Equilibrium issue 2

Magazine

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

Second IssueSpring 2013A new target?

The future of monetary policy

[ 2 ]

EditorAmaar [email protected]

WritersAlexander AlbertLouisa BrandtMorten FylkesnesEven Comfort HvindenFabian HarangFarzad KhoshnoudPetter KongslieAmaar MalikKjetil Stiansen

Layout & graphicsLasse André [email protected]

ONLINEequilibriummagazine.no

PublisherEquilibrium Magazine FLIc/o Økonomisk instituttPostboks 1095 Blindern0317 Oslo

Cover photoAdam Fagen

Colophone

M ACRONominal issues 4The euro crisis 8Guest article: Misconceptions of wages and unemployment 10

FI NA NCEWhy being a turkey before thanksgiving is not a good idea 15Financial leverage and capital structure 18Financial derivatives 22Alternative marketplaces 25

I NTER NATIONA L E X PER I ENCEManaging emerging markets 29

Ca r eer sNorges Bank 32

''Inflation, if anything, is a little bit too low.'' – Ben Bernanke Photo: Federal Reserve

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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 appli-cations 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 policy-making 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 top-ics covering financial risk management, corpo-rate finance and alternative marketplaces.

Our academically founded views on these topics encompass theories ranging from neo-Keynesian economics to Austrian perspec-tives 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 anal-yse the content as well as ultimately partici-pating 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 opportu-nities going forward.

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

Continuing tobuild on our success

Digest and analyse the content as well as ultimately participating

in the economic and financial de-bate by writing a guest column

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◆ Macro ◆ Finance ◆ International Experience ◆ Careers

Replacing the inflation target?Central bankers have become super-

stars. As the financial crisis and Europe’s debt crisis unfolded, central banks took the stage, using conventional and uncon-ventional means to stave off disaster and return the world to prosperity. While the influence and power of central banks have expanded rapidly, they are still subject to rules. The rules come in the form of mon-etary policy regimes, given by politicians, which govern what central banks are al-lowed to do and which economic variables they should be targeting.

Inflation targeting, which is the mone-tary policy regime adopted by most cen-tral banks in the developed world, has succeeded in bringing stable inflation and stable growth for several years. However, during the crisis, it has increasingly shown itself to be a distraction, diverting fo-

cus from returning the economy to full employment, giving inflation an unwar-ranted amount of attention, as if by de-fault. Rather than looking at the economy through the lens of inflation, countries might be better served with a central bank that targets the level of economic output directly. The time may have come for re-placing the inflation target with a target for nominal GDP.

What is NGDP-targeting,monetary policy targets?

Governments leave the issue of con-trolling monetary policy to an independent central bank due to issues of time incon-sistency. According to standard macro-economic theory, there exists a trade-off between inflation and unemployment in the short run but not in the long run. A democratically elected government will

have problems taking the long-term view, essentially because it faces re-election and will thus have incentives to pursue an ex-pansionary policy, sacrificing price stabil-ity (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 re-vise 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 indepen-dent central bank the responsibility of

Nominal issues✎ Kjetil Stiansen

Photo: U.S. Department of the Treasury

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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 (NGDP-targeting) 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 NGDP-target 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 expectationsThe current economic climate is best

characterised by the standard Keynesian liquidity trap. In the liquidity trap, produc-tion has fallen due to a powerful negative demand shock, such as a large increase in desired private savings, with a correspond-ing increase in unemployment. To coun-teract this, the central bank has lowered rates all the way to zero as a way to expand the economy. However, even a zero inter-est 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 inter-est 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 cur-rent US Federal Reserve policy of keeping monetary policy accommodative until the unemployment rate falls below 6.5 per-cent 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 to-day, feeling less of a need to save in order to sustain themselves in the coming years. However, in the current situation, the in-flation target acts as an unhelpful distrac-tion. 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 appar-ent unwillingness to allow inflation to run temporarily above 2.5 percent creates un-necessary uncertainty: would the Federal Reserve for instance move to tighten pol-icy in the face of a supply side inflation shock such as an oil price surge? It prob-ably wouldn’t, but it would come under political pressure to do so, and the uncer-tainty is unnecessary. In an economic envi-ronment 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 under-stand. 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 accommoda-tive for as long as necessary to return the economy to the growth path. The message in this scenario is simple and lacks the res-ervations and contradictions of the cur-rent messages from central banks in both Europe and the US.

More inflatingFar 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 be-ing helpful. Moderately higher inflation would help in two main ways: most obvi-ously 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

NGDP-targeting would provide a better paradigm for expectations management

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over a decade, with nominal interest rates essentially at zero. Long term interest rates have, however, been positive, as they are an average of expected short rates, which can only go up, being already at zero. The recent message from Japanese policy mak-ers has been one of targeting higher infla-tion, and markets seem to have responded. Expected inflation (which can be mea-sured by looking at so called breakeven rates, which are the spread between nom-inal and inflation indexed bond yields) have increased, with no increase in interest rates; in other words long term real inter-est rates have fallen. Lower long term real interest rates means higher future real in-come and lower costs of managing new debt (as real interest payments would be lower). This should make households more willing to spend, and firms more willing to invest today, expecting higher income and demand, respectively, in the future.

It’s (still) the politics, stupid!In principle, there is nothing preventing

policy makers from pursuing the policies outlined above within the framework of an inflation target, but the politics are dif-ferent. First of all: people tend to dislike inflation, and policies that are perceived to increase inflation tend to be unpopu-lar. Completely rational agents shouldn’t be too concerned with this, as prices nor-mally move in response to wages, leaving most people no worse off. However, peo-ple arguably judge the benefits of inflation in relation to their current, nominal in-come, perceiving inflation as something that erodes their standard of living. As such, announcements by the central bank calling for higher inflation are unlikely

to gain much traction. By the same token, raising the inflation target to, for instance, 4 %, while economically sound, is probably politically unfeasible. This makes it diffi-cult for the central bank to alter inflation expectations: the central bank often finds itself under pressure from politicians and the public when the inflation exceeds the target, but rarely when it dips below. It thus

becomes hard to make promises (or threats, depending on your position) of higher in-flation credible. (In econspeak: inflation expectations are too well anchored.)

