Wells Fargo did not change its practices in order to adapt to Black and Scholes orientations; CAPM was still only an academic theory.
Several months later, the new trend was to offer to clients a market index fund (S&P 500) aiming only to match the market no to beat it. Thus, the main issue was to reduce costs of trading. Fischer had the idea to consider that the index fund manager as a liquidity trader who does not care about which particular stock he buys or sells. That flexibility could be exploited by advertising a list of stocks and prices at which one was prepared to trade, so that he would not lose to other markets.
For a leveraged fund, Fischer thought that borrowing at a rate that would change daily could solve the equation. Besides, the banks would prefer such an arrangement that guarantees a profitable loan even if interest rates rise.
B for Neo - it's a minor mistake, but this is a writing exercise and editing is important.
ReplyDeleteDo note that index funds did exist earlier than this — but no one had a decent justification for why they might be desirable.
The advantage to an investor with this early index fund, was that Wells-Fargo could borrow more cheaply than the typical investor could do on their own. They could then loan that money internally to those investors, making a little profit for the bank, while offering a better product for the investors.
Also, Neo has missed the connection to earlier lectures. I discussed back in January that one of the criticisms of the CAPM is that it requires a complete market portfolio, but no market is complete. Mehrling makes clear that Roll was making this point 40 years ago.