Pace University Lubin School of Business

International Banking/ Financial

Markets Final Examination

Andrey V. Semenov

10.05.2010

Question #1 :

Describe IMF`s recommendations to redesign Financial Regulation – specifically Risk. Do you agree or

disagree ? Why ?

In the last three decades, financial crises (either currency crises, banking crisis, or simultaneous crises also called twin crisis) increased, becoming a well-known fact of the global economy. These crises are all the more dramatic for developing and transition countries, either middle-income countries (like some Latin American and former socialist economies) or fastened growth countries (like some Southeast Asian economies). In all likelihood, the link between these problems of EM and the increasing international and domestic financial liberalization is at the core of the numerous crises. Consequently, understanding the international capital markets for EM economies is the key for finding solutions to these problems. Despite this basic agreement, the field intersected by international macroeconomics, financial economics, institutional design, and developing studies, does not offer a consensual diagnostic or solution. In the meantime, policy makers either belonging to EM’s national governments or the International Financial Institutions (IFIs), make daily crucial decisions in the midst of turbulent episodes. The recent financial crisis has triggered a rethinking of the supervision and regulation of systemic connectedness. While there is a clear need to take a multipronged approach to systemic risk, and a flood of regulatory reform proposals has ensued, there is considerable uncertainty about how those proposals can be practically applied. Thus, this chapter aims to contribute to the debate on systemic-risk-based regulation in two ways. First, it presents a methodology to compute and smooth a systemic-risk-based capital surcharge. Second, it formally examines whether a mandate, by itself, to explicitly oversee systemic risk, as envisioned in some recent proposals, is likely to be successful in mitigating it. Wide range of official, academic, and private sector financial reform initiatives have surfaced in response to the recent global financial crisis. These include the establishment] of a specialized supervisor of systemically important firms, refinements in the lender-of-last-resort principles, new funding liquidity and leverage restrictions for banks, and capital surcharges based on an institution’s likely contribution to systemic risk. Several of these proposals suggest that regulations uiding the risk management practices of financial institutions are in need of significant improvements and, more specifically, that the focus on the stability of a financial institution in isolation needs to be reassessed. The proposals also suggest that prudential reform efforts need to be supported by an overhaul of the current structure of financial regulation. The introduction of capital charges based on an institution’s contribution to systemic risk is one regulatory proposal that has attracted attention. Although it does not necessarily endorse the adoption of such charges, it illustrates how they can be made operational and at the same time correct for the procyclicality of these charges, thereby countering a critique

often leveled against the current set of Basel II capital charges—and one that the Basel Committee on Banking Supervision is now addressing forcefully. The adoption of capital surcharges and related regulatory measures is likely to represent an additional burden on the financial sector at a time when capital is scarce, and should thus be implemented carefully so as to ensure the availability of adequate credit to support the recovery. Moreover, to fully assess the desirability of surcharges, their costs need to be contrasted against the benefit of lowering systemic risk and the desirability of other measures. At the financial regulatory architecture level, one of the most prominent proposals is the creation of a systemic risk regulator that would focus on the macro prudential monitoring of the financial system as a whole. This responsibility could be carried out either by new regulators or existing regulators with a new focus. While the benefits of strengthening oversight of systemic risk are considerable, implementation of such oversight may not be straightforward, as it will require close coordination and clear delineation of responsibilities between the new and existing (or systemic and nonsystemic) supervisory bodies. This chapter therefore suggests some key principles that need to be borne in mind in implementing the oversight of systemic risk. It shows that under an expanded mandate to oversee systemic risks, regulators will tend to exercise more forbearance against systemically important institutions than no systemically important ones. This suggests that, regardless of how regulatory unction’s are arranged, regulators’ toolkits will need to be augmented to mitigate systemic risks. It is worth noting that there is no one definition of systemic risk, which IMF defines as the large losses to other financial institutions induced by the failure of a particular institution due to its interconnectedness. So now let`s look at that IFM recommendations : 1- Data requirements. The first step in rendering systemic-risk-based charges operational is the measurement of potentially systemic (direct and indirect) financial linkages. This requires more detailed, regular cross-market and cross-border exposures data for individual institutions that could be reported to relevant data repositories, possibly the Bank for International Settlements. When necessary to address confidentiality concerns, national laws should be modified to allow supervisors to fulfill this commitment. At a minimum, national supervisors could rely on international arrangements— such as the Financial Stability Board—to share confidential information at restricted forums with the appropriate safeguards. 2- Procyclicality of systemic-risk-based capital surcharges. It is important that newly designed systemic-risk based surcharges do not have procyclicality features. The surcharge designed in this chapter shows how this can be done. Evaluation of alternative methodologies. In order to advance the debate on how, and whether, to impose systemic-risk-based capital charges, it is important to draft concrete, practical proposals that can be reviewed and evaluated.

