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VOLUME III: ISSUE X

JANUARY 2013

Dear WUFC members, As Co-Presidents of WUFC, we are pleased to welcome you back for your spring semester and are excited to share our vision for the upcoming year. Following our recent board elections, we continue to revamp our board structure with a greater focus on general board members. Our Corporate Relations, Membership, Marketing, and Events roles have all seen a transition of leadership, one that has been seamless thanks to our continued focus on providing you with applicable industry knowledge and valuable networking opportunities. Looking ahead, some of the events we will have are Training the Street workshops, mock interviews, and other additional networking opportunities with employers. Please to continue to check our emails, which will contain details for our events over the course of the year. Thank you for your continued support and participation in our clubs events. - John Geagea and Jonathan Hwa

their peaks. Also, as Alexander Gerschenkron aptly points out in his Modernization Theory, industrialization follows an exponential curve; the earlier a country is on that curve, the faster their rate of industrialization. Currently in sub-Saharan Africa, infrastructure is virtually non-existent, nations are detached from the pressing financial problems of the West, population is growing at a healthy rate (bigger consumer base), people are living longer (more reliable workforce), and cities are bustling. The International Monetary Fund expects 5 percent GDP growth in Africa this year and many insightful investors have been testing the waters of Nairobi and Abuja already. FDI in the continent has increased about fifty percent since 2005, and prominent Wall Street firms have purchased a few African nations sovereign debt. The Drawbacks So whats the catch? Many of these nations have unstable governments and capricious economic policies. In addition, there is not much reliable quantitative data to base market research on. However, investors are hopeful that the situation will improve at a promising rate even considering the continents inauspicious beginnings. Political restructuring, albeit modest, is off to a good start, and stabilizing conditions have attracted more purchases of the continents government bonds. It is true, however, that foreign businesses will face daunting red tape, perhaps worse than what they have had to face in China or India during those countries initial developmental stages. Legal systems are not well established, making it tricky to enforce contracts and ensure patents and licenses. By taking into account the opportunities presented by this vast, detached, and resource-rich continent, the downside does not outweigh the upside. The Recommendation First one in the market usually wins, said Leonard Lauder in his special lecture at the Wharton School a few weeks ago. This applies to the development of infrastructure in Africa remember, Africa boasts a massive landmass bigger than the United States, China, India, and the Western Europe combined. However, it lacks the appropriate infrastructure to propel development, vigorously soliciting foreign in vestments, and is abundant in labor force ready to be trained. Accord

Oh africa!
By Jeon Kang
The Motive Subsequent financial crises, stymied growth in the West, and the stalling development in the East have left global investors baffled, asking where now? Beijing recently anointed their new leader, Xi Jinping, expressing confidence that he will continue the decade of skyrocketing economic growth stewarded by Hu Jintao and address (and possibly resolve) corruption issues that the Communist Party has faced in recent years. Tokyo and Seoul are also set for selecting their new leaders who will hopefully bring much-needed vigor and spark to their lagging economies. Although these changes in Asia could clear up impediments for progress, Asia is still heavily influenced by the financial crisis in Europe and the slowdown in the United States it could be a while until the West redeems its past years of advancement. The Opportunities So, think Africa. One of the major advantages of Africa, especially West Africa, is its vast potential for growth and speed of development, which could match the growth rates of Korea or Japan at

