Financial Research Company

Financial Research Company which is a company that hides many experts to do the research, such as inventing models and quantitative method and integrating with the database to turn them into a computer package or software which can improve portfolio performance for those traders, investors or even a bank, a firm. The buyers can use the latest method to do the financial analysis themselves without lots of difficult and sophisticated theory. Therefore, this industry is mainly B2B and we seldom hear about how they work and survive.

Now we will pack up two big players to let you know more on this industry, one is Moody’s KMV, another is Barra.The most two important things for them are “Products” and “Research”. And the following paragraph, I will mainly focus on Barra on “Research” and Moody’s KMV on “Product”

Barra

Background

Barra provided risk management solutions services for more than 25 years. Clients trust Barra's products and services to support their business-critical portfolio and enterprise-wide risk management needs.Barra is a public company, traded on the NASDAQ stock market under the symbol BARZ.Her headquartered is in Berkeley, California. There are 9 main braches on everywhere.

Research & Indexes

Standard an Poor’s (S&P) began collaboration with Barra since 1992. There are three famous pioneer (Eugene Fama, Kenneth French and William Sharpe). When you see S&P on the news, it is already combined by two components, and it is S&P/ Barra Growth and Value indexes. They split into two parts which it’smutually exclusive by “book to price ratio B/P. Lower B/P means that you are in growth indexes, and the higher B/P means that in value indexes. All stocks insides S&P will be classify the group, Growth/ Value. Finally, add up two groups into the full index (S&P). Like the full S&P, the value and growth indexes are capitalization-weighted, meaning that each stock is weighed in proportion to its market value. Although both groups can not trade directly on the market, but you can see their index on the newspaper with the code ^SVX and ^SGX very often.

Outgrowth of research

There is some other research besides collaboration with S&P. 1990 Nobel Laureate William F. Sharpe found that the value/growth dimension ( as represented by price-to-book rations), along with the large/ small dimension, (as represented by market capitalization ) appears to explain many of the differences in returns to U.S. equity mutual funds. And later Fama and French found that the combination of book-to-price ratios and market capitalization explain much of the cross-sectional variability in average stock returns over the period from 1963 to 1990. Besides the new book-to-price ratio, there are also some other method to characterize “value/ growth”. However, they found that book-to-price tend to be more stable over time than alternative measures such as price-to-earnings ratios, ROE.

Moody’s KMV

Background

Moody’s acquire KMV and merger with her own risk management services subsidiary formed Moody’s KMV (MKMV) in April 2002. The mainly focus of her is credit risk. Her headquartered in SanFrancisco, CA, and serves 2000 clients operating in over 80 countries. The mission is to help the customers increase the value of their operating franchise.

Credit Risk

Credit risk means the possibility that a bond issuer will default, by failing to repay principal and interest in a timely manner. Bonds issued by the federal government, for the most part, are immune from default (if the government needs money it can just print more). Bonds issued by corporations are more likely to be defaulted on, since companies often go bankrupt. Municipalities occasionally default as well, although it is much less common, also called default risk.

Products

Moody’s KMV provides EDF, expected default frequency, (explanation given in the following paragraph) credit measures by subscribing to one of the following products:

Credit Monitor

CreditEdge

EDFWatch

RiskCalc

EDF (Expected Default Frequency)

The credit risk measurement of MKMV, Expected Default Frequency, is a probability that a firm will default over a specified period of time. “Default” is defined as failure to make scheduled principal or interest payments. EDF is based the Vasicek-Kealhofer model. The main feature is that it reflects a cause-and-effect relationship among the model drivers and final default probability estimates. The three main factors to determine EDF: market value of assets, default point and asset volatility. MKMV EDF credit measures have been tested on over 30 years of data representing approximately 4,000 defaults in the United States alone as well as on smaller samples in various countries around the globe.

After introduce the main focus of MKMV, now we discuss some main different between products. Credit Monitor and EDFWatch depend on credit risk. CreditEdge and Risk Calc depend on probability of default. (Will be explain in the following paragraph) Credit Monitor is a windows-based desktop software package but CreditEdge is a Web-based tool measure the probability of default which is designed for those traders very often. EDFWatch is special for medium size banks, corporation and investors. It is a monitoring tool make you focus on those credits that present the most risk or opportunity to their portfolio. Moody’s Risk Calc is also a web-based, and calibrated Probability of Default (PD) models. This model is used in the credit evaluation of private corporate borrowers.

Probability Default

The reason why MKMV use two different systems (PDs and EDF) to measure default risk, and it is mainly related to the acquisitionof Moody’s and KMV. Before April 2002, Moody’s risk management services used PDs to notify the credit risk while KMV used EDF value. Both are interpret the same concept which is the firm’s probability of default. However, PDs is superior in measuring credit risk of private firms and EDF has much power on making decision on public firm.