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When someone can only just manage monthly debt payments, how do they cope when the cost of living shoots up? According to consultancy Capital Economics, the average household is spending far more on food, bills and other unavoidable expenses than they were just 6 years ago, when these costs accounted for 25% of their income. Today, this figure stands at 31%.
The rising cost of living may be causing everyone hardship, but it’s particularly dangerous to borrowers, many of whom are finding their finances stretched to breaking point or beyond. Someone who could comfortably afford their repayments back in 2002 may well struggle to manage their debts today. In many cases, it’s a struggle they can’t win on their own: more and more are turning to debt management and other debt solutions.
Leave room to manoeuvre
“These figures prove a point we always emphasise: just because you can afford something today, that doesn’t mean you’ll be able to afford it tomorrow,” says a spokesperson for Gregory Pennington. “Managing debt can be like walking a tightrope if your expenses grow to take up every penny of your income.”
And increases in the cost of food and utilities aren’t the only danger here. “Your income could drop. Your mortgage / rent payments could rise. You might need to repair the roof or replace an expensive item like the freezer. Any one of these events could seriously reduce your disposable income. You can’t always predict these problems, but you can protect yourself against them by not taking out credit you can only just afford.”
But what if we need to take out a loan to get through a financial crisis, or buy a car so we can accept a new job? “Life is full of calculated risks. When things don’t work out as planned, our debt management plan can be the ideal way to bring income and expenditure back into line.”
Why debt management?
“When someone asks about joining our debt management plan, we start by discussing their situation and helping them decide which debt solution is right for them – it could be debt management, but it could be a debt consolidation loan / remortgage, an IVA (Individual Voluntary Arrangement) or a Trust Deed. If debt management is the best way forward, we talk to their creditors and find out what they can do to help our client repay the debt at an affordable rate.”
“The vast majority of creditors are understanding and realistic about people’s finances. If they see that someone on our debt management plan genuinely can’t maintain their payments, they’ll be prepared to negotiate: accepting lower monthly payments, waiving charges and/or freezing interest. And they’ll renegotiate if the client’s situation changes again. It’s in everyone’s interests to keep payments at a realistic level, and that level can change all the way through the client’s debt management plan, whenever their disposable income changes.”
February 10th, 2011
Without financial futures, investors would have only one trading location to alter portfolio positions when they get new information that is expected to influence the value of assets—the cash market. If economic news that is expected to impact the value of an asset adversely is received, investors can reduce their price risk exposure to that asset. The opposite is true if the new information is expected to impact the value of that asset favorably: an investor would increase price-risk exposure to that asset. There are, of course, transaction costs associated with altering exposure to an asset—explicit costs (commissions), and hidden or execution costs (bid-ask spreads and market impact costs).
Futures provide another market that investors can use to alter their risk exposure to an asset when new information is acquired. An investor will transact in the market that is the more efficient to use in order to achieve the objective. The factors to consider are liquidity, transaction costs, taxes, and leverage advantages of the futures contract. The market that investors feel is the one that is more efficient to use to achieve their investment objective should be the one where prices will be established that reflect the new economic information. That is, this will be the market where price discovery takes place. Price information is then transmitted to the other market. It is in the futures market that it is easier and less costly to alter a portfolio position. Therefore, it is the futures market that will be the market of choice and will serve as the price discovery market. It is in the futures market that investors send a collective message about how any new information is expected to impact the cash market.
How is this message sent to the cash market? We know that the futures price and the cash market price are tied together by the cost of carry. If the futures price deviates from the cash market price by more than the cost of carry, arbitrageurs (in attempting to obtain arbitrage profits) would pursue a strategy to bring them back into line. Arbitrage brings the cash market price into line with the futures price. It is this mechanism that assures that the cash market price will reflect the information that has been collected in the futures market.
November 26th, 2010
When an investor takes a position in the market by buying a futures contract, the investor is said to be in a long position or to be long futures. If, instead, the investor’s opening position is the sale of a futures contract, the investor is said to be in a short position or short futures. The buyer of a futures contract will realize a profit if the futures price increases; the seller of a futures contract will realize a profit if the futures price decreases; if the futures price decreases, the buyer of the futures contract realizes a loss while the seller of a futures contract realizes a profit. Notice that the risk-return is symmetrical for a favorable and adverse price movement.
