Chocolate Burrito - Chatham Financial

If you Google “more art than science,” your top 25 results will find that phrase applied to most everything – investing, leadership, IPO pricing, calling up minor league ballplayers, SEC cooperation, and basketball game officiating. At least we didn’t find basic arithmetic on the list!

As newsletter writers on financial derivatives, you might guess we enjoy the interplay between left-brained and right-brained activities. But these two news stories from earlier in the month had us positively beaming with delight:

1 Financial Musings as Art: There’s a thought-provoking new Dadaist art exhibit in lower Manhattan in which the artist, known as t. Rutt, openly questions the Black-Scholes-Merton option pricing formula. Rutt’s centerpiece is a toilet seat – a nice shout-out to Marcel Duchamp’s urinal Fountain – on which he mocks the assumption of infinite time that he regards as invalid for derivatives pricing. There are many other toilet seats hanging on the wall, each with the name of a finance thinker like Merton or Soros, and he welcomes each to visit the gallery in person and claim his monogrammed toilet seat. Everywhere is the symbol for infinity, ?, frequently with a large red line through it. We can’t think of a time when modern art engaged with finance as directly since Ann Hamilton dropped 750,000 pennies into honey for her privation and excesses, but we hope it’s a new trend!

2 Culinary Analytics: Remember the IBM super-computer Watson, which rose to particular fame after dominating two Jeopardy! champions at their own game? According to Popular Science, Watson is at it again, and this time he’s in a food truck! The super-computer draws from the universe of online recipes, professional cookbooks, and a molecular textbook to create pleasing culinary masterpieces from the quintillion (1 followed by 18 zeros!) choices available. All you have to do is select one ingredient as a starting point, and Watson will pick other ingredients to form the optimally delicious recipe. At that point, a trained chef takes over to prepare the ingredients in a sensible fashion. Results are often unexpected – apparently human chefs don’t typically propose strawberry and Vietnamese pork kebabs – but generally quite tasty, and developers continue to improve Watson’s ingredient-picking algorithm. Optimized cuisine, it seems, is the perfect blend of computing power and culinary training, and we can’t wait to try the Belgian bacon pudding or the Austrian chocolate burrito!

At Chatham, as in the worlds of modern art and cuisine, we also believe that the best recipe for thoughtful risk management incorporates both sound analytics and deep expertise. It can be inappropriately reductive to adopt a hedging policy based solely on either a black-box financial model without any expertise behind it, or the advice of an experienced advisor without any sophisticated modeling capabilities. So we’re launching our three-part webinar on interest rate hedging on March 26th to articulate a comprehensive approach to understanding and responding to market complexities, covering such areas as:

Pricing: What are the components of interest rate derivative instruments’ pricing? Which are more transparent, and which are more opaque? Which can be negotiated, and at what stage? How have pricing spreads shifted over time due to changes in market discount curves, pricing bases, volatility, or new regulatory charges?

Execution: As banks consolidate, exit certain business lines, or navigate new capital requirements, how is derivatives pricing affected? What does the reduced bank credit capacity and appetite for risk due to Basel III requirements imply for liquidity, funding charges, and mandatory break clause requirements?

Accounting & Regulatory: What does the new regulatory framework imply for an interest rate derivatives portfolio? What reporting requirements apply for newly originated or terminated trades, and how soon after trading must reporting happen in each instance? What internal processes will be required to adhere to hedge accounting standards and binding regulatory frameworks?

Documentation: How significant are the commercial implications of the ISDA/CSA terms being negotiated? What lending documentation points should be reviewed carefully to ensure they do not significantly reduce latitude on hedging alternatives?

There are many complexities to navigate when determining a hedging strategy; we believe the approach that marries deep expertise with strong analytics can yield optimal results. If you have any questions about structuring, execution, accounting, valuation, or regulatory issues for your risks, we’d love to speak with you, give us a call at 610.925.3120 or email us. And don’t forget to sign up for our webinar on Wednesday the 26th at 2 PM ET, where we’ll discuss all these topics in much more detail, trying not to talk with our mouths full of chocolate burritos or our feet stuck in honey.