The politics of NGDP-targeting would be substantially simpler, as well as easier to understand. In response to a slump, poli-cymakers would not have to sell a message of targeting higher inflation explicitly, but

rather reaffirm their commitment to bring nominal income back on track. As long as nominal income remained below its tar-get path, the central bank would be un-der pressure to get it back on track, rather than have their every policy decision scrutinised in light of the inflation target. Even under a regime such as that of the US, where there is a double mandate to target both unemployment and inflation, policy has arguably been biased towards moderat-ing inflation. Either way, the inflation tar-get acts as an anchor in the debate, and in an environment such as now, the distrac-tion it creates is damaging.

A fittingly imperfect policy “Monetary policy is not a panacea”.

The US Federal Reserve Chairman, Ben Bernanke’s warning to US policy makers goes for all forms of monetary policy mea-sures and its regimes, including NGDP tar-geting. However, as Christina and David Romer of Berkeley argue in a recent paper, being overly pessimistic about the power of monetary policy, even in the face of ma-jor challenges, can be dangerous, having resulted in limited and slow response to both the current and past crises. A good monetary policy regime is one that en-ables the central bank to credibly commit to whichever policy it deems appropriate for the current situation. An NGDP target could help enhance central bank credibil-ity, even in instances when what is needed is a dose of monetary recklessness. While politicians remain hard at work squabbling over structural reforms, budget deficits and other “real issues”, there may be some-thing to gain by considering the nominal ones.

Inflation expectations are too well anchored

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The medium term prospects for a successful resolution are be-coming 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 in-compatibility 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 econo-mies, explaining differences in competitiveness and productivity and ultimately the countries' real income level. When asymme-try (figure ❶) is represented as differences in macro indicators such as GDP per capita and the current account balance they ul-timately 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 one-size-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 fac-tor-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

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-all-currency 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 in-formation 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 econ-omies reduces their medium to long term potential and the euro zone becomes ever more suboptimal as a currency area.

Far from over✎ Even Comfort Hvinden

THE Euro CrISIS:

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

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

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

SpainGreece

ItalyPortugal

Germany

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2007 2008 2009 2010 2011 2012

Sweden

Italy

Germany

Ireland

Greece

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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 un-employment. Governments, politicians and economists are proposing solutions. Underpinning their policies is that they advocate increased government control and regulation, in order to create oppor-tunities. 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 direc-tion; 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 im-portant 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

like any other commodity. It is unfortu-nate that wages should be differentiated from other prices in the language of eco-nomics. 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 consider-ation the cost of forgone leisure. Workers may, however, overcome this disutility in several ways. They could justify the disut-ility 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 noth-ing more than a price, the price for which workers are willing to sell their precious time and skills. Both workers and employ-ers 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.

Determination of wagesThe most obvious and easy way for work-

ers to compete is by the price they charge for their labour. Furthermore, workers can compete on efficiency or other attri-butes. Ultimately, all relates to the price paid. Based on the continuous competi-tion between workers and employers, mar-kets 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 abun-dance of a certain skill or attributes, that plays the most important part in the deter-mination of wage rates. Consider the sim-ple example of a film production; the actor obviously adds more value to the overall production than the cameraman, as cam-eramen are more common than high qual-ity actors. The sum of the prices an em-ployer pays for the factors of production, must therefore at least equal the price of the product he sells. There are several fac-tors 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 ef-ficient 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 respec-tive industries will be determined

Misconceptions of wages and unemployment

✎ Alexander Albert (Guest Writer)

A wage is nothing more than

a price

[ 11 ]

by the consumer. In a free market, wages across industries will tend to equal over time. Businessmen are under the neces-sity of producing what consumers ask for, and of selling goods at prices the consum-ers can afford and are willing to pay. It is human action working at its finest. This is one of the most important economic prin-ciples. This principle is, sadly enough, con-stantly violated by highly ranked econo-mists.

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 complemen-tary factors of production. In a changing economy, there are several factors affect-ing 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 motiva-tion for moving, acquiring new set of skills, gaining education and their personal value of leisure.

Unemployment and what it meansFollowing the principle of supply and

demand, unemployment tells us that the supply is greater than the demand. The de-mand for a commodity is usually low when the price is unsatisfactory. A producer would usually lower the price on his prod-ucts if he observes that the demand for his

products is decreasing. The same princi-ple 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 ser-vices.

The truth about unemploymentAs the chart above shows, unemploy-

ment 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 soci-eties in general, are disastrous. Moreover, all income that is derived from taxation

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 pri-vate 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 un-employment 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 situ-ation in the labour markets.

What could cause unemploy-ment to reach such levels?

If we assume that people need to work to be able to live and prosper, every per-son able and willing to work would be employed in a free market. Hence, real un-employment 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 in-tended 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

The public sector is detached from the

private sector's require-ment of profitability. Therefore, the public sector leads to large

inefficiencies

ã Unemployment. (*September 2012, **October 2012, ***Q 3 2012) Source: EUROSTAT

5% 5% 5% 6% 7% 7% 7% 7% 8% 8% 8% 8%10% 10% 11% 11% 11% 11% 11% 12% 12% 13%

14% 14% 15% 16% 16%

26% 27%

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AT LU DE NLRO M

T BE CZUK*

DK FI SEEE** SI FR PL

EU27HU** IT

EA17BG LT CY

LV*** SK IE PTEL* ES

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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 ac-quiring important and highly valuable skills are by getting work experience. This will allow workers to gain highly valuable skills, making them more attractive for fu-ture employers. If minimum wages are set above the unhampered market rate, unem-ployment 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 re-sults. It increases the risks and costs of hir-ing, 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 par-ties 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 produc-tive 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 min-imum 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.

Employers would then compete on hiring productive workers and this would deter-mine 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?

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 agree-ments. 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 micro-economic principles discussed above. However, when unemployment rates reach levels as high as 26 % and over 50 % among people aged 15-24, it is evi-dent 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 pos-sible. Regulation on labour markets is definitely one of the sources to this struc-tural 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-

cies advocated by most western nations over the last decades. These easy money policies lead to abnormal misallocation of resources. This happens because by print-ing 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 mis-doings 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.

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 under-stand the consequences of years of misdo-ings, there must be a reduction in wages. When countries experience high unem-ployment 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.

Supply ofLabour

Demand forLabour

Number of Workers750

£3,80

£4,20

1000

Wag

e R

ate Figure ①

[ 13 ]

No statuary minimum wage < 500 500 - 1,000 > 1,000 No data available

The common man does not usually under-stand 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 com-mit political suicide. Elected representa-tives 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 some-thing governments does not want when they currently can't service their debt loads, it is less tax income! Years of mis-allocation of resources caused by central banks’ inflationary policies need to be re-versed. 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

you a better sense of why we are where we are today. Even though it would help noticeably to deregulate labour mar-kets, much more has to be done in order to have long lasting prosperity. Keep in mind that the root of the problem is sim-ple; Governments have grown to unsus-tainable levels. Debt is what is causing governments to further lead their econ-omies 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 out-look for the future is not even slightly en-tertaining.