When a position is taken in a futures contract, the party need not put up the entire amount of the investment. Instead, only initial margin must be put up. Thus a futures contract, as with other derivatives, allows a market participant to create leverage. While the degree of leverage available in the futures market varies from contract to contract, the leverage attainable is considerably greater than in the cash market by buying on margin. While at first the leverage available in the futures market may suggest that the market benefits only those who want to only speculate on price movements. This is not true. Futures markets can be used to reduce price risk. Without the leverage possible in futures transactions, the cost of reducing price risk using futures would be too high for many market participants.
October 26th, 2010
The term to maturity of a bond is the number of years over which the issuer has promised to meet the conditions of the obligation. The maturity of a bond refers to the date that the debt will cease to exist, at which time the bond issuer will redeem the bond by paying the amount borrowed. The maturity date of a bond is always identified when describing a bond. For example, a description of a bond might state “due 12/1/2020.” The practice in the bond market is to refer to the “term to maturity” of a bond as simply its “maturity” or “term.” As we explain later, there may be provisions in the bond agreement that allow either the bond issuer or bondholder to alter a bond’s term to maturity.
There are three reasons why the term to maturity of a bond is important. The most obvious is that it indicates the time period over which the bondholder can expect to receive interest payments and the number of years before the principal will be paid in full. The second reason is that the yield on a bond depends on it. Finally, the price of a bond will fluctuate over its life as interest rates in the market change. The price volatility of a bond is dependent on its maturity. More specifically, with all other factors constant, the longer the maturity of a bond, the greater the price volatility resulting from a change in interest rates.
September 26th, 2010
Quasi-equity items are accounts that have been recorded as liabilities for accounting purposes, but should be treated as equity for purposes of determining how much capital the shareholders have invested. In Germany, companies can set aside reserves for unspecified future purposes. They typically use these reserves to smooth out earnings. The reserves do not represent liabilities in the sense of amounts that are known and payable at a certain time. We generally treat these as quasi- equity accounts.
Deferred income taxes are the most typical quasi-equity account for U.S. companies. Until the taxes are paid to the government, the funds belong to the shareholders and the shareholders expect to earn a return on these funds.
August 26th, 2010
We will use a simple example to show how a short sale may result in a profit irrespective of how the market moves. In this example we have $1m to invest. $200 000 is set aside as a buffer to meet any margin calls arising from the short position. We use $800 000 to buy Stock A and $800 000 to enter a short-sale agreement for Stock B. We receive $800 000 from the short sale of Stock B and invest this in a money market instrument.
We will assume that we earn 2% interest on the $1m we now have invested in cash equivalents.
In the first case the market rises by 7.5%, our long position rises by 10% giving a gain of $80 000 while our short position rises by 5% giving a loss of $40 000. Total profit from the transaction is $60 000. If on the other hand the market falls by 7.5% and our long position by 5% and our short position by 10% we get the following. The long position posts a loss for $40 000 but we make a profit of $80 000 on the short position. Total profit remains $60 000. Systematic risk has been eliminated (or at least reduced).
This does of course depend on us getting the relative movement of the two stocks correct of course but does not require us to forecast whether they will go up or down.
September 2nd, 2009
Any other assets or non-interest-bearing liabilities that are related to the operations of the business are also included in invested capital. In deciding whether an item is operating or non-operating, make sure that the treatment of the asset is consistent with the treatment of any associated income or expense in calculating NOPLAT. Also, consider industry norms so that the calculation of ROIC is as consistent as possible with the company’s peers.