3- Cross-border issues. Were capital surcharges to be introduced, they would need to be designed and implemented from a global perspective in order to be effective. The chapter illustrated some potential problems in designing surcharges for globally active institutions from a local perspective. The lesson is very relevant for those who oversee globally active large and complex financial institutions. 4- Communication. To facilitate communication among regulators—within and across countries—confidential systemic risk reports could be prepared on a regular basis. Such reports would be an effective and parsimonious way to track institutions deemed systemically important and their relative ranking. Most proposals for capital charges will likely accomplish the goal of raising capital buffers in line with the systemic importance of an institution—an important objective, but one that does not explicitly show institutions how they can adjust their behavior so as to be less systemically important. However, more analysis is required to design capital surcharges in a way that would induce institutions to take into account their spillovers to the rest of the global financial system. The task is difficult because, among other things, measures of systemic risk should consider second- and third round effects following a distress event, and these effects are often beyond the direct control of the institution. Market-based measures do not allow institutions to trace back their individual effect on systemic risks either. Furthermore, financial institutions may respond to the introduction of these surcharges by attempting to reverse the effects of the regulation (as institutions have attempted to do through, say, off-balance-sheet transactions) or by attempting to exit the perimeter of systemic risk oversight altogether. Therefore, it is important to consider the implementation of capital surcharges in conjunction with other proposals aimed at lessening systemic linkages (e.g., limiting business activities and channeling derivative transactions through central counterparties). This is another reason why there is a need to assess multipronged approaches to mitigate systemic risk. Moreover, all these possible approaches will require further examination through quantitative impact studies. So will they succeed …? Let`s look at that IMF wrote in 2006 before financial crisis almost crushed entire world banking system : The international financial system facilitates trillions of dollars of capital flight from developing and developed countries to onshore and offshore financial centres, with the active participation of banks and other financial institutions. The consequences are massive tax evasion, a resultant erosion of state budgets, and rising disrespect for the law. The international financial architecture must be redesigned. The UN general assembly at the 2005 world summit resolved to "support efforts to reduce capital flight and measures to curb the illicit transfer of funds". The relevant international organizations that, working

together, can achieve such a redesign are the IMF, the Organization for Economic Cooperation and Development (OECD), and the UN. To confront the problem of capital flight and to help developing countries mobilize domestic resources and meet the UN's Millennium Development Goals, the IMF should work with developed and developing countries, in accordance with the March 2002 joint IMF-OECD-World Bank proposal. Firstly, the Fund should - following OECD recommendations - encourage international financial centers, both onshore and offshore, to override bank secrecy (both de jure and de facto) in international tax matters, and to require automatic reporting of income, in order to facilitate automatic exchange of tax information. So they try to redesign it even in 2006 … and that happen next : GBP/JPY 01.01. 2005- 04.05.2010 :

Will IMF more lucky now …. Well we`ll see . … but I think they need more accurate instruments )

Questions #2 World Economic Outlook Report from IMF . What effect have changes in exchange rates , changes in commodity prices have on forecasted growth , real GDP , unemployment and investment opportunities .

