current price is 5.83. And may I ask you if you bought it lower or higher? We bought it lower. She then consults a chart showing the rate of the Polish zloty. So it's moving along, getting a little weaker. And look at that. That is not a good sign. Hey, David, check this out. Yes? Zloty-euro today. Today? That doesn't look too healthy, does it? Well, it could be bad data, no? There's just so much information and so many channels for transmitting that information. The more channels there are, the less possible it is to have perfect information. And the more advanced that computers become in generating, processing, and distributing information, then the less possible it is to have perfect markets and to have efficient markets. Hi. Then, a phone call to an analyst colleague based in Warsaw. What have you seen as far as pressure against the zloty? And I'm more concerned about the zloty against the euro, quite frankly, than I am against the dollar. We have Polish growth of 2.6%. Consumption credit expanding already, but we do expect still-widening account deficit in this year. If you're having pressure on your currency, then you could be expecting all the FDI in the world in June because you're doing a big privatization. But that's not going to help you now. Well, unless people have realized that and-- No, I totally disagree with that. FDI is not a sure thing. The deal is not done until the money has been transferred. Well-- Deals get cancelled all the time. Nobody in their right mind running money in Poland is going to consider that a sure thing. Excellent, excellent. Good. OK. OK thank you both for your time. All right, guys. Talk to you later. Bye bye. Bye. Well, they had very poor auction results today, so interest rates look like they're going a little bit higher. Now, that will impact this credit growth that he's talking about. Economics is very dynamic. And unless you can sort of factor that into your thinking, you could be an interesting economist, but you're not going to make a very good fund manager. So I sort of have to mull this over. Constance's extreme prudence with regard to the Polish money is easily explained. Firebird has lost a lot of money due to the Russian default and nosedive of the ruble. Nobody could predict that Russia would default. I mean, I thought that they were going to devalue and that we would lose money. It happened over the weekend. The Thursday before, the finance minister were on a conference call saying, no, we will not devalue. You could almost hear the irony in their voice. And meanwhile, we're selling our bonds. As that conference call's happening, we have orders in to sell our bonds. Friday, by that time, it was a bit obvious that something was going to break. To put it bluntly, you've lost some money. Over $100 million. What did you say? Over $100 million. Over $100 million, which is shocking. Ooh, what's this in dollar terms though? All the European telecoms are off these days. Yeah. I would say we wait until that trend comes around. Well, I'm just trying to figure out what's wrong. I mean, we were talking yesterday-- I guess you weren't here yesterday. We were talking about whether the euro looks like it's not working. Like from its first day, it hasn't worked. I think if one's misunderstood, that would be a multi-year sort of process. It's not going to happen this quarter. So we know we're going to sell half the position. And we're waiting to figure out if we get more information about whether or not to keep the other half. Oh, and FDI is such a big thing to them, and this has been their most high-profile offering. And they want to do more. And I would just think that if they're going to support any stock, any company, this is a company that they would support. What do you mean support, though? They're not going to go into the market and buy the shares. No, but-- I'm not saying we sell it and walk away from it. What I'm proposing is that we sell it, see where it goes. If it seems to get some support at a lower level, we buy it back. Because I agree with you that it's fundamentally a really good company. It just happens to be in a bad market right now. [INAUDIBLE] pragmatism and cross-border efficiency is very impressive, but also arouses a lot of criticism. These buildings belong to the Center of Economic Studies at Yale University. This is where the project to tax international financial transactions was conceived-- the famous Tobin tax, named after its inventor, Professor James Tobin, Nobel Prize winner for economics in 1981. His work is structured around a central interrogation-- do the ultra-rapid movements of capital have a positive social function or not? Most of the fluctuations in the stock markets, in short term, are not of tracking fundamental values at all. They're just speculations, and they're often speculations on what other speculators think or will think about. That's certainly true right now. It's not a guaranteed stable situation, even though your friends who are doing the job in their little cubicles with