Figure ② : Minimum wages in European countries as of July 2012. Source: EUROSTAT

1462

1244 1456

1472

1801

1426

748566

763

312327

353

232

287

290

323157

680

148

684

412

371

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[ 15 ]

Currently Apple Inc., the world’s largest listed company by market capitalisation, has 54 analysts tracking their performance.

Ever since the late mastermind Steve Jobs introduced the i-products to the market, analysts’ estimates for the company performance have gone higher every quarter, without looking down. Until recently. For the last five months the share price has seen a near 40% collapse since its 52-week high, just south of $700. Apple still continue to bleed from its “bombshell” quarterly re-sults, just below market expectations. The last time Apple missed their estimate for a second successive quarter was ten years ago, in 2003. Yet, with a growth estimate of around 60% last year such a high price (relative to earnings) could be considered reason-able. However, what has happened over the autumn and winter is a classic play of market irrationality or humans behaving like hu-mans. By mid-August last year, analysts had slashed their growth estimates for this year’s EPS growth by two-thirds. Nonetheless, while the price was tumbling over the next nine weeks in a row, all you could hear on Bloomberg, FT or any other financial re-lated news-provider was analysts literally every day telling us how cheap Apple was at 650, then 600, then 550 and so on. So, one might wonder why the guys who actually makes the estimates in the first place, after cutting the growth rates from 60% to 20%, were on T V telling you to keep buying the stock?

One does not need a Harvard degree to work out the relation-ship between a decline in growth and what is going to happen to the share price of a company, yet today there are still 39 analysts recommending buying A APL shares. Whereas the analysts are watching Apple more carefully than ever, this article is going to turn the tables and direct its attention on the market and to the analyst themselves. As introduced above, understanding why you should be very critical about any estimate or forecast is rather es-sential to any investment-related action. Furthermore, in the fol-lowing sections, several human behaviour phenomena are intro-

duced, hopefully offering some mind-tinkering revelations that should be helpful to anyone investing capital in the markets.

Why we suck at probabilities

A rather fair assumption in the wake of the late 2008 crisis is that the financial sphere includes a population who, indeed, has a lot of confidence in their own abilities. Alas (and perhaps more surprisingly) in the same population, a somewhat innumeracy is also rather common. Suppose the weather forecaster on T V pre-dicts (say, with 80% probability) a clear sky tomorrow because of little wind and increased pressure (air density). The next morning you arrive at work soaking wet, cursing a certain anchor-man’s in-competence for not suggesting taking the umbrella. Concluding that the forecaster is unreliable based on a single instance is the

“data beats your lying eyes”-fallacy; forgetting that an 80% proba-bility of something happening also implies a 20% chance of it not happening, i.e. no reason to feel surprised by rain, unfortunately. Similarly, as will be introduced throughout this article, the hu-man mind prefer heuristics or comprehensible stories, and are (es-pecially) prone to overlooking logic when it comes to probabili-ties and decision-making with stakes (risks) included. It turns out that even if you are the CEO of a Fortune 500 company, an elite equity analyst or a graduate trading your precious savings, when faced with choices and assessments involving risk and probabili-ties, your decisions will often be based on heuristics, and not the

“rational optimal choice”. Heuristics are everyday simple men-tal “shortcuts”, possibly deviating from logic, which people base (complex) decisions on. In an economic framework, the most promising ideas come from what is called prospect theory, intro-duced in the late 1970’s by Daniel Kahneman and Amos Tversky. Their seminal work on behavioural finance, also later awarded the Nobel Memorial Prize in Economic Science (2002), offers some interesting contrasts from the conventional textbook alter-

Why being a turkey before Thanksgiving is

not a good idea✎ Morten Fylkesnes

[ 16 ]


native; expected utility theory – where the rational agent operates regardless of the reference point. (E.g. with a 98% probability to win, would you bet $10 to win $100? What if it was $1,000,000 to win $10,000,000? If you are indifferent between the two bets, you are likely either very rich or poor with numbers, possibly both).

Another phenomenon, particularly found in social science and fields with unexpected and ambiguous events occurring, is the

“narrative fallacy”; a preference for stories to data. Events does not always go down the road as we had anticipated in the first place. Therefore, we are often trying to explain history by evolving a story around what happened or fitting history neatly into a predetermined story (cherry picking) – or both. However, the financial market is an organic creature by humans and not an exact pre-dictable science. For that reason, dealing effectively within such a context requires the acceptance of randomness and its influence (which cannot a-priori be in-cluded in a story).

Irrespective of model and theory, beating the market has never been easy. As introduced in the previous passage, most investors prefer coun-selling analysts, online forums, bankers, Google search engine, etc. rather than looking at the facts (empirically) when making investment decisions. Even if you do not believe in technical analysis (forecasting price levels by charting), why argue with the market? Don’t listen to the analyst (or anyone) on Bloomberg telling you to buy Apple when the price, P/E, EPS and so on is telling you otherwise. Let the market tell you the direction. In 99 out of a 100 cases, an analyst (even if he works for Goldman Sachs) does not know something the market doesn’t know. Don’t play the sucker’s game, at least get the odds in your favour: the trend is your friend, until it bends.

Curb your enthusiasmFor many market participants, certainly agents relying on fore-

cast models, uncertainty and volatility means bad news. In the smooth linear narrative world, surprises are usually on the down-side, e.g. when things are not “in line with consensus or expec-tations”. Such a system is very fragile and must be handled with care.

Let’s turn back to our 54 Apple analysts. The earnings game is all about accuracy, right? Analysts generally make a living of fore-casting company earnings four times a year, plus recommending some market over-performers in-between. The delinquent part

however, is the incentive to not be worse than the other analysts and not hurting the overhead-business (i.e. banking and mergers and acquisitions activity with the respective company), rather than being correct. Specifically, it hurts an analyst a lot more to be completely off (blowing his reputation and possibly being replaced), then it yields him credibility to be in line with oth-ers (keeps the job). Why take the risk? One of the killer trades last decade would have been shorting Lehman Brothers in 2008. Surely, someone following the financial sector and in particular Lehman would spotted some forthcoming gloom and doom, and

recommend a sell? Turns out, in the beginning of the year, there were 17 analysts covering Lehman. The break-

down was nine had "hold," five at "buy" and two had "strong buy" and by headcount, only one

had sell (although, this recommendation came not of fear of collapse but because it

was seen as overvalued). In fact, a paper by Pablo Fernández López, and Javier Aguirreamalloa Arízaga published last year, confirms the herd mentality,

“Indeed, only one out of a total of 106 (emphasis mine) reports issued

by analysts between January and September of that year recommended

selling Lehman stock.”