“ Let me begin with some good news. The global recovery has evolved better than expected. We at the IMF now forecast global growth to reach 4.2% in 2010, an upward revision of 0.3% from our January forecast, and 4.3% in 2011. Alongside growth, global trade has also shown a strong rebound, and so have capital flows. And, as discussed in the newly released Global Financial Stability Report, financial market conditions and stability have improved. These good global numbers hide however a more complex reality, namely a tepid recovery in many advanced economies, and a much stronger one in most emerging and developing economies. Let me discuss each group in turn. We forecast growth in advanced economies to be 2.3% for 2010 and 2.4% in 2011. This is just not enough to make up for the ground lost during the recession. Output for these countries is now 7% below its pre-crisis trend, and this “output gap” is expected to remain large for many years to come. Associated with this prolonged output gap is persistent high unemployment. We forecast the unemployment rate in advanced economies to reach 8.4% in 2010, and to only decline to 8.0% in 2011. The main factor behind this weak performance and this prolonged output gap is weak private demand. In the United States, consumers, who were the drivers of the economy before the crisis, are being more prudent. In Europe, where banks play a central role in financial intermediation, the weak banking sector limits credit supply. In Japan, deflation has reappeared, leading to higher real interest rates, and putting in danger an already weak recovery. By contrast, we forecast growth in emerging and developing economies to be much stronger, 6.3% in 2010, and 6.4% in 2011. Developing Asia is in the lead, with forecasts of 8.7% for 2010, and 8.6% in 2011. Growth appears not only strong but sustainable. While fiscal policy often played a central role in supporting activity in 2009, private demand is strengthening, and can sustain growth in the future. “ - Olivier J. Blanchard ( Posted on April 21, 2010 by iMFdirect) What's happening is a "multi-speed" expansion, with emerging-market nations generally moving faster than advanced economies, the IMF said. The broad pattern, though, is that almost all nations are growing and faring much better than last year. The "World Economic Outlook" report sees 3.1 percent growth for the United States this year, while acknowledging large uncertainty for its predictions in the US and elsewhere. If

any continent appears to be the laggard, it's Europe, with many nations still in recession or with growth so tepid – in the 1 percent range – that recovery is barely discernible. By contrast, from Latin America to Asia and Africa, developing and emerging economies are showing solid growth. The performance isn't spectacular, but the clout of rising nations is visible in this fact: The IMF's overall forecast for global growth (4.2 percent, up from 3.9 percent in January) is substantially higher than the growth expected this year for industrialized economies such as the US, Japan, or European Union. Easing of monetary policy, stimulus spending by governments, and regulatory efforts to defuse problems in credit markets have all played a role in the pickup. Global commerce has been reviving alongside consumer confidence within many nations. "The outlook for activity remains unusually uncertain, even though a variety of risks have receded," the report said. One prominent risk: Banks in the US and Europe still remain exposed to weak real estate markets. Also, the IMF said it's possible that "market concerns about sovereign liquidity and solvency in Greece could turn into a full-blown and contagious sovereign debt crisis." Although such a crisis may not occur, rising government debt leaves many nations with little room to maneuver if the world economy was hit by a new shock. Still, a separate IMF report this week also shows nations have made some headway in combating the crisis in private credit markets. The reports comes ahead of a weekend meeting of the IMF and World Bank, at which finance ministers will consider ways to make the global economy better insulated from financial shocks like the crisis of 2008. Top priorities urged by IMF officials include reform of financial regulation and for advanced nations to set plans for controlling government deficits over the next few years. Bu doing that they`ll try to achieve more stable commodity process , more stable growth and lowering unemployment and incise investment horizons …. At least they`ll try right . ?)))

Questions #3 3 pages on you favorite Financial Topic : Well I think… I’ll write about How to make money on stock market )))

But first thing first , stock market as I see it is a fractal structure and that do we know about fractal structures … and stock price move by FEAR and GREED which is underling human nature : So first thing first that is a fractals ?

A fractal is "a rough or fragmented geometric shape that can be split into parts, each of which is (at least approximately) a reduced-size copy of the whole," a property called self-similarity. Roots of mathematically rigorous treatment of fractals can be traced back to functions studied by Karl Weierstrass, Georg Cantor and Felix Hausdorff in studying functions that were analytic but not differentiable; however, the term fractal was coined by Benoît Mandelbrot in 1975 and was derived from the Latin fractus meaning "broken" or "fractured." A mathematical fractal is based on an equation that undergoes iteration, a form of feedback based on recursion. A fractal often has the following features:

It has a fine structure at arbitrarily small scales. It is too irregular to be easily described in traditional Euclidean geometric language. It is self-similar (at least approximately or stochastically). It has a Hausdorff dimension which is greater than its topological dimension

(although this requirement is not met by space-filling curves such as the Hilbert curve).

