Friday, June 17, 2011

Risky business!

Old man Newton once upon a time said that every action has an equal and opposite reaction. Given the number of engineers who end up becoming fin geeks, it is no doubt that such a dictum forms the basis of the whole finance industry. For every risk averse guy out there, there is an equal risk-loving guy out there too! You make your profits by expending effort in looking that dude up. Which is why, the episode of a Chinese entrepreneur hurling abuses at Morgan for purposefully underpricing their IPO looks bizarre!

Now the story caught my eye not just because it involved Chinese, IPOs and Morgan. But because it was an out and out war on.... TWITTER! Speak about suits in wall street putting their BBs to good use. The issue was more like the Chinese entrepreneur of an e-commerce company called Dangdang (I know!!! wonder how bankers managed to go past the name in the first place) was disappointed when his IPO was priced at $16, but opened and settled at $29. Close to $240 million apparently was 'left on the table', or rather was money that could have been got with niftier pricing! A war of expletives broke out on Twitter between Mr. Dangdang and someone claiming to belong to Morgan. I say claiming, since Morgan was quick to wash it's hands off this dirty business.

But the issue is not so much the use of Twitter or the entrepreneur's endless tirade but rather how exactly is one to quantify risk. Morgan underwrote the issue, which, in other words means that if the IPO went undersold, they would pick up the pieces at the issue price. So obviously, being the risk absorber in the face of the ebullient risk-loving entrepreneur, by Newton's law, Morgan is bound to be risk averse and hence cautious. Besides, underwritten IPOs have an inherent conflict of interest, is perhaps a given, as they need to set the best price for the client, while minimizing their losses. So, in all honesty, Newton perhaps dictated the price!

One place where Newton's law does not apply though, is in the wonderful world of insurance, which perhaps has been the theme of countless books and movies to date, with the term 'pre-existing condition' being used akin to a cuss word in places! The most elegant part of insurance is the inherent irony in the whole concept. One, usually the more risk averse people are the ones who prefer to get insured, in order to protect themselves in the event of a rainy day. However, while Newton might have said that a risk lover is to be coupled with a risk-averse entity, as it turns out, given the wriggly, defensive stance taken by most insurers, you wonder why two risk-averse individuals have been thrown together into the bond of not-such-a-holy matrimony!

All in all, the fact remains that Newton not just missed out on a lovely red apple, but also set the very foundations of the frameworks that underlie this risky business!

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