Another human behaviour effect enlightened by prospect theory is anchoring – When estimating a num-

ber (say, a distance, a percentage, a stock index level or a share price) people tend to start from an offered (but not necessarily applicable) available number. I.e. is the kilometres of road in the U.S more or less than 150,000,000 km? By the same fallacy, when dealing with confidence intervals, say, asked to estimate a 98% range, people still miss the correct answer 30-40% of the time, lacking enough deviation around their best estimate. (Try make a 98% upper and lower boundary for the question in italic above. The answer is found at the bottom of this page).

Forecasts and estimates may give you a ball park clue of where a particular stock or index could be heading, but even if being a his-torical, statistical or educated estimate, it is still just an estimate, if the market disagrees, you’re in trouble. Again, and sadly for investors, the same anomaly described above applies to brokers

“hot stock” or best picks of the year, those usually covering finan-cial front pages in January. A short backtesting done by The Wall Street Journal in 2011, looked at the performance of the 10 most cherished (with most buy recommendations) and most loathed 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.)

Photo: Dennis Skley

[ 17 ]

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 al-most right most of the time, forgetting about those 5% - 2% prob-ability of, say, rain, missing an earnings estimate, or a Greek de-fault. 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, head-ache, allergies, stitching, cosmetic surgery etc.), his usefulness ultimately comes down to detecting (and curing) the low-prob-ability but high impact illnesses, (think cancer, heart diseases or other complex/emergency interventions). Same applies to driv-ing, 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 of-fers a primer in unpredictability and how uncertainty and shocks plays an underappreciated important role in our lives.

The Black Swan theory and the turkey500 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 fea-sible 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 ex-plainable 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 dy-namics of historical events, to elements of our own personal lives."

Pay close attention here, by definition we are not able to pre-dict or model these Black Swans (the first attribute) or their im-pact (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.”

[ 18 ]


In aftermath of the Lehman Brothers collapse and the subse-quent economic turmoil, the economic environment has been characterised by ongoing challenges and changing regula-tions. 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, ma-jor 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 developmentsFirms 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 tur-moil in Europe triggered activity in the corporate bond markets. As interest rates were historically low, investor demand for corpo-rate 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.

Equity versus debt financingConventional 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 require-ments 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 restruc-turing outweigh the potential costs on global GDP is worth an-alysing. 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 sup-port 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 operat-ing 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 in-vestor can buy the exact same fraction of both the debt and

Financial leverage and capital structure

✎ Amaar Malik

[ 19 ]

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 every-body 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 in-creases if a company’s cost of equity or cost of debt increases as higher risk leads to a decrease in valuation.

This equation shows that three variables can change a compa-ny’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 as-sume 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 in-crease in risk and thus an increase in the return required by share-holders (cost of equity). According to the Modigliani and Miller theorem, these two effects will exactly offset each other and en-sure 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-deduct-ible (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

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

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

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

E = equityD = debtV = D + E

Re = cost of equityRd = cost of debtTc = tax rate

00 %

10 %

20 %

30 %

0 0.5 1 1.5 2 2.5

00 %

10 %

20 %

30 %

0 0.5 1 1.5 2 2.5

0 0.5 1 1.5 2 2.5 3

WACC EXCLUDING TA X ES

WACC INCLUDING TA X ES

MAR K ET VA LUE

Cost of Equity

Cost of Debt

WACC

Cost of Equity

Cost of DebtWACC

PV (Finan-cial Distress)PV (Tax Shield)Value of Equity

Debt Ratio

Debt Ratio

100mn

200mn

300mn

400mn

0

Debt Ratio

= + −WACC EV

DV

Rd Tc* Re * * (1 )

[ 20 ]


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):

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 off-set by the increase in the present value of the cost of financial dis-tress. 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 tax-able income, such as ExxonMobil, usually have high debt ratios. Companies like Facebook, which are characterised by risky and intangible assets have lower debt ratios and rely more on equity financing. As the banks’ main assets are financial assets such as government bonds, and they also generate a large taxable income to shield, banks generally benefit from higher debt ratios than other firms.

Implications of new regulationIntroducing new capital requirements such as the Basel III

might lead to a deviation from the banks’ optimal capital struc-tures. This can lead to further mispricing in a market where Goldman Sachs, JPMorgan Chase, Morgan Stanley, Credit Suisse and Deutsche Bank all have price/book ratios that are be-low one (which implies that the market prices their assets lower than their accountants). Furthermore, introducing one-size-fits-all capital requirements, which the Basel III requirements aim to

do, might squeeze out the smaller players in the banking sector in a time regulators are trying to reduce the systemic risk by break-ing up the ‘’too big to fail’’ institutions. Thus, smaller players will suffer as their profitability takes a hit (as lending out becomes rel-atively 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 histori-cally 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 indica-tions of the re-emergence of shadow-banking and risky off bal-ance 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.

SummaryDebt financing enables banks to leverage their balance sheets

and create higher returns on equity as the WACC declines. As banks hold a limited number of intangible assets and generate a large taxable income to shield, banks generally benefit from higher debt ratios than other firms. Although, borrowing seems beneficial in this environment with record-low interest rates, banks might not be able to take advantage of it as they are adapt-ing to new regulations and building capital strength. Thus, policy-makers have to ensure they do not become too aggressive imple-menting new capital requirements as banks might be tempted to engage in risk-taking in their search for yield. As banks are seek-ing to generate a return on capital that exceeds the cost of capital (WACC), capital restraints may force significant deviations from the banks’ optimal capital structures.

Banks generally benefit from higher debt ratios than other firms

Value = Equity + PV (Tax shield) + PV (Cost of financial distress)

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[ 22 ]


Derivatives are mystified instruments, which combined with their central role in the financial crisis of 2008, have resulted in massive attention. Some people endorse them, while others hate them. Warren Buffett referred to them as ''Financial weapons of mass destruction'' in his annual report for Berkshire Hathaway in 2002. There is now a debate going on as to whether derivatives are beneficial for the economy as a whole or not. This article will give a historical perspective on derivatives, as well as explaining some basic concepts.

