South Sea Bubble Flashcards
What is it that the SS company does with government debts/bonds?
They buy all illiquid bonds at a small discount, and put themselves over the government debt. Then sell their shares –> the value they create is that people value liquidity and now they can buy the illiquid bonds indirectly via stocks from SS that are liquid.
Why is it not irrational to buy the subscription plan instead of the stock, even though the subscription fees are higher than the stock price?
Because if you see that the stock price go down, you can stop making your installments, they are not legally binding. So the subscription is more like an option that is very valuable as long as the stock price goes up. Because if If I sign up for 1000, and make the first installment of 100.
Then the value increases to 1100. –> my payment is already worth 100% more! 100+100=200.
What financial engineering did SS do?
They created value from government debt, by increasing the inherent value in every subscription.
How does price changes differ between dotcom mania and SS bubble?
The price changes are more volatile in the 18th century. SS company for ex increase by 800% which is huge. Whereas for ex Cisco in the dotcom mania (which increased a lot!!) only increased by 220%.
Why does the SS company stock price collapse eventually?
Because they engaged with the Sword Blade company and when they went to the government and asked for help to shut down competition, the bubble act had unintended consequences for SS –> they could no longer continue their financial business in the Sword Blade company and no one wanted to subscrie anymore. SO their whole trading mechanism shuts down and stock price falls.
What is the similarity between 1720 SS bubble and Nasdaq bubble when it comes to predictable sentiment?
The similarity is that in both times, there are incentives structures that makes things more likely ot push up prices and increase the mispricing.
- In Nasdaq - it was small free float, short-selling constraints etc, that makes investors know that this can only go one way (up) so we should invest.
- In 1720 bubble, it is the subscription schemes that makes investors know that the inherent value will go up IF there is additional rounds of subscriptions.
So, it is about incentives structures –> making predictable sentiment important and useful
