Table of Contents. Case Study VW. Case - Study. Common Stock vs. Preferred Stock Common Stock VOLKSWAGEN - SHORT SQUEEZE

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1 Table of Contents Case - Study VOLKSWAGEN - SHORT SQUEEZE 99 Common Stock Common shares/stocks represent ownership in a company and a claim (dividends) on a portion of profits Investors usually get one vote per share to elect the board members, who oversee the major decisions made by management Over the long term, common stock, by means of capital growth, yields higher returns than preferred stock or other investments in the company This higher return comes at a cost since common stocks entail the most risk If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders and preferred shareholders are paid 100 1

2 Preferred Stock Preferred stock represents some degree of ownership in a company but usually doesn't come with the same voting rights With preferred shares, investors are usually guaranteed a fixed dividend as long as the company exists This is different than common stock, which has variable dividends that are never guaranteed An advantage is that in the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders) Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime for any reason (usually for a premium) 101 How are Common and Share Stock usually connected? 102 2

3 What happened here? 103 To understand the current market situation no expertise is needed

4 To understand the current market situation no expertise is needed What happened here? 106 4

5 What happened here? 107 A possible scenario Hedge-funds, investment funds and other financial participants consider the Volkswagen common share overvalued According to their market and stock appraisal they open short positions on VW common shares What is a short position again? Market participants borrow (in this case) VW stock from other market participants (banks, funds, etc.) They sell the acquired amount of stock at a market price of (let s say) 400 and speculate that the price of the VW stock will fall to 150 If this was the case, they repurchase the VW stock at 150, give the physical stock back to the original owner and keep a profit of 250 per share (minus some commission fee) 108 5

6 A possible scenario The risks of short selling: The asset value moves in the other direction as the speculator expected There are physically no more assets, which can be bought back The role of Porsche: Porsche announced on Sunday that their share of VW common stock reached 42,6% Porsche also announced their holding of 31,5% cashsettled options on VW common stock, which in case of exercise brings them to 74,1% Niedersachsen owns another 20% which leaves about less than 6% free-floating shares in the market 109 A possible scenario On Sunday the market received the information that there are only less than 6% of free-float shares available To the same time, the market realized that there are 15% of short positions on the VW common shares Additionally, considering the VW common shares options: A lot of those contracts are traded OTC Some of the investors who are having long-put position in VW options might have been forced to execute their positions due to the counterpart investors who have a long-call option on VW common shares The result

7 ... A SHORT SQUEEZE! 111 Consequences of a short sqeeze If the market participants (short-sellers) can not repurchase and deliver the physical stocks according to the contractual agreements they will suffer from Legal consequences Loss of reputation These circumstances might end up in the illiquidity of these market participants Exit strategy: PANIC PURCHASE OF VW common stocks! VW was for some periods during Tuesday the most expensive company on the planet (peak: 296 billon ) 112 7

8 Consequences for other market participants The DAX as a international benchmark of the German stock market is no longer valid (market-portfolio?) The German Investment Law restricts investments of funds to be larger than 10% in a single asset The weight of VW common stock in the DAX became 26% on Tuesday, restricting fund managers to invest in the DAX Deutsche Börse reacts today and reduces the VW weight in the DAX to 10% Porsche plans to reduce its cash-settled option position for 5 % 113 Volkswagen and the WestLB 2007 Going back to the risk of options, preferred and common stocks 114 8

9 Volkswagen and the WestLB 2007 Going back to the risk of options, preferred and common stocks WestLB speculated on a reduction of price difference between VW common and preferred share in the spring of 2007 Long-put option on VW common shares Long-call option on VW preferred shares Again it is Porsche who announced to raise its part of VW on 30,9% which again triggers the common share to raise The West LB speculation goes bad and within a few days the losses are more than