Story continued on page 4, Oh Africa! MICROSOFT &APPLE Karan Parekh


Pages 3 & 5

FINDING vALuE IN JuNK Guilherme Baiardi


Page 2

TRADE OF THE MONTH (GOLD) Kevin Goldfarb


Page 3

CHINAS GROWTH STORY Charles Bagley


Pages 4 & 6

INSIDE THIS ISSUE

WharTOn undergraduaTe finance cluB

januarY 2013

finding value in junk


By Guilherme Baiardi
After the post-election sell-off, much attention was focused on the stock market and the inevitable (further) decrease in government yields as a result of the so-called flight to safety. However, not all bonds are created equal, and high yield bonds moved inversely to their investment grade counterparts. Unlike investment grade bonds, which saw an increase in demand, high yield bonds were dumped as investors sought to unload risk. Although this is one small example, it is true that high yield bonds share many characteristics with equities that regular bonds do not. The discovery of these similarities was one of the main theoretical foundations that led to the exponential expansion of the high yield market in the 1980s. Let us start with the basics: a high yield bond, or a junk bond, as they are sometimes called, is a fixed income security that has been awarded a credit rating below BBB (or its equivalent, Baa, in Moodys case) by the rating agencies. Implicit in this rating is the assumption that these companies are significantly more likely to default on their obligations than the companies that have been awarded investment grade (IG). Usually, when we are talking about AAA rated companies or treasuries, the practical default risk is basically zero. This implies that the company has been historically able to service all of its debt and there is no reason as to why it will not be able to do the same in the future. In other words, the expectations are fairly constant. With high yield bonds, these expectations are anything but certain. In these cases, the high yield issuer will usually only be able to service its debt payments if their future cash flows are sufficient. To justify this risk to investors, companies and investment banks offer yields that are much higher than those found in investment grade companies, usually with a spread of 4-5% over government treasuries. IG companies yields, in contrast, average a 2% spread over the comparable government security. High yield bonds end up, very much like stocks, depending on future cash flows for their valuation. This is different from an IG bond, where future cash flows are often inconsequential to the debt payments (the companys balance sheet is so strong they can service debt notwithstanding future performance). If the company registers particularly strong results, there will be higher chance of fulfilling its obligations, and as a result, high yield bonds price will increase, as their yields decrease after adjusting for the new risk levels. A positive aspect of high yield bonds is that, if the company does well, there is a chance the companys ratings will be upgraded, significantly increasing its price and effectively allowing its investors to register big capital gains. Inversely, these bonds are also significantly more sensitive to bad news and will perform poorly in the wake of bad earnings reports. To summarize, there can be significant capital gains from high yield

understanding the world of high yield bonds


bonds, somewhat less than equities but definitively greater than gains from investment grade bonds. High yield bonds, then, provide investors with a hybrid security - one that acts as a regular bond but shares many characteristics with common stock. A number of empirical studies have been conducted to test these assumptions, and the results have been largely positive. In the 40-year period from 1971 to 2011, corporate high yield bonds have had a correlation of 0.469 with the S&P 500, showing a strong link between the two. Furthermore, correlations usually increase in down markets and decrease or remain constant in up markets. The reason as to why the correlations are higher in down markets is somewhat obvious: as the markets fare worse, there is a higher chance the company will not fulfill its obligations. In upwards trending markets, there is a limit to the effect positive earnings can have: there is little difference if a company earns $1,000 or $10,000 if it only needs enough to service $100 of debt. Another reason for this is that high yield bonds are not nearly as exposed to interest rate risk as other bonds. These bonds have low duration (it takes less time for the investors initial investment to be repaid), and, due to the fact that interest rate changes have a greater effect on future rather than shortterm cash flows, show very little sensitivity to changes in rates. By now, you are probably asking why people would even bother holding equity (or any other security for that matter), but the story on these high yield bonds is not as rosy as it seems. Before the 1980s, institutional investors (the main buyers of fixed income securities) and rating agencies did not acknowledge the influence of future cash flows on junk bonds. Their rating only represented historical data, and they categorized a company based solely on past performance. Institutional investors, bound by statutes that prohibited the buying of junk bonds, stayed away from these securities. Today, the ratings issued by the agencies tend to incorporate future cash flow forecasts, and the market is much more efficient in categorizing certain issues as high yield, making it much harder for a high yield investor to realize positive returns (alpha) on these rating inefficiencies. Furthermore, these securities are still riskier than your average securities. Future cash flows can still come below what is necessary to pay the debt, and the debt holders can lose a significant percentage of the bonds value. The fact remains, however, that high yield bonds fit into a very unique niche, right between equities and investment grade bonds - they provide relatively lower risk than equities while still providing the security of fixed cash flows. These bonds are thus invaluable in terms of portfolio diversification and every conscientious investor should consider holding some junk in their portfolios.