The general definition of a derivative from Wikipedia is: “A de-rivative is a term that refers to a wide variety of financial instru-ments or contract whose value is derived from the performance of underlying market factors, such as market securities or indices, interest rates, currency exchange rates, and commodity, credit, and equity prices.”

One of the most basic derivatives is called a forward contract. A forward contract is an agreement to buy a certain good (com-modities, equities, interest rates etc.), at an agreed price, at some time in the future. One example could be a farmer selling the grain he will harvest in six months, today. The advantage of such a contract is that the seller of a forward contract secures his future income, and the buyer secures his future payment, at an agreed price. Another important feature with forward contracts, and most derivatives, is that the contract itself can be traded in the secondary market. This is probably one of the main reasons why such contracts occurred in the first place, as we will examine later on.

Another very important derivative is the option contract. An option is a contract where the buyer pays an amount for the right,

but not the obligation, to sell an underlying asset at an agreed price, at some agreed time in the future. Today, there exist numer-ous types of options with the two most common types being the European option and the American option. The European may only be exercised on expiration of the contract, but the American option can be exercised at any time until expiration.

Some highlights from the history of derivatives. In the book of genesis, chapter 29, Jacob was interested in mar-

rying Laban's daughter, Rachel. He agreed with Laban to work for seven years to get the right to marry Rachel. This can be seen as the first purchase of an option. The option premium being the seven years of labor, and the underlying good being Laban’s daughter, to which Jacob received the right, but was not obliged, to marry. The seller of the option was Rachel’s father Laban. This incident, which apparently took place around 1700 BC, is not only seen as the first option like agreement that we know of, but also the first default on such. At settlement date, Laban required Jacob to marry his older daughter Leah, as it was custom to give away the youngest daughter first. Jacob did marry Leah, but be-cause he still loved Rachel, he bought another option to marry Rachel, again, costing him seven years of labor. As bigamy was allowed at the time, Jacob ended up with two wives, and twelve sons. The debate among finance academics still goes on whether the contract Jacob purchased from Laban was a forward contract or an option; whether he was obliged to marry the daughter or if he had a choice, after working for seven years.

Another interesting story is from the first book of ''Politics'' by Aristotle in 350 BC. In par XI he tells about Thales of Miletus.

Financial derivatives:A historical perspective

✎ Fabian Harang

[ 23 ]

Thales was a poor man that was skilled in reading the stars. One winter he saw that there would be a great harvest of olives in the upcoming summer. Having little money, he gave deposits for the use of the olive-presses in Chios and Miletus. As no one bid against him, he won the auction at a bargain. When harvest time came, and many people wanted to use the presses, he could rent them out for any rate he wanted. Thales made a lot of money by in-vesting in something that could give a payoff in the future, a sort of a forward contract.

If you look closely in the history books you can probably find many stories like this, people agreeing on exchanging goods at some fixed “price” at some time in the future.

Around the 17th century the first forward contracts, in the way we know them today, were traded in the Netherlands. The traded contracts were for tulip bulds, an asset that was considered to be worth ten times the average annual income. People borrowed money to purchase and speculate in the tulip bulbs. In 1637, the bubble burst and the price of tulip bulbs was in free fall. Many people lost all their money. This was not only one of the first fi-nancial crises but also the first crisis involving derivatives.

Hundred years later, on the other side of the world, Japanese

rice traders started trading rice on future prices. At the rice market in Osaka, they arranged standardised contracts to trade on different delivery months. These contracts looked a lot like todays futures contracts, in their standardised form, although it is unclear whether or not the contracts were marked to mar-ket. The agreements were kept in a book at a clearinghouse, and were settled within the contract periods. The contracts were set-tled in cash, and the counterpart had to pay or receive the differ-ence between the spot price in the market and the agreed future price. All future trades were done through the clearinghouse, so if one trader defaulted, the clearinghouse was responsible for the payment. The clearinghouse operated with strict credit lines and margin requirement and had to adjust their risk. This type of rice trading was operating until 1937.

In the beginning of the 19th century, the city of Chicago grew larger and larger, becoming a trade center for many commodities. In 1848, The Chicago Board of Trade (CBOT) was established. The trading at the exchange worked much like it had done cen-turies earlier. The traders made forward-like agreements, and settled when the agreements where due. The big problem was the risk of the counterpart backing out of the agreement if the

ã Tulip price index (1636-37) Source: Earl A. Thompson in Thompson, Earl (2007), "The tulipmania: Fact or artifact?"

Dec 12

Nov 25

50

200

150

Nov 12

Dec 1

May 1

Feb 3

Feb 5

Feb 9

100

[ 24 ]


prices moved too much. CBOT lacked a very important ingredient to make the trading efficient and secure to investors; the clearing-house. 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 fu-tures. CME and CBOT have been the lead-ing exchanges for derivatives and com-modities to this day.

The Midas formulaThe next evolution in derivatives trad-

ing 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 per-son 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 be-haviour in the markets. The theory was not well received in academia at that time. In the 1950’s, economist Paul Samuelson, a highly influen-tial economist, discovered Bachelier’s work. The word spread, and in a couple of years, everyone was using geometric Brownian mo-tion in their models on stock prices. Many people tried to calcu-late the value of the option by looking at the expected discounted pay-off, all of them using different discount rates. Often the dis-count rate was non observable, and would not serve well in real market situations. In 1973, Fischer Black and Myron Scholes de-rived what has been one of the most influential formulas in finan-cial history, the Black-Scholes model. By using stochastic calcu-lus, 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

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 immedi-ately, and the volume in options trading took off. In 2008, the no-tional amount of all outstanding positions in the futures and op-tions 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 deriv-atives, 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 compa-nies and individuals achieve from using these instruments is huge. One thing his-tory has shown is the importance of the ability to store future value and hedge un-

wanted 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 legis-lated 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 na-ture and uncertainty. Financial regulation will increase financial innovation, and financial innovation will increase financial regu-lation. 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

[ 25 ]

Approximately a quarter of all stock trading in Norwegian shares is now through alternative marketplaces. Cost, efficiency, infrastructure, latency and ano-nymity are the main advantages of trading through such marketplaces. The increas-ingly competitive nature of the market-place has contributed to a higher degree of fragmentation in trading. A typical agent may trade the same security on many dif-ferent platforms as she seeks to avoid mov-ing markets when carrying out big volume transactions.

