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FREE TIME, GOOD FRIENDS, AND CONVERTIBLE BONDS How Darden is Teaching Me To Think Like A Human Being Having a little bit of extra free time does weird things to my newly established MBA brain. For example, I was sitting in class today when a strange connection began to form in my mind between convertible bonds and good friendships. Somehow or other the crazy antics of my Valuations Professor Yiorgos made me realize that the underlying concepts behind every finance concept (if they're correct) are actually valuable in the real world.
I'm not quite sure how he does it, but this crazy Greek manages to make our class laugh every day (sometimes hysterically) about material as thrilling as *drumroll please* Options Pricing!, Bond Valuation! and the Tangential benefits of Black-Scholes’ Pricing Model.
Today, the topic in Valuation was how to understand the underlying value of convertible bonds. What we ended up saying was that, although on the surface it looks like you're paying a lot of money for a fairly small stream of coupon payments, the added value of holding the option to exchange your bond for equity in a company if they become awesome is so valuable that many people are willing to take that risk and join themselves to the fate of the firm for better or (slightly) worse.
This seems a lot like how friendships work. That is, when I make a decision to visit my old group of buddies from college every year, or decide to get married, or just become close to someone in general, I have to give something up to make that commitment - it costs me something. But, the way I see it, while I might not get "paid back" by them -with energy, reciprocal good will, or whatever- the chance that the friendship will be much more joyful than the cost I expend, is so valuable, that I'm willing to step out and make what seems to be an uneven trade for that upside.
To illustrate the point, take he picture above. It's from a few years ago at the house where I grew up in New Mexico. The guy on the right is my brother Peter, and I'm the guy with the guitar. My groomsmen presented me with a beautiful new guitar as a wedding gift, and this picture was taken right after we had finished singing together. For most of the guys that came down for the wedding there is a serious cost associated with being my friend, but they came anyway.
For them, being friends with me with me isn't totally a derivative option because they do get something from me - Christmas cards, the occasional phone call, prayers, good wishes, etc. But the real value, I think, that they receive is knowing that I've got their back, and that if they ever need me, I'll probably be able to help them out. This is how humans think, and it seems like this is how the financial markets work as a result. Most of us don't go around making zero-risk decisions about life, and those people who do are often boring and don't receive much benefit from the people they "invest" in.
Anyway, it's getting late. But I want to end this by saying that one of the main reasons I decided to write about this is because of an email exchange I have recently been having with Dean Bruner about how pragmatically people often view the world. In spite of almost overwhelming evidence to the contrary, many people continue to act as if (even though the way they live their life says otherwise) the world is made up of neutral transactions - entered into exclusively for the benefit of each one side.
Humans, thankfully, don't work like that, and I know marriages don't work like that. In fact, after today's class I'd say that our financial system don’t work like that either, because they depend on people being willing to help each other out -sure, for the chance of making more on the upside- but the concept still holds in exchange for potential mutual benefit. We need to remember we are interdependent upon each other and will create far more opportunities for ourselves and our world if we join our fortunes to the fortunes of those we trust to make the world more like we think it should be.
Isn't that what life is all about? And to think that that all came from a class discussion on convertible bond pricing…
Posted April 08, 2008 Great Read Posted by: JulyDream Just wanted to say I thoroughly enjoyed your post today. Though I do understand the financial markets, it's great to have real world analogies that make it all the more clearer. :) Posted 2008-04-10 14:37:25 thoughful Posted by: Anand I'll echo the sentimetn above. This is indeed very well written and thought provoking. The analogies are great. I am kicking myself for not taking Yiorgos's class. I hear such great thing about his class daily!! Posted 2008-04-10 17:59:44 JulyDream should win an award Posted by: Christof You are like a blog machine... If you ever get the chance, go ahead and let me know how in the world you manage to stay so connected to all of our blogs.
For real though, I'm not kidding, you came in a meeting today as one of those people who really represent the next wave of "blog literate" B-school students. Thanks for reading, and I always look forward to checking out your site as well! Posted 2008-04-10 18:11:02 COMMENT ON THIS POST