their monitor and all that and their computer, they don't see the whole picture of it. They just see what they're doing. And it makes sense to them, but it doesn't mean that it makes sense for the world. Is it efficient? It's efficient in a very minor, technical sense of the word efficiency. It's efficient in providing people who have paper assets liquidity in the sense that on short notice, whenever they want, they can turn the promise of the Korean government to pay them back next week into cash today. And so it's efficient in that sense. It's efficient in making assets which are intrinsically not liquid liquid from the point of view of the individual holder of them. So the individual holder of them, he thinks that's great. But the economy, the world, is not liquid. The wealth which is really represented by these paper clients is buildings, stones, factories. You can't liquidate them all of a sudden. John Maynard Keynes said it might be a good idea to make an attachment, a union, between an investor and the stock he buys in the stock market or the bond he buys in the bond market. Make that as permanent as a marriage of a man and a wife-- well, those are not so permanent as they were in 1936, but anyway-- so that the dissolution of the bond between them would be a big thing. And not just something you do at 2 o'clock and think about going the other way back at 4 o'clock. What is true for stock markets is even more so for currency markets. London's financial center, the City, is the uncontested world capital of foreign exchange markets. This trading room centralizes the transactions of a major European bank. Here, decisions aren't made within the day, or even within the hour, but within the second. Its manager is a former highly-reputed foreign exchange broker, Nathalie Rachou. [SPEAKING FRENCH] Here, you have the dollar/yen desk. Swiss francs here, Swiss francs with two people. Yen here. Over there, sterling. And there, the euro, three people. Financial markets do not necessarily mean high-tech organization. The foreign exchange market, for example, despite its size, still uses an old-fashioned listing technique. The brokers shout out their bids all day in the same way as an auctioneer. 68 and 1/3. 68 and 1/3. 58. 58. 5.8 58. When the trader hears a price that interests him, he gives his agreement. It's a method that owes everything to tradition and nothing at all to modern technology. 34, 38. 34, 38. 57 and 80. 575. 575. How many brokers do you listen to at the same time? I listen to three. You get used to it, trying to hear which voices are whose. Because they've all got different voices, and you can really listen. [SPEAKING FRENCH] The emerging countries desk handles 150 currencies, which are quoted spot and forward. Just then, to everyone's surprise, the Czech central bank announces that it isn't lowering its interest rates. [SIDE CONVERSATIONS] The Czech central bank had in fact been expected to raise its interest rates in order to support the falling koruna, due to the country's weak economic situation. It's panic aboard. No, wait. Cut them all off. Cut them all off and wait. 45? Wait. Do nothing. Cut everybody off. Cut them off. Don't quote. OK. I've got my 36 though, right? Wait a sec. The market was long, possibly in anticipation of a rate cut. So the euro/Czech got sold off. This group of five traders is organized in accordance with the traditional method. The four traders, considered to be too closely wrapped up in their screens, are seconded by an economist who is there to guide them and enlighten them. I think that the ECB is going to cut rates very soon. And that means that the pressure on the Czech and the satellites to keep going, pushing the rate cut button is going to-- And that's exactly when euro/Czech bounced. The traders listen politely, but immediately turn back to their keyboards to ask for the opinions of their colleagues in other banks through the use of an electronic mail system, Reuters, which instantaneously links up traders all over the world. [SIDE CONVERSATIONS] We broke the 400 levels again. It's gotta go a lot, lot lower. We've got all-- I feel like we might have to wait half an hour, an hour now. Or we're both going down the pub. We're in a sort of period of calm before the storm. The never-ending storms. Now, we're betting that it will trade lower by the end of the day. So if we break through this 400 level, where we've found these good supports, and you can see the euro/Czech accelerate on the lower side. From 38.400 you can see that change to 38.200, 38,250. Even so, that's another 150 points lower. While they wait, the traders listen to the voice broker reciting the progressive decent of the Czech currency. 30.52 by 3. 30.52 by 3. Is that a given? 