Regulatory authorities are losing track of financial markets as markets are becom-ing fragmented. Traditionally, big volume transactions were carried out under regu-lated and transparent terms. Proliferation of alternative trading markets, however, has impaired market efficiency and raised issues concerned with transparency. In re-cent years, less than half of the total trad-ing in Norwegian equities have been car-ried out on the Oslo Stock Exchange, while as much as 25 % of the trades have been carried out in the dark. "Technological de-velopment and new regulations have been

the main drivers of the growth in alterna-tive marketplaces we have seen in recent years. It had not been basis for all the new platforms without a rapid development in technology" says Per Eikrem, a press con-tact and senior vice president of corporate communications at Oslo Stock Exchange.

Algorithmic tradingAlgorithmic trading is carried out by

the usage of computers in order to place orders on stocks and other securities. The software's settings dictate the circum-stances that must be present for an order to be executed. These settings may include absolute values that refer to time, price, or quantity. Once this pre-programmed cri-terion is fulfilled, the algorithm will place the order automatically. Due to the tech-nological development, the increase in use of algorithms has been a natural develop-ment in the global markets.

The European Markets in Financial Instruments Directive (MIFID) was im-plemented in 2007 and lead to increased competition in securities trading. As a result, a number of establishments of new

electronic marketplaces were created. The shares of the largest and most liquid com-panies on the Oslo Stock Exchange are now traded on several markets in Europe, most of which are located in London. This internationalisation has enabled al-gorithms to function simultaneously on multiple marketplaces, and thus take ad-vantage of time delays and mispricing on different marketplaces for the same secu-rity.

There are many reasons why algorith-mic trading has become more widespread. The most important ones, however, is the mathematical accuracy and cost-efficiency such pre-programmed algorithms offer. Furthermore, this service also offers in-vestors more options in terms of risk di-versification of trades. Some people argue that the rise in pre-programmed algorith-mic trading is a natural development as the increased sophistication in computer softwares has led to automation in several other industries as well. Furthermore, sup-porters of algorithmic trading have also highlighted the fact that their presence promotes efficiency by exploiting

alternative marketplaces

✎ Petter Kongslie

[ 26 ]


market imperfections and short-term fluc-tuations in valuation.

"It is also challenging for firms to offer best execution for their customers as this requires that they must have lightning fast technology that can follow the order books (algorithms) of multiple markets si-multaneously. This has resulted in signifi-cant investments in networks and technol-ogy, while the revenues have been under pressure due to increased competition" is Eikrem`s verdict on the current situation.

High Frequency Trading (HFT) dif-fer from traditional algorithmic trading as these algorithms perform a very large number of orders and transactions in a short time. There may be several thousand orders, changes and transactions within seconds. These algorithms’ main goal is to make small low-risk profits several thou-sand times a day.

"Even the exchanges' revenues have de-clined as a result of the increased compe-tition and lower volumes in the markets after the financial crisis of 2008," says Eikrem.

OTCOver-the-Counter (OTC) market is an

alternative to stock trading as it encom-passes trading in unlisted companies. Trade is conducted among investors who meet directly for trading. This market has five players: companies, investors, bro-

kers, regulators and trade systems. The OTC market is not as strictly regulated as an exchange, which allows smaller compa-nies to attract capital easier in this market. Unlisted companies that make their entry here is often in their early stages, and the risk is higher than for companies listed on exchanges. In addition to small busi-ness start-ups, one may also find compa-nies that have fallen out of the exchange. Investors in the OTC market want returns proportionate to the risk, so that the re-turn is often higher than on the exchange. Contracts and negotiations take place di-rectly in the market, so anonymity is not a top priority here, but the lack of reporting on trade has created concerns for govern-ments.

“European governments are now work-ing on a new Directive (MIFID II), which among other things will address the im-perfections of MIFID. This includes the opportunity to monitor trades as well as shifting the trades towards regulated ex-changes”, Eikrem comments.

Alternative Trading Systems (ATS)In recent years, the number of trades

that has taken place outside regulated ex-changes has risen, which has forced many exchanges to merge in order to recapitalise on their market share. The U.S. stock mar-ket has undergone a significant growth and innovation in trading platforms in re-

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, or-der-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 net-work, was developed in 1987 and marked the beginning of the ATS revolution.

Crossing networksCrossing networks are markets outside

the exchange developed by institutional investors. Buyers and sellers are directly connected with each other and large or-ders are intersected. This multinational trading platform matches buy and sell or-ders, for example, to the last transaction price in another large market. Buy and sell limit orders are held until there is a

"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

[ 27 ]

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 influ-enced along the way.

Dark poolsDark pools are private crossing net-

works with the difference being that inves-tors 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 inter-nally. Vendors cannot see listed prices, but they can place orders. Once the order is ex-ecuted, 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 in-formation which may be leaked. If an in-vestor does not get rid of her order, it can be passed on to a stock exchange to be ex-ecuted. If an investor places purchase or-ders 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 se-curity. Trading in dark pools is therefore best suited for high liquid securities. This is because we find the most likely buyers

and sellers with low price volatility. The other risk is that information might be leaked from operators that govern trade in dark pools. There is nothing to suggest that they will never use the information to their advantage, which implies that inves-tors must blindly assume that everything is correct.

"Users are not necessarily superior to the new platforms, but they have more op-tions to utilise. A typical agent (broker)

may trade the same security on many dif-ferent 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 pre-vious 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 sys-tems that contribute to high frequency trading (HFT). Investors who have access to dark pools can now execute trades ex-tremely fast. This implies that liquidity and transparency in the traditional market is reduced to smaller investors. A reduc-tion of liquidity may result in fewer op-portunities to improve prices, which may lead to the dispersion and the execution of orders becoming more expensive. A trend among some exchanges has been that they have developed dark pools themselves in order to not lose market share to the ATS, which is regarded as a major threat.

“There is still a very small share of the total trades that are executed through dark pools. We also have the functional-ity of the trading system of the Oslo Stock Exchange that is equivalent with dark pools", Eikrem concludes.

ã Per Eikrem Photo: Oslo børs

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

Per Eikrem

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[ 29 ]

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 devel-oping world. Seven emerging economies—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 cur-rently 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 rela-tively 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 re-alising 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.

Using innovation to adapt to local markets

Product standardisation is the possibility for a firm to offer a product with uniform characteristics that matches the needs of consumers in all markets. For a firm that strives to break into and develop their business in emerging economies, product standard-isation poses a problem because there are significant differences in consumer needs, income, and literacy to name a few factors. Hence, products that are targeted and sold in developed markets

do not always translate into maximised profits in emerging mar-kets. 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 sen-sitivity 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 in-novated and brought a product to a local market, it is very tempt-ing 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 po-tential of the market.

