Thursday, July 20, 2006

Newtonian Physics

On the 18th of June I woke up, turned 28 and found my room full of balloons and books. My girlfriend had bought me a great stack of presents. After a lovely day doing birthday type things, I opened my presents to find a pile of books, many of which I already own. I think that its terribly super that my girlfriend knows me so well to have bought me books that were perfectly up my alley. One of the books is a collection of letters written by my all time favourite geek and childhood hero, Richard Feynman.

As a kid I read 'Surely your Joking...' and while involved in the Australian Physics Olympiad, I read through his infamous 'Lectures in Physics'. I felt terribly proud of myself when one day I derived the shape of water coming out of a tap and learned that he did the same exercise in his teens.

Jump forward 10+ years, and I was in yet-another-strategy meeting that wasn't holding my attention, but had a notepad and a pen and needed to come up with a way to look busy and keep my mind active. Casting my mind back to the days of APO, I drew a triangle and a box, put on some arrows for forces and started to answer a question that had been plaguing me for all of 30 seconds: how fast do you have to raise an incline so that a box starting at the top of the incline will reach the bottom in time T?

Some equations here, some there and bang! solved! And it felt really good, because even though the problem was enormously trivial, I was quite curious to see if I could remember how to solve such things. While I would be totally lost if asked "Whats Newton's 3rd Law?", I can clearly remember the seven D's of solving physics problems:
  1. Diagram
    • Not just any diagram, but a BLOODY BIG DIAGRAM (you must remember that this was the Australian Physics Olympiad)
  2. Dimensions
    • Mark out all the useful lengths, angles, times
  3. Directions
    • Which way is 'up' ?
  4. Data
    • Are there any known numbers, write them down, but don't use them yet!
  5. Define
    • What are you trying to solve?
  6. Derive
    • Solve the sucker
  7. Dimension Check
    • If you are looking for an answer in seconds, make sure that the units of your answer aren't in cubic seconds per coulomb.
  8. subDitute
    • Only at this point do you put the numbers from (step 4) into your formula to get a final number. This isn't even a real 'D', because numbers don't really matter.
You might think that its odd that there is no gut-check step listed. I think the point is that you should be gut checking along the way, and even if you don't have a good gut feeling for what you are doing, then dimension analysis and a diagram go a long way.

I quite possibly have forgotten the exact list, but I think the spirit is there.

In his autobiography, Emanuel Derman quickly talks about how bamboozled he was when he first opened a modern finance textbook. As a particle physicist he had no idea how economists could possibly need such complex/erudite/obtuse analytical mathematics to solve problems. Even the notion of 'solving' a problem in economics was bizarre in that physicists could apply relatively simple math and predict fundamental universal constants to 11 significant places, whereas economists worked in the realm of 1 or 2 significant places.

Having recently gone through business school, and one that is renowned as (while simultaneously ashamed of) being highly quantitative, I am very familiar with the inane detail involved in making extraordinarily subjective financial predictions. I recall hours of lectures on the best way to calculate WACC, knowing that in the real world (at least for my industry) people discount at 20%. Given what we know about a companies cost of equity, industry comparisons, etc., the discount rate is invariably 20%.

This is not a bad thing. This is not poo-pooing the value of quantitative analysis. In fact, it is a reinforcement of the seven D's. You need to know what is important and have a system whereby gut-checking is part of the process.

So, now I find myself with the task of coming up with a structure to open up a lead exchange that is currently hidden within a public company. The question is vague, I'm still not sure what the dimensions are, but first thing tomorrow I am going to draw myself a bloody big diagram.


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