It has a simple and recursive definition.

Because they appear similar at all levels of magnification, fractals are often considered to be infinitely complex (in informal terms). Natural objects that are approximated by fractals to a degree include clouds, mountain ranges, lightning bolts, coastlines, snow flakes, various vegetables (cauliflower and broccoli), and animal coloration patterns. However, not all self-similar objects are fractals—for example, the real line (a straight Euclidean line) is formally self-similar but fails to have other fractal characteristics; for instance, it is regular enough to be described in Euclidean terms. Closest understanding of stock market structure was in my mind accomplished by Ralph Nelson Elliott (1871–1948), an accountant who developed the concept in the 1930s. He proposed that market prices unfold in specific patterns, which practitioners today call Elliott waves. Elliott published his views of market behavior in the book The Wave Principle (1938), in a series of articles in Financial World magazine in 1939, and most fully in his final major work, Nature’s Laws – The Secret of the Universe (1946). Elliott argued that because humans are themselves rhythmical, their activities and decisions could be predicted in rhythms, too. But all Eliot Wave counting was difficult, and kind of lead nowhere … it was too subjective, nothing was precise to many alternative wave count exist .They was simply too subjective and difficult to use in real life. I started the Financial Architecture Int. 6 years ago with simple and at the same time difficult task - find solution for analyzing stock market and find way to estimate underling human behavior patterns. We analyze market from different angles, test it seasonality, we use reverse modeling..uffff.. I think we try more than 1000 different algorithms using biosoftware created by us for exactly that purpose. The idea behind it was quite simple - if Bern Stern have the mechanic algorithm for the profitable trading , it`s exist , and if it`s exist we`ll find it . Well , long story short - that was one of most difficult tusks that I ever had … but We find it ;) And most beautiful thing is that it` will work with any financial instrument , stock , bond , Interest Rate Swap , futures , currencies , options … basically for any financial instruments traded publicly . We design Intelligent software using self learning algorithm which give us the most vulnerable points in time there Fear and Greed of the traders are essentially equal „ the points of uncertainty .But most beautiful thing are those points of uncertainty , if you accept fractal structure of the stock market, became points of estimated certainty . I’ll give a example that I mean by that:

GBP/JPY 01.01. 2005- 04.10.2010 weekly chart Sell Signal was given 03.11.2007 @ 234.47 and by shorting just one contract of with initial deposit (and stop loss in a sense) $19800 you`ll gaining just simply waiting for next equilibrium point to occur on 05.12.2009 @ 149.00 : (234.47-149.00 )*$10 (roughly price of 1 pips of GDP/JPY pare per contract lev. 1/100) = $85470 (minus transaction costs) So it`s: $85470/$19800=4.3167 * 100%= 431.67% on initial investment of $ 19800 It worth to notice - what result was achieved at the time when your institutions were collapsing. On charts:

Green candles - Greed Black Candles - Fear

EUR/USD 09.09.2009-05.10.2010

Futures : 30 year treasury bonds expiration Jun 10 :

Futures S&P 500 e-mini USD Sep 10

In a sense we combine stocks with options in the same trading instrument .Basically Fear and Greed patterns can be seen on any financial instruments publicly traded, more people trade it „ more liquidity -better results. We found that we hope to find …. So How to make money on stock market? Well in my opinion if you expect to make money on stock market you should trade FEAR and GREAD of people, and it is the only way to have dissent return on your investment. Also it gives us opportunity to use portfolio theory of Markowitz but in quite a different way:

