Loans and money issues

Loan Options available for You

admin — Fri, 03 Dec 2010 14:53:49 +0000

Are you in need of a loan? Is a loan your best option given your current situation? Loans may seem like an easy fix, but they are not always going to be the best option. Before you can even apply for a loan you have to know what products exist out there. You need to find the loan that will serve you the best, but also the one you will be able to obtain. Here are a few of the different types of loans, what they are, how they work, and the risk they might pose to you.

Personal Loan: a personal loan is often unsecured meaning it has no collateral to back it up. This type of loan is based on your credit history and credit scores. It will have a higher interest rate than a secured loan. It is a better option for a person who needs a loan, but is unwilling to risk damaging their credit with a paycheck loan.

Paycheck Loan: paycheck or payday advance loans are products designed for quick lending. You can usually get the loan within 24 hours with a direct deposit of cash into your account. The loan is short term meaning it has to be paid back by your next payday. These loans have high interest rates upwards of 400 percent as an APR. They are unsecured and just about anyone can get this type of loan, but it can damage your credit if you leave it outstanding or fail to pay other bills as a result of having to pay the loan back.

Secured Loans: secured loans are mortgages, car loans, and any other loan that you can secure with collateral. The collateral you have will determine the amount the loan can be. This is the lowest risk product on the market because you have something to pay the loan back with should you default. It might lead to repossession of the property you place on the loan as collateral. With secured loans you will find the lowest interest rates when compared to the other products on the market.

Student Loans: student loans are a specialty loan offering you a chance to go back to school or to go to college for the first time. They can only be used on college expenses making them a specific product and these loans may not be helpful for other situations.

Two Basic Derivatives: Call Options and Put Options

admin — Sun, 18 Oct 2009 07:18:17 +0000

A derivative (also known as a contingent claim) is an investment whose value is itself determined by the value of some other underlying base asset. For example, a bet that a Van Gogh painting—the base asset—will sell for more than $1 million is an example of a contingent claim, because the bet’s payoffs are derived from the value of the Van Gogh painting (the underlying base asset). Similarly, a contract that states that you will make a cash payment to me that is equal to the square of the price per barrel of oil in 2010 is a contingent claim, because it depends on the price of the underlying base asset, oil. As with other ﬁnancial contracts, we believe that both parties engage in derivatives contracts because it makes them better off ex-ante. For example, your car insurance is a contingent claim that depends on the value of your car (the base asset). Having the insurance is valuable only if the underlying base asset has been involved in an unfortunate accident. Ex-ante, both the insurance company and you are better off contracting to this contingent claim than you would be without the insurance contract. Ex-post, more than likely, only one of you will come out better off.

Who are we working for?

admin — Sun, 11 Oct 2009 07:16:51 +0000

I have allowed our corporation to be multinational, but I have silently sneaked in one big assumption—that you are a U.S. corporation, living in a U.S. CAPM world, working on behalf of U.S. shareholders who consumes in U.S. dollars. This is a reasonable assumption if your share- holders (owners) are all Americans who are not otherwise internationally diversiﬁed, perhaps because they have a strong home bias that makes them hold the U.S. stock market portfolio only. These investors naturally like projects that help them reduce the U.S. stock market risk— and in the end, they care only about consuming in U.S. dollars. This was the scenario that you have worked out above.
But what if your investors are not Americans, concerned only with their opportunities in the U.S. ﬁnancial markets? What if your U.S. company shares are held by Chinese investors, and you are now considering an investment in a German plant? How should you think about the risk contribution of your investment projects now? The answer is surprisingly clear. Ultimately, as a corporation, you exist for the beneﬁt of your owners. Your goal is to earn a rate of return on the money handed to you that exceeds the opportunity cost of capital otherwise available to your investors. This is how your corporation adds value. If your owners are Chinese investors, who otherwise have access only to the Chinese stock market (plus your ﬁrm’s shares now) and who only consume in Chinese yuan, then your appropriate cost of capital would be determined by the Chinese stock market. You would have to compute the beta of the German plant opportunity with respect to the overall Chinese stock market, measuring the returns produced in euro after translation into yuan.
In an even less plausible scenario, your Chinese investors would want to consume all their . returns in British pounds, but still remain restricted to investment in the Chinese stock market, plus your single ﬁrm. In this case, your opportunity cost of capital is still determined by the alternative investments (the Chinese stock market), but all calculations, including measurement of the expected rate of return in the Chinese stock market, should now be done in British pounds. After all, this is what your investors care about in the end.
We forgot one “little detail,” though: what if Chinese investors are not allowed to invest in American companies? Like investors in many countries, Chinese investors suffer from capital controls. And, even when there are no formal capital controls, investors in many countries fail to diversify themselves internationally. Even U.S. investors are often not diversiﬁed, although international diversiﬁcation is no longer difficult: there are U.S. traded funds that hold foreign stocks. If your U.S. investors “forget” about foreign investment opportunities, your U.S. corporation might still be able to do it for them through foreign operations, and thereby expand your investors’ investment opportunity set.
One ﬁnal task. As a corporate manager, you know that you must think of the opportunity cost of capital of your underlying corporate owners when you decide on projects. But, who are your investors, and what do they care about? In the CAPM, you could just assume that they cared about the portfolio with the highest expected rate of return, given minimum overall portfolio risk. Now, you may have Chinese investors, who care about the best Chinese yuen portfolio in the context of the Chinese ﬁnancial markets, but who ultimately want to consume in Canadian dollars; British investors, who care about the best British pound portfolio in the context of the British ﬁnancial markets, but who ultimately want to consume some goods sold in/priced in euro and other goods priced in British pounds; and other investors who are represented by funds, and are thus totally anonymous. In short, the possibilities are endless. What opportunity sets are your investors really facing, and how can your projects improve them? In what currency should you determine the optimal alternative investments? What kind of CAPM world do you live in? For a manager, these are not easy questions. Most managers appropriately focus only on the project opportunities that they are providing to their domestic investors. Given home bias, this is a reasonable assumption, even if this is not perfectly correct. Fortunately, I am just an academic, and therefore do not have to make such difficult decisions!

