57° CURSO DE EXTENSION UNIVERSITARIA DE ECONOMÍA 2010.

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Now the question is whether Porsche has pulled off a brilliant new-fashioned corner in Volkswagen stock, using derivatives in clever ways that no one had thought of before, or whether it was too clever for its own good.

In a corner, a buyer or group of buyers buys a lot of stock. As the price goes up, short-sellers appear. They borrow stock — perhaps from the very same group — and sell it, hoping to make a profit when the price declines.

Then comes the squeeze. The group, which now owns more shares than exist, demands the return of the borrowed stock. The only way the short-sellers can comply with that request is to purchase shares, and the only one who has shares to sell is the corner group. The group can set its own price, and make a fortune.

One reason you don’t see many corners these days is that they are illegal in most countries. But another is that almost everybody involved tends to lose in the end, with the exception of lucky investors who happened to own the stock before the fun started and can sell into the big run-up in prices.

Those who execute corners usually make lots of money from the short-sellers. But they end up owning a company for which they paid too much. The stock is delisted from the stock exchange, since there no longer are enough public shareholders, so there is no ready market for the stock. If the group that executed the corner used borrowed money, they may be in big trouble.

(…)

Now, from Germany we have a new version of the corner, using derivatives in a way that may have removed much of the risk for the people planning the corner.

Briefly, here are the relevant facts: Porsche, for some reason, wants to control Volkswagen, and has been building up its stake, thereby driving up the price. Hedge funds, figuring the share price would fall as soon as Porsche got control and stopped buying, sold a lot of VW shares short.

Then last weekend, Porsche revealed that it owned 42.6 percent of the stock, and had acquired options for another 31.5 percent. It said it wanted to go to 75 percent.

The result: instant short-squeeze. The German state of Lower Saxony owns a 20 percent stake in VW, which it said it would not sell. That left precious few shares available for anyone else. The shorts scrambled to cover, and the price leaped from about 200 euros to a high of over 1,000 euros. VW became the world’s most valuable company, if you believed that market price.

(…)

NY Times (30/10/2008)

http://www.nytimes.com/2008/10/31/business/worldbusiness/31norris.html?dbk

- Which of the following statements defines the best what a corner is?

- Someone sells a large amount of stock of a company, in order to make the price go lower. After the prices have gone very low and the seller buys back the stock cheaper.

- A buyer starts buying a large amount of stock of a company and making it more expensive, then short -sellers borrow that stock and sell it. Then, the buyer demands their stock back, so the short-sellers have to buy them at a very high price since there is only very little stock available.

- A buyer starts buying a lot of stock of a company, making the price go up. When the buyer controls a majority stake in the company, it forces the minority stockholders to sell their stock.

- None is correct

- Who wanted to control Volkswagen?

- The state of Lower Saxony

- Porsche

- A group of hedge funds

- A sovereign wealth fund

- What explains best that VW stock went from 200 euros to over 1000 euros?

- Short-sellers needed to cover their positions and there were very few shares available to buy.

- The state of Lower Saxony holds 20% of VW shares.

- Volkswagen announced they were the only German carmaker that wouldn’t need government funds.

- All are correct

- What is new regarding Porsche’s corner on VW stock?

- The ones who sold short a lot VW shares were mainly hedge funds.

- The move made Volkswagen the world’s most valuable company.

- The use of derivatives in order to gain control over Volkswagen.

- None is correct

- From whom is profit extracted in a successful corner?

- Short-sellers

- Majority stockholders

- Institutional investors

- From all the previous

READING 2: Rewarding Failure: Will the Crisis Leave a Residue of Moral Hazard?

The federal government has poured hundreds of billions of dollars into the banking system, and most experts seem to agree that the financial crisis is closer to its end than its beginning. But as attention shifts from fire fighting to rebuilding, many are worrying about the "moral hazard" that may remain, with an apparent government safety net encouraging a new round of foolish risk taking.

"We have created huge moral hazard by, in most instances, sparing all creditors from the consequences of their choices," says Wharton finance professor Richard J. Herring, noting that bond owners and others who lent vast sums to financial institutions have not been forced to take the kind of devastating losses suffered by stockholders.

"They are rewarding failure," Wharton finance professor Franklin Allen says of the government's response to the crisis. "Going forward, these companies will know that if the management takes risks and things go bad, as long as they are a big enough company, the government is going to come along and bail them out." A better government response, he says, would have been to temporarily nationalize some of the big failing institutions, clearing out the devalued assets, ensuring that debtors and shareholders were wiped out and allowing the firms to emerge healthy.

Many products and practices that contributed to the crisis have passed from the scene. The