July 26th, 2009
As with investors, corporations can use an “optimization” model to create an “efficient frontier” of hedging strategies to manage their currency risk. This measures the cost of the hedge against the degree of risk hedged. Thus, the most efficient hedging strategy is that which is the cheapest for the most risk hedged. This is a very efficient and useful tool for hedging currency risk in a more sophisticated way than just buying a vanilla hedge and “hoping” it is the appropriate strategy. Hedging optimizers frequently compare the following strategies to find the optimal one for the given currency view and exposure:
100% hedged using vanilla forwards
100% unhedged
Option risk reversal
Option call spread
Option low-delta call
While such an approach to managing risk is extremely helpful in providing the cheapest hedging structure for a given risk profile, it is not perfect and relies on a discretionary exchange rate view. Further research needs to be done in turning a corporation’s risk profile into a mathematical answer rather than a discretionary view. A starting point for this may be found in the type of equity market profile the corporation wants to create — value, income, defensive and so forth. From this, it may be possible to suggest an optimal profit stream the corporation should generate according to this profile and from this in turn we may be able to extrapolate a more exact hedging strategy to maintain that profit stream than simply a discretionary view might give. As it is, optimization, using a corporate risk optimizer (CROP), can be undertaken for transaction, translation or economic currency risk as long as one knows the risks entailed and gives a specific currency view within that. For example, if a corporation is looking for the best and most efficient hedging strategy in emerging market currencies, a CROP model can integrate the specific characteristics of those currencies together with the size of the expo- sure and hedging objectives (efficient frontier, performance maximization, risk minimization).Performance can be measured as P&L, an effective hedging rate or a distance to a given budget rate. The risk embedded in the hedge is expressed as a VaR number that will be consistent with the performance measure. While most CROP models do not provide a hedging process for basket currency hedging, they are very useful for finding the most efficient hedge for individual currency exposures. A CROP model is thus a tool for optimizing hedging strategies for currency-denominated cash flows.
Users of a CROP model are able to define the nature of their specific exposure and hedging objectives. The model also allows for scenario building, whether it be a neutral market view, the incorporation of budget/benchmark rates or the jump risk associated with emerging market currencies. If the objective is risk reduction, an efficient frontier can be created to find the most efficient hedge, which incorporates the cheapest hedge which offsets the most risk. Both performance and VaR are measured as effective rates.
Emerging markets are an example where corporate hedging used to adopt a binary approach — that is, to hedge or not to hedge. Options are a perfect tool for hedging, taking account of long periods when emerging market currencies do nothing and also capturing dramatic moves when they occur. They are cheaper and leave the corporation less exposed to an adverse exchange rate move. Furthermore, a CROP model can give the optimal hedging strategy using options or forwards for a given currency view and a given currency exposure.
The way this works is as follows:
Determine a possible exchange rate scenario over a specified time period, say six months.
Run a random distribution within the scenario specified.
Calculate the effective hedge rate for each hedging instrument used and the risk in local currency points.
Solve to find the hedging strategy with the lowest possible effective hedge rate for various accepted levels of uncertainty.
It should of course be noted that it is not possible to choose a single optimal hedging strategy without defining the risk one is allowed or willing to take. In scenarios reflecting a perception of volatility or jump risk, options will always produce a better or similar effective hedge rate at lower uncertainty than the unhedged position. Where the local currency has a relatively high yield and low volatility, options will almost always produce a better effective hedging rate than forward hedging.
July 5th, 2009
Economic risk or exposure reflects the degree to which the present value of future cash flows may be affected by exchange rate moves. However, exchange rate moves are themselves related through PPP to differences in inflation rates. A corporation whose foreign subsidiary experiences cost inflation exactly in line with the general inflation rate should see its original value restored by exchange rate moves in line with PPP. In that case, some may argue economic exposure does not matter. However, most corporations experience cost inflation that differs from the general inflation rate, which in turn affects their competitiveness relative to competitors. In this case, economic exposure clearly does matter and the best way to hedge it is to finance operations in the currency to which the corporation’s value is sensitive.
July 4th, 2009
While corporate Treasury is usually active in hedging transaction currency risk, it rarely considers translation risk — or hedging the balance sheet. This is largely because balance sheet risk is largely made up of foreign direct investment or the debt structure of the corporation. In the first case, the management has a natural and instinctive objection to the idea of hedging the balance sheet risk, involving a direct investment abroad, since that would seem to negate the reason for the initial investment. For this very reason, many corporations do not hedge translation or balance sheet risk because of:
The long-term nature of their investments in subsidiaries
The perceived zero-sum nature of currency risk over the long term
Accounting and tax issues
Cash flow impacts
A further disincentive is that currency translation affects the balance sheet rather than the income statement, which may make it less of an immediate priority for management. Equity analysts tend to focus on EBIT (or EBITDA) before debt/equity ratios. Eventually, however, the deterioration in balance sheet ratios can impact the corporation’s average cost of capital and ultimately its valuation in the market place.
July 3rd, 2009
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