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januarY 2013

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Trade Of The mOnTh: BuY gOld


By Kevin Goldfarb
A Brief History The use of Gold as a commodity money is as old as the concept of currency itself, dating back to before 600 BC. Since then, Gold has been used as a currency or a basis for pricing currency all the way through to the 1970s. Asset-backed currencies facilitated the exchange of currencies at known rates when the flow of information was not as fast as today. In addition, the convertibility of banknotes for physical gold added another layer of stability to currency prices. Under the Bretton Woods System, most major currencies pegged their exchange rate to the Dollar, which was then pegged to gold at $35/ounce, making most global currencies pegged to gold. In the early 1970s, the pegs became unsustainable because of large balance of payments deficits, and the Gold Standard was officially ended. Rationale Even though Gold pegs and asset-backed currencies were abandoned in the 1970s, the use of gold has become even more important. Gold is now seen as a hedge against exchange rate risk, inflation, adverse economic conditions, or even a hard asset investment. Should the dollar depreciate due to expansionary monetary policy (read: QE3), the price of gold will appreciate conversely because of its nature as an asset and speculation from other investors seeking safety. The current state of the global economy is not far off from a situation such as the example above. Every major central bank is printing money in order to devalue their currency and aid their respective economies. These banks include the European Central Bank, Bank of Japan, Bank of England, Australian Central Bank, and, of course, our lovely Ben Bernanke. The fact that all these nations are effectively sabotaging their own currencies leaves little safe haven because of their race to the bottom. Of the major currencies, the only ones that are not throwing money out the window are Switzerland and Singapore, which are pegged to the Euro and Dollar respectively. We have begun to reach the point where the safest place for money is in gold itself. Fund managers have been calling this trade since 2007, which is what pushed Gold to all time highs of $1900+. The currency, however, has cooled off considerably since then. The one situation in which gold would not perform well is under a sizeable market uptick, in which case the price of gold would probably increase, but less relative to the market. Another benefit of gold is that it tends to increase in price during sociopolitical unrest, which is not absent from our times. This happens because investors partake in a flight to safety and hard assets. Nobody wants to hold positions that will tank during wartimes or massive social unrest, and thus everybody dumps those assets to buy gold, causing appreciation. Strategy Common methods to invest in gold are through purchases of asset-backed ETFs, physical stock, gold miners, or their respective ETFs. I recommend purchasing asset-backed ETFs or gold mining ETFs. Physical stock doesnt work because there are inventory costs associated with it, along with the fact that a standard Gold Delivery Bar (400 ounces) costs around $650,000. Some specific names I recommend are GLD (SPDR Gold Shares Gold Asset Backed ETF), GDX (Market Vectors Gold Miners ETF), and NUGT (Direxion Daily Gold Miners Bull 3X Shares).
This article was written on January 18, 2012, when Gold traded at $1684.60. Disclosure: I currently have position in GLD and GDX. All data is sourced from Bloomberg or Yahoo! Finance.

micrOsOfT TOdaY, apple TOmOrrOW?


By Karan Parekh
Microsoft was once at the forefront of technology, with competitors always a step behind. Their operating system, MS-DOS, catalyzed the boom of the modern personal computing industry. Recently, however, Microsoft has begun losing market share to rising star Apple and has failed to take advantage of new market opportunities in mobile OS. Microsoft has, in several ways, slipped from the lead to the middle of the pack. The company is now looking to play catch-up with a new business strategy that is uncannily familiar to that of its competitor, Apple. Retail Microsoft has never established itself as a retail company. Raising revenue mainly through the licensing of software, it never followed a brick-and-mortar approach, which would have unnecessarily raised capital expenditures. Even when it created its own hardware products, such as the Xbox and Xbox 360, Microsoft sought intermediary retailers. This approach lies in stark contrast to Apples decision to revolutionize retail with minimalistic design, currently producing an unparalleled $6,000+/sqft in annual sales, approximately twice the amount of the secondranked company in that category. Microsoft, however, has rethought its approach. This year, Microsoft launched its own retail stores on the East coast for the first time in company history. The store designs were strikingly parallel to those of Apple: tables of computers, clutter free and