30.52 by 3. [SPEAKING FRENCH] Who makes the market? The market is made, in fact, by a multitude of dealers, all with different objectives. For example, the market is supplied by exporters and importers who need to sell the currencies in which their exports are denominated. And then again, you have importers who have to pay for their commodities purchases in a given currency. The most typical examples of this are the petrol companies who pay the petrol-supplying country in dollars. Oh, dear. But Richard, it's not as bad as it was earlier. Oh, dear. Lordy. [SPEAKING FRENCH] Yes, but there are also the pure speculators-- the Chicago dentists, as they're called-- who just like to speculate. Yes, of course. There are a lot of speculators, although there have been a lot less since last year. Because the crisis in the emerging markets reduced the speculation capacities of all the main players, whether they be companies or banks. So while we still have the Chicago dentists-- although not so many of these now-- they aren't responsible for the size of the foreign exchange markets. New York are coming in now. So you've got another set of market players which are going to analyze the information that's come out. If they were looking for rate cuts, and they haven't found it, that might create some selling pressure. ECB says a strong euro to help Eastern European entrants. A strong and stable euro will help the European Union's Central and Eastern European applicant countries as they prepare for EU. The support seems to be disappearing at the moment, all right? Oh, it's dropped 100 points from the last 15 minutes when you were here. So now, we'll wait and see what happens. And hopefully, we'll get active again. It was at 440, and now it's at 400. So its 40 points lower. In less than an hour? Oh, yeah. That just did that in the last two minutes. This is a short-term move for part of the big picture. There's nothing more rewarding than having a view, taking a position, and maximizing return out of it. There's nothing more satisfying than that. This sort of ultra-rapid movement of money is the nightmare of finance ministers. But what about for traders? [SPEAKING FRENCH] My teams love volatility, and so do I. Because in general, it provides good opportunities to make profits. It's coming lower. We're smiling a little bit. The Czech koruna is taking a nose dive. It's the right time to buy. You want to sell 15 euros? OK, one sec. 15 euros. 95. One sec. [SPEAKING FRENCH] You learn to rely on your instinct. It's as simple as that. A trader is either born lucky or not. It's like in cards. The most important thing, I'd say, for me is learning when to stop listening to all the noise. It's learning to find out what the right decision is. There's so much information here. You could find 15 reasons to buy it, 15 reasons to sell it. But only one thing is going to be right. It's either going to up, or it's going to go down. A trader who is unlucky doesn't remain one for very long. This may seem fantastical, but I assure you that it's very important. A trader will learn to just follow his nose. 15 at 385, sir. See you, buddy. I gotta put this in. 15. There's a further sudden drop, but the quantities negotiated are too large to be true. It's Gary, isn't it? It's Geary. Oh, is it? Curiouser and curiouser. Do you want another 290? Yeah. Yeah, I'll have him hit you. At 4 and 1/2, I got, all right? You think this is an elaborate spoof? Well, he's a spoofing bastard to be honest, but yeah. I don't like him, but-- There are some very big offers being made. Yes, and far too loudly, replies a colleague. Yeah, a couple of London banks just bought this aggressively and loudly, all right? But there are some offers up here, all right? Thank you. What do you mean when you say an elaborate spoof? They'll sell with one guy to buy it somewhere else. You do the opposite with a guy who you think is going to run out of the position. And you give him, and he'll go [PANTING]. And at the same time, he's sitting there going, yeah, I'll take all those. I'll take all those. Sometimes it works. Sometimes it doesn't. So you mean that someone is manipulating? Trying to manipulate the market, yeah. Trying to trick us into doing the opposite thing. And how do you detect that? You have to just keep your eye on the screens a lot. And there's nothing better than getting the right side of the market and squeezing some of these bastards. And there's nothing worse than getting it wrong. So that has big highs and big lows. Peter? This is looking pretty heavy. I've just been given by an investment house 400. It looks like they've got them all and it looks like it's going to come off. Thanks. All right. Who were you talking to? One of the corporate dealers. He sits right over there on the far side of the room, and it stops us shouting. There's two things, really, that sort of drive the market. One's fear. The other's greed. When the market's scared, or people who are in the market are scared, then it becomes pretty volatile and pretty dangerous to run positions. Because it starts moving around all over the place. You don't actually know what's going on. It's like a sinking ship. First guy jumps, I'm selling because it's not moved. And then the next person, and then it's just the whole. It's just like one person