For any company, it is important to weigh relative advantages. On one hand, it is beneficial for multinational companies to build strong global brands with standardised products. On the other hand, they want to develop products targeted for local markets with specific consumer demand. An interesting example of a company who has succeeded in developing a product that works well in an emerging market is multinational brewer SA BMiller. The company struggled with supplying a low-priced beer that could attract additional consumers who would not be able to

How multinationals should shape their emerging markets strategies

MAnAgIng

Emerging markets

✎ Louisa Brandt and Farzad Khoshnoud(Emerging Markets Team at Capital Magazine)

[ 30 ]


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.

Identifying and retaining local talentsAt 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 lo-cally and globally and who understand both the local market and also the global operations of the firm. Often there is also a short-age of senior leaders, both home and abroad, with a truly global mindset, an understanding and experience of entering new unde-veloped markets.

A company faces strong competition for talent at all levels of seniority from both local and global competitors who compete for competent employees. Hence, it is difficult to find employees at all levels, and retaining them might be even harder. Successful executives in emerging markets might not be content working for the local branch of a global company and they might find other more attractive opportunities at local companies as these firms grow global. It does not matter if an executive leaves because he or she sees little possibility of upward mobility at the local branch or if he or she is poached by local competitors- the result is the same: a shortage of competent staff at the top.

In order to combat this problem, companies need to make sure that there are multiple ways for local leaders to develop and move up in the organisation. One approach is to invest in training and development of local leaders and make sure to make the most use of them in the global organisation. One way of achieving this is to use expat programs where potentials from emerging markets is stationed at the global headquarter. The expat programs can vary in length.

A company could also shift more responsibilities to func-tional or geographical hubs in emerging markets instead of man-aging those markets from the head office. An example of this is the Cisco Globalization Center East in Bangalore. The leaders trained in Bangalore will account for 20% of Cisco’s senior leader-ship team in emerging markets.

Equally important is to look over incentive schemes to make sure that they adequately motivate employees in emerg-ing 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-moti-vated due to low payouts. A company could hence reallocate the-global 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 pack-ages such as pensions and stock options. Naturally, a good under-standing of local compensation preferences is key when trying to attract the best local talent.

Creating a globally coherent corporate culture and values

To function across different cultures can be a challenge for multinational corporations as cultural differences must be ad-dressed. Strong corporate values that truly guide the everyday function of the enterprise can act as glue that holds a global com-pany together, speeds up decision-making processes, and im-proves employee attraction and retention. When the company values are communicated clearly by top management, behaving in accordance with these values will become intuitive even in re-mote locations far from the corporate headquarters.

The company values must also resonate with the personal values of the employees and the values therefore need to guide hiring decisions at all levels. To become cemented in the organi-sation's culture, everyone must be held accountable for living up to and demonstrating the company’s values in their day-to-day work. Because of this, values need to be incorporated intocom-pensation and promotion decisions.

Assessing and mitigating relevant risksEmerging market investments are exposed to additional

risk compared to developed markets, including accelerated inflation, exchange rate fluctuations, adverse repatriation laws and fiscal measures, and macroeconomic and

Emerging markets will have a significant impact on multinationals' growth prospects

[ 31 ]

political distress. These elementsclearly call for a differentap-proach to investment decisions.

Unfortunately, the perception of the elevated risk leads com-panies to reject good investment opportunities and to underes-timate the performance of existing businesses. What should be a clinical evaluation of a company’s many investment decisions become distorted, affecting even the analyses used to evalu-ate a project’s risk-and-return profile. As a result, analysts and business managers overestimate the risk premium, assigning it to levels that even substantial underlying risk would not justify. Addressing these risks correctly may therefore lead to better in-vestment decisions for the multinational corporation.

Creating credibility through transparency This scenario plays out all too often in emerging markets: A

company wants to get a new facility up and running as quickly as possible and assigns a manager to deal with regulatory obstacles. The manager meets with a local official that makes it clear that for $500 certain obstacles will be “resolved” and the project can move forward quickly. The payment would be illegal, but the company will gain millions in revenue by opening the facility sooner and the manager has thousands of dollars in bonuses riding on the project’s success. What should he or she do?

Unfortunately, bribery is not uncommon in emerging mar-kets. New York Times reported that a 2005 internal investiga-tion at Walmart found evidence that executives in the company’s Mexican subsidiary paid more than US$ 24 million in bribes to officials in “virtually every corner of the country” to clear the way for the rapid expansion of the retail empire. Consequently, there are two factors that are in work. Firstly, local officials can tell when a foreign company is in a hurry to get things done, which they naturally leverage. Secondly, local competitors may be “ac-customed” to paying bribes, which gives a competitive disadvan-tage for multinational corporations (which wants to be bribe-free). The question remains, how can business leaders tackle this problem?

Business leaders need to accept certain facts, e.g. that it takes time to set-up new facilities, projects, and businesses in emerging markets. Providing bonus rewards for quick delivery creates in-centives for bribery. Instead, business leaders may want to accept

the difficulties from the beginning, adopt a transparent business model, and be consistent and defend their policy of not accept-ing bribery. By doing so, it may provide long-term sustainability as the organisational values are protected and corporate scandals may be avoided.

Go beyond country-level and build strategy at a granular level

A massive wave of urbanisation is propelling growth across the emerging world. This urbanisation wave is shifting the world’s economic balance toward the east and south at unprecedented speed and scale. It will create an over-four-billion-strong global

“consumer class” by 2025, up from around one billion in 1990. Moreover, nearly two billion people will be living in emerging market cities. These cities will inject nearly US$ 25 trillion into the global economy through a combination of consumption and investments.

In order to accelerate growth in China, India, Brazil, and other large emerging markets, it is not enough, as many multinationals do, to develop a country-specific strategy. Opportunities in these markets are also rapidly moving beyond the largest cities, which often are the focus of many multinational companies. For sure, the top cities are important: by 2030, Mumbai’s economy, for ex-ample, is expected to be larger than Malaysia’s economy today. Even so, Mumbai would in that year represent only 5 percent of India’s economy, and the country’s 14 largest cities will be 24 percent. China has roughly 150 cities with at least one million inhabitants.