Story continued on page 5, Microsoft Today


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januarY 2013

chinas grOWTh: a revieW


By Charles Bagley
As China has grown to be the second largest economy in the world, it has become a principle force in global commodity markets. Chinas mining industry is incredibly large. Although precise figures are hard to find, direct mining activities comprise around 5% of Chinas annual gross domestic product, and the industry employs around 4% of Chinese workers. Using the South African and Australian mining industries as models, we can deduce that mining-related activities constitute an additional 5-10% of GDP. This represents a huge leap forward as China shifted from small village co-operative mining enterprises to large mining projects. As of now, only a small fraction of China is developed enough to support these ventures, so the output of the mines will increase exponentially in the near future. The size of the mining industry is due the Chinas unusually richness in natural resources: The country is the leading producer of many minerals and metals including aluminum, antimony, barite, cement, coal, gold, iron, lead, molybdenum, salt, tin, and zinc. The Chinese industry as a whole has an incredibly large appetite for these products, which puts it in the interesting position of being the worlds leading producer as well as the leading importer of these commodities. For China to maintain growth for the future, much of its GDP growth will depend on how self-sufficient it can be. China does not have an export economy in the classical sense of the term because although many goods leave China to be sold abroad, the truth is that manufacturing in China is based on assembling parts created outside of China rather than refining domestic raw materials. Case in point, FoxConns factories dont make iPhones but merely put them together. Most of Chinas metal and mineral imports come from Australia and New Zealand, which in turn causes the Aussie and Kiwi economies to depend on Chinese demand. However, there is considerable opportunity for growth and development in Chinese metal and mineral production to meet domestic demand. It is likely in upcoming years that Chinese production will phase out the countrys tendency to import raw materials from abroad to manufac-

A countrys road to success and its path to the future


ture consumer products. Shorting the Australian dollar (AUD) and Kiwi dollar (NZD) has become a common method of shorting the Chinese economy, because a lapse in Chinese growth will lead to lesser demand for those two countries exports. On the other hand, as Chinas domestic mining develops, once again demand for oceanic metals and minerals will fall, meaning that value of the AUD and NZD are likely to fall even as China grows larger. Similarly, China is the worlds fourth largest oil producer at 4.3 million barrels per day, but simultaneously the worlds second largest oil consumer in the world at 9 million barrels per day. This incredible demand derives from the countrys population and industrial economy. China has the worlds 13th largest oil reserves in the world. In other sectors of energy, China has the 12th largest reserves of natural gas and 3rd largest reserves of coal, but most doubt the quality of the coal. Regardless, China has enough energy reserves to support considerable manufacturing growth in the near future. Chinas demand for mineral and metal ores like copper and iron, as well as energy, drives the entire global market. However, Chinas agricultural output is also a worthy topic of discussion. Agriculture constitutes over 10% of Chinas GDP not only in the value of the output, but also the number of people it employs. Not surprisingly, China is the worlds largest producer of rice, but China also stands as the worlds largest producer of wheat and fresh vegetables as well. China is also the second largest corn grower and fourth largest soybean producer. In terms of foreign trade, China is the worlds largest exporter and second largest importer of agricultural product. In summary, commodity production in China will continue at an unstoppable rate, so it seems likely that the countrys production will be able to support its demand without having to rely on foreign markets. China may see imports rising in the energy and agricultural sectors, but will still maintain a large amount of self-sufficiency in those areas. Given this analysis, Chinas growth in terms of commodity production will bolster the countrys growth.