jumps too, and then everyone's jumping. And that's when it becomes irrational. That's when it becomes total madness, because everyone's jumping. And then everyone just will hit any price. They don't care. They just want to be out, because they're scared of losing so much money. Looks like you're a profession of sheep. Yeah. At the end of the day, I wouldn't say we're a profession of sheeps. But when the market's scared, everyone becomes a sheep. And it takes a very strong man to go against the sheep. Andre Orlean, a professor at the Ecole Polytechnique, has made these phenomena the subject of his research. [SPEAKING FRENCH] Very often, the traditional image of market traders is that of isolated, calculating, individuals who study the basic economic data of the companies in which they're investing, and then, on the strength of their calculations, behave in certain ways. Now, what one actually observes in the markets is a behavior which, although rational, is very different from the behavior of an isolated, calculating individual. What interests an investor more than the basic economic figures is the way in which the market is behaving. And therefore, he finds himself focalizing on the market's fluctuations. So that means the market becomes almost a being in itself. Yes, exactly. Something like that. There's a sort of hypostasis of the market which enables it to be considered as a kind of global entity, whose movements can be predicted and forecast in advance. This is exactly how it works. And even more so in the sense that it will sometimes be credited with characteristics that are different from individual characteristics. For example, an individual may consider that a certain drop in an exchange rate is excessive in relation to what he believes, in relation to the data he's observing, and in relation to what the other financial analysts are saying. But he can think at the same time that the market itself may consider that a 40% percent drop, for example, as has been known for exchange rates, was entirely plausible. And therefore, he's going to credit the market with having beliefs and behaviors which may be different from his own personal ones. And what is paradoxical and wonderful about this is that if everyone reacted in this way, then the behaviors that appear on the market will, in fact, end up by conforming to these forecasts. This is what we call in economic theory a self-fulfilling prophecy. It was looking very break. Now it's just looking foggy. Financial speculation also has its great names. On the right side of the law, George Soros, Warren Buffett. But on the shadier side, we have Michael Milken with his junk bonds and Nick Leeson and the Barings catastrophe. It's now time to take a look at the more obscure rank-and-file speculator. People like you and me. Ramon doesn't work for a bank. This former car park attendant speculates for his own account with his own money. It's a beautiful day in Florida. It's another wonderful day here. He's what's known as a day trader. Hello? Yup. Yeah, so if you see the stock change, then go back to-- I guess, what is it? 108 and 1/2 or 109? Yeah, just give me a shout. All right, thanks. Well, last year I turned $30,000 into $1.4 million last year. And this year, I'll expect to at least do three times that much, maybe four times. That's $3 or $4 million? Yeah. When the market opens for the day, Ramon possesses nothing. And in the evening, he'll sell everything before it closes. He spends the day swinging backwards and forwards, buying and selling. Hence the name of this perfectly legal but 100% speculative activity, day trading. Ramon rents his technical space here, like three other day traders who are also speculating for their own account. Hello. The large players in the market-- your institutions, your banks, mutual funds, retirement funds, right-- they're the ones that are really in charge of moving the market in directions. And so we're basically looking to catch a ride on where they want to move a stock. In a sense, we're almost like leeches, where we just basically look for the right opportunity that they're pushing the stock. And we'll just kind of attach ourselves to that trade and ride it with them until we think we've got a good enough profit. How much stock do you hold at the moment? At the moment? Let's see. I'm probably long 15,000 shares and I'm short 6,000 shares. I'll narrow that down. In US dollars, it's about? US dollars? Let's see. That would be $2 million. You're holding at the moment? Yeah. Probably just a little over $2 million. Look at this thing. It went from down four to up six in probably 15 minutes. Wow. Something's going on here. We're going to take our profits out of this thing at $12. I bought this just a few minutes ago. And it continues to show a lot of strength and stuff. So there it is. I'm knocked out of it. I mean, that's how fast. Just flipping over this other screen to find a trade, I just made $4,000 back. So sometimes it happens that fast. Not all the time, but sometimes. Obviously, with