Should Firms Hedge?

admin — Fri, 02 Oct 2009 07:15:07 +0000

Hedging can reduce the volatility of cash ﬂows. But does this add shareholder value? Maybe, but it should not usually be a ﬁrst-order effect for two reasons. First, our shareholders should care little about the idiosyncratic currency risk our corporation faces, because they are heavily diversiﬁed. As long as the foreign currency does not comove with the (U.S.) stock market, any extra currency risk should not change the U.S. market beta. For our investors’ portfolio, currency ﬂuctuations across many different companies—some net exporters, some net importers—should mostly wash out. Second, if our shareholders dislike the risk of losing money when the euro goes up or down, they can themselves buy the proper currency forward hedges to neutralize any such risks.
Still, many corporations hedge currency ﬂuctuations. Why? There are a number of possible explanations, but they are probably only second-order effects. Here are some examples.
• If adverse currency ﬂuctuations could lead a ﬁrm to incur ﬁnancial distress, the resulting costs to handle the ﬁnancial distress are quite real. (In a sense, hedging is really just like capital structure policy—the ﬁrst-order effect should be that ﬁrms should be worth what the underlying operations are worth, which should not strongly depend on how the ﬁrm is ﬁnanced. But if a ﬁrm is close to ﬁnancial distress, too much debt can cost value.)
• Managerial and corporate performance may be easier to evaluate if the ﬁrm can reduce the effects of unexpected currency ﬂuctuations. This can reduce agency problems.
• Managers may just not like the uncertainty of currency ﬂuctuations, and try to neutralize this risk even if it does not increase value.
Sadly, many ﬁrms hedge because they believe they can outguess the ﬁnancial markets and thereby increase their proﬁts. This is often a sign of poor control, because the compensation of lower-level employees who handle the hedging often implicitly or explicitly depends on the proﬁtability of their hedges. Therefore, these employees often participate more in the upside than in the downside of their contracts. Thus, they may be quite willing to gamble with shareholders’ money.