Oh Africa!, story continued from front page


ing to Informa Telecoms and Media, Africa is expected to cross the 750 million mobile subscribers threshold during the fourth quarter of 2012, and the continents mobile data revenue is projected to reach $18.5 billion in 2016. Just a decade ago, the use of the telephone was limited to a mere 0.7% of the population. Mobile service is just one of the myriad possibilities hidden in the continent, and as Mr. Lauder insightfully pointed out, pioneers do win most of the time. Infrastructure needs are imminent in Africa as many nations cry out for roads, factories, electricity, water supply, medical care, airports, and ports (to name a few of the major ones). Many shrewd investors are already vying for talents who can guarantee their ROI and steer through formidable stumbling blocks lurking in the continent. Africa is without a doubt a worthy place to keep an eye on, as its potential will soon become apparent enough to attract serious capital traffic in the region.

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januarY 2013 Microsoft Today, story continued from page 3


spacious layout, and tech geeks standing by, ready to assist. Microsofts 10-K highlights these new retail stores as part of a long-term strategy, stating additions to property will continue. Establishing brand recognition for products that have hitherto been known only as support for other companies hardware is a step forward for Microsoft and one that will hopefully mirror the success Apple had when it introduced the concept over a decade ago. Hardware Microsoft is chiefly known as a software company. Few hardware products in computing carry the Microsoft logo. In a realm outside of computing, however, Microsoft has made its mark with its Xbox gaming hardware. In past years, as markets for cell phones and mobile devices spiked Microsoft chose to stay within its traditional software sphere. Instead of creating its own phones, Microsoft offered its operating systems to complement other companies hardware. Apple is renowned for producing the complete package, and it uses its unparalleled hardware and software pairings to charge heavy premiums on its products in an industry that runs on the margins. Microsoft has begun to follow suit with the creation of a line of Surface tablets that stand as legitimate competition to Apples iPad line, as well as the attempt in the mobile sector with the Windows Phone. The Surface is one of the few tablets priced competitively on the higher end with Apple to provide direct competition, whereas other Android and Amazon tablets have versions that are aimed at those looking for lower prices. The integration of new features such as the keyboard cover has sparked consumer interest. On the corporate end of the spectrum, companies have recently begun to move away in small numbers from traditional providers to Apple in mobile areas. However, with the launch of Windows 8, Microsoft looks to retake this enterprise foothold. Admittedly, Microsoft is spending much more money marketing the products than perhaps it should, but, as with its proven Xbox market penetration plan from a decade ago, it hopes this initial net loss through heavy marketing will create a permanent market sphere for the Microsoft Surface and future tablets to come. This would take market share away from Apple and Google, ending their effective stranglehold on the mobile sector; Microsofts 10-K states that they will continue to broaden market penetration of hardware. Cloud Services/Integration One of Apples key strengths lies in the interconnectedness of its many products; its cloud computing services through iCloud sync data across multiple devices. Cloud computing has been available for several years but was never popularized and never implemented as effectively across various products. Microsoft has sought to create its own cloud computing and storage system, known as SkyDrive, in order to penetrate this growing market and potentially integrate a product line of its own. With potential moves in hardware across various markets,
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a cloud storage system could create linkages across these products for the Microsoft ecosystem. Skydrive currently aims to link all devices through an overarching cloud service not exclusive to Microsoft products. However, it is the first cloud service tailored for Windows 8 and specifically Windows devices, and, with its pre-installed integration on Microsoft devices such as Windows Phone, and compatibility with key Microsoft Software such as Microsoft Office, Skydrive is poised to play a large role in connecting the Microsoft family of devices. The company states, we see significant opportunities to drive future growth in smart connected devices The future Microsoft appears to have taken a page out of Apples book, adopting an aggressive strategy for the future that critics have found uncharacteristic of the company. While there are significant risks in launching products too differentiated from those the current market is accustomed to, Microsoft looks to regain its footing in an industry where stagnancy can only lead to failure. With future aggressive moves such as the full implementation of the revolutionary Windows 8 OS, Microsoft can be the Apple of tomorrow.

[crediTs]
kevin goldfarb Editor-in-Chief
Vice President of Financial Analysis

shruti shah
Managing Editor

jasmine azizi & alejandro villero


Assistant Editors

guilherme Baiardi, Tony murphy, matt parmett & Teddy Xiong


Senior Financial Analysts

charles Bagley, jeonkang &karan parekh


Financial Analysts

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