things happening at such lightning speed, the problem is finding the time to go and have lunch. Yeah. I'd rather be safe than sorry. Sometimes lunch is a good thing. You can relax and not look at all the numbers moving around. Early on when I was trading, I had taken a position in a stock. And we went to lunch, and we went to a Mexican restaurant. And when I got back, the stock had moved like two points against me. And so for a quick lunch., my tacos ended up costing me about $3,000. So we kind of refer to it as the taco effect. Ramon learned this trade, which isn't really one, by following a five-day training course here in New York at Harbor Securities, a company that rents day trading technical space by the hour to private individuals. I do know that day trading is something that anyone can try. Because all you need is money and a computer, and you can try it. Whereas you can't try to be a doctor or try to be a lawyer without going to years and years of school and very advanced certification. It costs $4,000 to learn everything you need to know to become a day trader. This afternoon, we're going to entertain thoughts about the most challenging aspect of trading, the emotional discipline factor. This is what separates the winners from the losers. The mechanics and the techniques, we can teach you. Anyone can learn those and do them. But not everyone has the personal discipline to exercise emotional discipline. How about yourself? Good morning, My name is Nehad. I recently graduated from Queens College. I turn 23 today. And-- Happy birthday. Thank you. Just been doing personal investing the last few years. I look not to lose too much money in the stock market. What I hope to get out of this is to live wherever I want to live and do whatever I want to do, whenever I want to do it. Put this picture on the wall here. It's Mr. Spock from the original Star Trek series. Why is he up there? What's he doing? Mr. Spock would've been the greatest traitor ever, because Mr. Spock operates completely devoid of emotion. Pure logic, rational thinking, truth is what governs his decision making. That would make him an excellent trader. Successful traders consider trading a serious intellectual pursuit. They practice defensive money management, and they guard their capital like a professional scuba diver watches his air supply. Mr Spock would've been the greatest trader, because he's devoid of emotions. Remember not to blame the market. The market does not care one way or another what you do. It's simply there for you to take advantage of. That's all. Once you find a place to defer responsibility, you're setting yourself up for any number of negative results from trading. Hoping a trade will go your way. Remember, hope is four letter word. Hope is a dirty word. If there's any time at all that you're hoping, get out of the position. Profits make traders feel powerful. It gives them a high, and then they go and try to get high again. They put on reckless trades, and they give back their profits or they suffer losses. Getting reckless is exactly what people have a tendency to do when they don't feel any fear. So to be successful, you can't trade for, need, or even think about the money. Any good trades? Corey, was it a good idea to sell at $58? I'd definitely sell it there. Right, that's your objective. When you put on the trade, that's where they're selling. So I figured it got so close. I mean, I could always buy it back later if it breaks above. So I did do it right. Very good. When you do day trading, and you only own shares for a few minutes, your main focus is obviously not on a company's long-term economic results. Day traders often know nothing at all about the companies they're buying into. No, day trading is based entirely on a mathematical method of market analysis, which is called "chartism," from the word "chart." The leading light in this discipline is John Murphy, author of the bible of chartist analysis, The Visual Investor. It's a very visual approach. We chart the price of the stock, and then we try to determine which direction it's going. OK. This is called a 50-day average. What the computer simply does is it goes back and it takes an average of the last 50 days' closing prices. It's a smoothing device that tends to trail behind the price action. The 50-day happens to be a very popular indicator. And the way we trade this is that when prices move above the indicator, which they did to the left there, you'll notice that at particular point, that is treated as a buy signal by technical traders. Over here, when prices moved below the 50-day moving average, that is taken as a sell signal. So traders would be buying the stock down here and selling the stock here. You can take all these technical indicators, and you can program them. And your computer will literally give you buy and sell signals. In fact, the computer can even be programmed to send those signals directly to a discount broker who will activate those signals for you. Which is exactly what Mike, the king