The emerging markets cities’ population and income character-istics are so different and changing so rapidly that consumption of a given product category is forecasted, over the next five or ten years by McKinsey, to range from a drop in sales to growth of five times the national average. Understanding such variability can help business leaders to invest more shrewdly and ahead of the competition rather than following others into the fiercest battle-fields.

Emerging markets will have a significant impact on multina-tionals’ growth prospects. The six core competencies as stated above will prove important for future business leaders who wish to capture these growth opportunities successfully, and lead their corporations in tomorrow’s business landscape.

[ 32 ]


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 head-quarters are located in Oslo with additional offices in London, New York, Shanghai and Singapore.

Human RelationsWhat is your job role in a nutshell?My job is a combination of recruitment and employer brand-

ing. In the employer branding part, my main responsibility is to promote Norges Bank as the employer of choice for clever mac-roeconomists. We try to showcase Norges Bank as an attractive workplace for both young professionals and seasoned candidates. In the recruitment part, we motivate and pick the best candidates that have the potential to help us reach Norges Bank’s goals and drive the organisation forward.

How has recruitment in Norges Bank changed over the past few years?

When I first started working here a cou-ple of years ago, we had job postings in newspapers like Aftenposten and Dagens Næringsliv, and recruitment was all about picking the most suited applicants for an interview. Now, there is more competition in the marketplace to hire the best macro-economists, especially after the financial crisis. We are proud to say that we also this

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

Norges BankHow 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 three main divisions: Financial stability, Monetary policy, and Markets and Bank Services.

Were there any changes in Norges Bank after the financial crisis?In the past couple of months, we have observed that mone-

tary policy and financial stability have many things in common. I think Norges Bank is the first Central Bank in the world that has combined the two documents that explain monetary policy and financial stability in one report. We had a press conference a month ago and the market response was positive.

We are at all times curious about how to set up the organisation in the best possible way to support our employees in their work

putting our strategies into action.What is your culture like?Norges Bank is in a transition now. 15-

20 years ago, a lot of the employees work-ing here were not highly educated econ-omists, but rather security guards and money-counters with their key respon-sibilities being transporting and produc-ing money. The organisation has been slimmed down as the headcount has

Careers in

norges Bank

✎ Amaar Malik

Interview with Petter Meyer

Petter meyer • Head of recruitment and talent manage-ment at the Central Bank of Norway

• Has held several posts within executive search and selection

• Holds a degree in organisation and man-agement development from the University of Oslo

[ 33 ] [ 33 ]

PHO

TO: N

orge

s ba

nk

[ 34 ]


been reduced from 1200 to 320 during the past years. The reason for that is that we are not doing the same tasks as we were doing 15 years ago. Today, we are more like a financial institution that needs fewer people. The kind of people that work here now are highly trained and educated. People, who have worked here for 30 years or more, would most likely say that the bank has changed as we have become more academic in our approach and our people are now coming from universities and top consultancy firms.

What is the message you want to convey to potential applicants?The main message is that Norges Bank is a great place to start

your career and a great place to stay for a couple of years as well. By starting your career here you will get a lot of responsibilities early on. For instance, you can play a role in the team that influ-ences the interest rate and the current state of the Norwegian economy.

Secondly, our message is that we have a huge interna-tional focus. At Norges Bank you will have the pos-sibility to have an exchange programme at central banks such as the Bank of England, the Reserve Bank of New Zealand, the Bank of Canada and the Federal Reserve. It is also possible to take a PhD programme at top schools like Harvard or Columbia.

Thus, Norges Bank is an organisation that invests a lot in its employees.

What is the international exchange programme like?

If you have been hired directly from University, you might have to wait for one or two years before being eligible for an exchange. However, if you inform your manager that you would like to exchange, we will discuss with the candidate what kind of role they want to develop into and thus which central bank is the most suitable for them. We have good relations with numerous central banks, especially with the Bank of England. We do not have any particular quotas, but we would rather con-sider employees who want to exchange on a case-by-case basis.

If you choose to go to the Bank of England, Norges Bank will set you up with an apartment in London and pay your wages. In return, we would receive an employee with new perspectives and a broader skill set.

How flexible are you in terms of continuous education for your employees?

We are very interested in people applying for the best schools in the world. If you apply to the schools with the best economic programmes, it can be hard to get admitted. As the application process is thorough, we would be happy to make the Governor of the Central Bank, Øystein Olsen, write you a recommendation

letter as we encourage our employees to go to such schools. What is the Phd grant you offer?Norges Bank would like to expand the field of macroeconomics

for people who are connected to Norway. Thus, we have made a list of sixteen top universities in the world for economics. If an individual would like to apply for a PhD programme at these uni-versities, we would be happy to help them with both the applica-tion process and a grant. Furthermore, there is no requirement to start working at Norges Bank upon completion of the programme. The purpose of this initiative is to expand the field of macroeco-nomics in Norway, and we expect to give this grant to one or two people annually.

do you offer any kind of training schemes for new employees?We offer basic courses and information, and on-the-job train-

ing programmes, but not any fixed schemes. It is more likely that most divisions will assign you a peer or a mentor that

will help you in the beginning. The purpose is that you should be working on authentic tasks from

day one. We think that the people we hire are on an academic level that enables them to start working on real projects from the start.

Graduate recruitmentWhat kind of educational backgrounds do

you prefer?The minimum requirement to work here is a

master degree. Some years ago, we would only hire people with a macroeconomic background. However,

as most graduate programmes have evolved, the course outlines are not as strict on macroeconomic specialisation as students have the opportunity to specialise in finance, microeco-nomics or other related subjects. Thus, the distinction between macroeconomists and micro-economists is not as strict as it used to be. Norges Bank is therefore also interested in hiring people with backgrounds in business administration (siviløkonom).

For more quantitative roles, do you hire people with more scientific degrees such as mathematics, statistics or engineering?

Norges Bank has a lot of different positions, and we have people with backgrounds in industrial economics (industriell økonomi og teknologiledelse) from NTNU as well as physicists and mathematicians. There is an increasing number of managers that demand people with strong quantitative backgrounds with mathematical and statistical knowledge rather than qualitative backgrounds. I would recommend people to do modules such as mathematics, statistics and econometrics in order to build supe-rior quantitative skills.

Photo: Norges Bank

[ 35 ]

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 de-gree 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 appli-cant 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 inter-national economy. You will also need the motivation to climb the career ladder at Norges Bank, and you can choose either progress-ing 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 peo-ple 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 un-

derstand 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 in-terested 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.

What about starting your career at Norges Bank?

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