The key to Prof. Markowitz theory is finding assets with lowest correlation coefficient ρ , and by combining them in to portfolio we can maximize return and minimize portfolio risk . In Financial Architecture Int we asked our self’s that is the most uncorrelated things in the world …? Well … that about human and machine. ? We simply give machine and human equal portfolio weights and let them trade on contra accounts … when human will feel fear of losing money, machine will not …when human will be greedy machine will be just the machine … when machine will buy

or sell on just signals human will always subjective and will use his own measurements … so ρ in our case close to -1 one will supplement another and both will increase our return „ that was the 2nd great idea . So we combine our self learning algorithm with experienced trader and result was as we expected „ lowered risk and incising return: So we did … we combine it:

And at result we got :

This is example of 1 week of experiment: 10 transactions 10 of 10 profitable … return on investment:

Simple probability = .5*.5*.5*.5*.5*.5*.5*.5*.5*.5 = 0.009765625 less that 1% that it was by chance Return on investment 12386.77/50000=0.2477= 24.77% a week, even if we`ll stop trading now we already beet you market return.)) If it was chance we thought ..we cannot repeat it , so we conduct other tests i`ll give some examples of them :

Different account different transactions: Durations 1 week, 11 transactions - 11 of 11 was profitable Return: Return on invested funds 31572.71/106551.10= 0.2963= 29.63% a week Probability that it was by chance: 0 =4.88* And we already beat your market expected return.) We went further and further try to check maybe we wrong and results that we got is simply game of the chance … well it`s not ))

Now we have 20.92% return on investment with depth to equity ration 428178.70/5000000=0.0856 We got cash flows which is easy to analyze with probability of existence cannot simply explained by chance … by probability theory such events should be so rare that … well let`s say that such events and in such frequency should not exist.) So in conclusion: Get return better that efficient market hypothesis suggests is possible if you have group of people who is ready and willing to work and if you using the right tools „ours) or you free to create your own one, the path is exist we prove it. Whom have a years will hear. P.S. I`m looking forward to find someone knowledgeable ,open minded and as much as I fascinating with markets as I’m to discuss our findings. Feel free to contact me directly. Best regards Andrey V. Semenov

References:

1. Markowitz, H.M. (1959). Portfolio Selection: Efficient

Diversification of Investments. New York: John Wiley & Sons. http://cowles.econ.yale.edu/P/cm/m16/index.htm. (reprinted by Yale University Press, 1970, ISBN 978-0300013726; 2nd ed. Basil Blackwell, 1991, ISBN 978-1557861085)

2. Ichimoku Charts : an introduction to Ichimoku Kinko Clouds , Nicole Elliott Harriman House Great Britain 2007

3. World Economic Outlook ( WEO ) IMF April 2010 4. Tarashev, Niokola, Claudio Borio, and Kostas Tsatsaronis, 2009,

“The Systemic Importance of Financial Institutions,”BIS Quarterly Review, September (Basel: Bank for International Settlements).

5. U.S. Department of the Treasury, 2009, “Financial Regulatory Reform: A New Foundation,” White Paper Report on Financial Regulatory Reform, June 17. Available via the Internet: www. financialstability.gov/docs/regs FinalReport_web.pdf.

6. Peura, Samu, and Esa Jokivuolle, 2004, “Simulation Based Stress Tests of Banks’ Regulatory Capital Adequacy,” Journal of Banking and Finance, Vol. 28, No. 8,

7. Kocherlakota, Narayana, and Ilhyock Shim, 2007, “Forbearance and Prompt Corrective Action,” Journal of Money, Credit and Banking, Vol. 39, No. 5, pp. 1107„129.

8. Brunnermeier, Markus, Andrew Crockett, Charles Goodhart, Avinash D. Persaud, and Hyun Shin, 2009, “The Fundamental Principles of Financial Regulation,” Geneva Reports on the World Economy (Geneva: International Center for Monetary and Banking Studies).

9. Upper, Christian, 2007, “Using Counterfactual Simulations to Assess the Danger of Contagion in Interbank Markets,” BIS Working Paper No. 234 (Basel: Bank for International Settlements)

10. Merton, R.C., 1974, “On the Pricing of Corporate Debt: the Risk Structure of Interest Rates,” The Journal of Finance, Vol. 29, No. 2, pp. 449„70.

11. Financial Architecture Int . www.FinancialArchitecture.org