of the mathematical method of speculation, actually does. As you see, I have three screens that I monitor. These are stocks I'm looking at buying. These are stocks I'm looking at selling. This is sort of a combination of the two. And when lights show up, it usually means there's trading opportunity. A few years ago, I didn't have these tools. And not only that, I'm really good at it. I'm really an expert at this. I'm watching this line right here at the moment. And whenever that number turns green, that tells me that the one stock is cheap. You should be able to realize a profit, like my customer's doing right now. Institutions trade millions and hundreds of thousands of shares. And if they can save themselves a few pennies going in, going out, they're going to improve their rate of return. If we can do it every time for them or most times for them, then we're really doing them a huge service. Oh boy. Look what's happening here. We got a yellow. Can you buy 1,000 units to save 54 and 5 [INAUDIBLE]? Oh, I missed it. Ah. Don't do it. Don't do it. Don't do it. I was too slow. Cancel the Unisys. Cancel Unisys. Right. Why did you say that? Cancel what? You said, cancel the Unisys. Why? I saw the color changed. The spread no longer makes mathematical sense. So when these colors change, or essentially when the numbers line up the way I like them, I'm able to take action very quickly. Whereas my competitors are still like, oh yeah, OK. My order's already down on the floor. I'm already buying stuff. They're still figuring out whether it's mathematically worthwhile or not. When you first sat down I was doing something. Now, 20 minutes later, if we were to unwind it, it would've made over $2,000. Which is nice. You can't beat that, right? Well, you can beat it. You can make $4,000. Hopefully, in 20 minutes that'll happen. But that's what we're trying to do here. We're trying to spot those opportunities. When we see 'em, grab 'em, Here is perhaps the ultimate stage in financial market organization. We're in New York, not far from Wall Street, in the office of an investment fund which manages several hundred million. Not too long ago in the past, dozens of traders worked here. But today, the rooms are strangely silent. No interphones buzz. No telephones ring. The television, which was always tuned to CNN, is now turned off. The only people working here now are a handful of programming experts whose job is to pattern market behavior. Investment decisions are now made by the computers in the basement. There's that characteristic short sale or volatility that always bothers me. Mm hmm. The actual trading that we do is 100% model driven, yeah. And I'm happy that way. You have to forget your personality. No. Personality, in words of George Bush, (GEORGE H.W. BUSH IMPRESSION) bad. Numbers, good. (NORMAL VOICE) We really like to create, effectively, a generic equivalent strategy of all the managers that we make allocations to. And sadly enough, it turns out to be reasonably easy to do in most cases. It's almost artificial intelligence. That's the only kind of intelligence we have around here. It does make use of some of the techniques involved in AI. I have had the opportunity in my time in this business to take a look at literally hundreds of different trading strategies, which are what makes one guy better than the other. Interestingly enough, 80% of the variation in performance between managers can be explained by asset allocation. In other words, if the grain markets do very well in a particular year, and he happens to be a grain trader, he's going to make a lot of money and look like a genius. If the stock market goes up eight years in a row, guys that have long-side equity exposure are going to look like geniuses. Are they? I've seen technical trend following, neural nets, fractal analysis, throwing chicken entrails against the wall. Actually, strangely enough, they had a guy at Bankers Trust who was using astrology, which I thought was fascinating. And he actually made money over time. I have no idea how he did it. So the reality is that while the strategies for defining trend and mean reversion may vary, the sources of value remain constant. And as a result, the returns tend to be highly correlated, and the performance tends to be quite close between managers. So why don't you just flip a coin? I mean, it would be cheaper. We've almost come to that conclusion. [MUSIC PLAYING] Common Income Statement Template Last Year Revenue (services) Cost (services) Gross profit (services) Revenue (sales) Cost (sales) Gross profit (sales) Revenue (financing) Cost (financing) Gross profit (financing) Total revenue Total cost Gross profit (total) Less expenses Selling, general and administrative Research, development, engineering Intellectual property and custom development income Other (income) and expense Interest expense Total expenses and other (income) Income before taxes Provision for income taxes Net income 2 Years Ago 3 Years Ago 
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