Eurobonds and the Issue-and-Swap Market

admin — Fri, 25 Sep 2009 07:14:02 +0000

Eurobonds account for a much larger share of borrowing than foreign bonds today, roughly by a factor of ﬁve. (Eurobonds were invented only in 1957, but the annual nominal issuing value had reached around $1 trillion by 2000, with outstanding debt of over $4 trillion.) Eurobonds are issued by corporations foreign to the host country in which they are issued, but in contrast to foreign bonds, they are denominated in non-host country currency. For example, when Ford issues a dollar denominated bond in Japan, it is a Eurobond despite the name. (As you saw in the last series of posts, when Ford issues a yen-denominated bond in Japan, it would be called a foreign bond.) Therefore, depending on the currency that they are issued in, they may or may not serve a hedging role. The ﬁrst important public Eurobond issue was an 1822 bearer bond, issued by Russia, denominated in British pounds, and payable at Rothschild bank offices anywhere in the world.) For U.S. companies issuing in Europe or Japan, the Eurobond market is often less a mechanism to hedge currency risk (many of their issues are denominated in U.S. dollars), as it is a mechanism to escape the regulation and supervision of the SEC. The institutional customs and features of Eurobonds are more ﬂexible and somewhat different from those that apply to ordinary U.S. bonds. (The typical issue costs are about 25 to 50 basis points of the market price.)
Another very large market for corporate ﬁnancing is the issue-and-swap market. A company like Disney may feel that its name recognition in the United States allows it a better borrowing rate in the United States than in Japan, even though it really wants to issue yen debt; while a company like Matsushita may feel that its name recognition in Japan allows it a better borrowing rate in Japan than in the United States, even though it really wants to issue dollar debt. An investment bank arranges for these ﬁrms to raise capital in their host countries, where it is cheap for them, and then sets up a swap. In this swap, Matsushita pays Disney’s debt service and Disney pays Matsushita’s debt service. The complication is that, although the obligations are a fairly close match at the outset, over time, one loan may become more valuable than the other. To reduce the risk of default, a large AAA-rated company (such as an insurance company) guarantees performance in exchange for upfront payment. So if Matsushita were to go bankrupt and could no longer pay for Disney’s debt, Disney would then no longer pay for Matsushita’s debt, either, and the difference would have to be picked up by the AAA guarantor.

Hedging with Foreign Financing

admin — Fri, 18 Sep 2009 07:12:42 +0000

Yet another method of hedging for corporations is to match assets and liabilities: if a ﬁrm has an asset (such as a foreign operation) that has a net present value of €100, then it can create a liability that is also worth €100. The easiest way to do this is to raise the ﬁnancing for the asset not in U.S. dollars but in euros. If an operation has borrowed €100 and is worth €100, the currency risk on the assets itself almost disappears: currency risk remains only in the earnings performance of the euro subsidiary.
If we raise this capital in the foreign host country itself, it may also mitigate political risk: if a revolution were to occur in Germany and our operations were nationalized, chances are that we would not be liable to pay German investors and lenders. This type of hedge is accomplished with foreign bonds, which have been around for at least a hundred years. They are issued by corporations foreign to the host country in which they are issued and denominated in host country currency. They are named differently in different countries— Yankee Bonds in the United States (i.e., issued by a non-U.S. corporation), Samurai Bonds in Japan, matador bonds in Spain, and Bulldog Bonds in Great Britain. For example, when Ford Motors issues a Japanese- yen bond in Tokyo, it would be a Samurai Bond.

Hedging with Real Operations

admin — Fri, 11 Sep 2009 07:12:31 +0000

Forward contracts are not the only method of currency hedging. For example, we know that a company that purchases inputs in its home currency and has sales in a foreign country is exposed to a rise in its home currency against the foreign currency. If it sets up a foreign operation, which can then also purchase its inputs in the foreign market in foreign currency, then its currency exchange risk will be much lower—both costs and revenues would occur in the same currency. Further, such international operations often create a “real option”, whereby companies can shift some production from the high-cost country to the low-cost country when exchange rates shift—and they can create important proﬁtable or unproﬁtable tax implications that require armies of tax experts to understand. Automakers in particular have invested heavily in such strategies: most Toyota Camrys for the United States are produced in Georgetown, Kentucky (but many are reexported to Japan!); BMW has manufacturing facilities in Georgia, Illinois, and California; and Ford and General Motors have large European subsidiaries.

Corporate Currency Hedging

admin — Fri, 04 Sep 2009 07:10:37 +0000

A corporation like the NFL thinking about building a German subsidiary like the GFL is not the only type of ﬁrm worried about declines in the value of the euro. In fact, there are three types of ﬁrms that immediately come to mind:
1. U.S. ﬁrms thinking about establishing a foreign subsidiary or selling products in foreign markets—like the NFL.
2. U.S. exporters. For example, Boeing builds aircraft in the United States, so its costs are mostly in dollars. It sells aircraft in Europe, and these aircraft may be paid for in euros. If the euro appreciates, it is good news when it is time to deliver. Instead of $108 million per plane, Boeing might receive $116 million per plane. But if the euro depreciates, it would be bad for Boeing. It might receive only $100 million per plane.
3. European importers. For example, the large mail-order computer retailer Vobis Germany purchases U.S. computer hardware and software in dollars, and resells them in Germany for euros. If the euro depreciates, its U.S. dollar inputs become more expensive.
In some cases, currency movements may not inﬂuence cash ﬂow volatility—for instance, it could be that Vobis and all computer retailers in Germany can raise their selling prices in line with their input costs, so there is no cash ﬂow volatility—but this is fairly rare. Our question now is: What can ﬁrms that are worried about currency movements do to reduce their cash ﬂow volatilities?

Valuing a Sample Foreign Project

admin — Thu, 27 Aug 2009 07:09:36 +0000

To gain more insight into how exchange rates and local market project correlations matter, we will make up a simple example. As a representative of the NFL, living in a U.S. CAPM world, you consider investing in creating a German football league, the GFL. Your problem is determining the appropriate cost of capital for this project. You have to worry about currency movements. Moreover, you know that project returns are typically linked to their local stock markets more than to the U.S. stock market. We shall assume the following macroeconomic scenario:
• The U.S. market can go up 16% or down 8% (expected rate of return: +4%).
• The spot rate is 1.0886 $/€. The one-year forward currency rate today is 1.0783 $/€. In addition, we now assume that the actual exchange rate will be either 1.0000 $/€ or 1.1566 $/€ next year, averaging to 1.0783 $/€. It is important that we assume that currency movements are independent of stock market movements.
• The German stock market index, the DAX, returns whatever the U.S. market returns (adjusted for forward/spot rate movements), plus or minus 10%. For example, if the U.S. market appreciates 16%, then the German market is expected to appreciate by 7.1% or 27.1%. (I have not assumed that it will be exactly 27.0%, because of the expected currency rate change embedded in today’s forward rate. The extra 0.1% is not an important factor here.)
With two outcomes each, there are eight scenarios. We assume that they are equally likely.
Actually, this is not a bad macroeconomic model: it has reasonable realistic annual rates of return, exchange rates, standard deviations, and mutual correlations. When the U.S. stock market increases by 16%, the German stock market is expected to increase by (27.1% + 7.1%)/2 = 17.1% (in Euro returns!). When the U.S. stock market decreases by 8%, the DAX is expected to change by (2.9% − 17.1%)/2 = −7.1%. So, the DAX moves about one-to-one with the S&P500—though the DAX returns are in euros and the S&P500 returns are in dollars. More recent historical data suggest that this relationship is empirically higher than the 0.65 that I reported above, and perhaps now closer to 1.0. And ﬁnally, there is also good empirical evidence that currency movements are empirically not correlated with stock market movements.
Now consider the German project. Starting the German Football League costs €100 (million) today. The rate of return on this project is assumed to be ˜ rp = 2.09% + ( ˜ r G M − 2.09%)·1.5 , (I.5) which really means that the GFL follows a German CAPM with a German market beta of 1.5 and a euro risk-free rate of 2.09%. For example, if the DAX were to return 7.1%, the GFL would return 9.6% in euros. This is not what you need to know, though—you are not representing a German corporation with German investors—you are representing a U.S. corporation with U.S. investors. What should be the project’s appropriate cost of capital and value for you?
The project costs you $108.86 today. Let us work through one of the branches—what happens if the U.S. stock market increases by +16%, if the exchange rate goes from 1.00886 today to 1.1566 next year, and if the DAX increases by 7.1%? Your project would then return 2.09% + (7.1% − 2.09%) · 1.5 = +9.6%. Having cost €100, your project would now be worth €109.62. At the 1.1566 $/€ exchange rate, this would be $126.79, equivalent to a dollar rate of return of 16.47% on your $108.86 investment. To determine the U.S. market beta, we need to ﬁnd out what we can expect when the U.S. market goes up vs. when the U.S. market goes down. The table tells us that your average return is $134.38 (or +23.44%) if the U.S. market increases by 16%, and $95.19 (or −12.56%) if the U.S. market decreases by 8%. Draw a line between the points (X , Y ) = (+16%, +23.44%) and (X , Y ) = (−8%, −12.56%), and you will ﬁnd that the slope is βP,S&P500 = 23.44% − (−12.56%) 16% − (−8%) = 1.5 . (I.6)
So, if the German stock market moves about 1-to-1 with the U.S. stock market (both in local currency, and even in the presence of extra volatility in the German market), and if exchange rate movements are uncorrelated with stock market movements, then the German project beta with respect to the DAX and quoted in euros is about the same as the project beta with respect to the S&P500 and quoted in dollars.
Now, we assumed that our project follows the German CAPM. Does the GFL also follow the U.S. CAPM? The U.S. CAPM would predict E ( ˜ rP ) = 1.12% + (4% − 1.12%) · 1.5 = 5.44% = r US F +