Looking for a partner in credit

Finances, Fiscal Regulations, Global Markets, Loans, Taxes | Posted by admin
Jan 05 2010

Another potential professional partner is your prototype designer. Again, like the patent attorney and patent agent, this is something that is suggested to prototype designers with some regularity. Unless your invention is that one-in-a-million idea, your prototyper would probably prefer to be paid in money than to bet on the success of your invention.

Almost any professional whose services you will use in the development and marketing of your invention has the possibility of becoming a professional partner. If you choose to pursue this avenue, be cautious not to sign on too many professional partners. This is another area where you could find yourself in the position of becoming a minority investor/owner of your own invention.

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Equity can still be threatened

Finances, Global Markets | Posted by admin
Oct 05 2009

In a growing economy, equity can still be threatened. Home equity does not deserve the same confidence as FDIC insured CDs. Neighborhoods can change, hurting home values. Residential neighborhoods become commercial, family neighborhoods get drug infested, single family homes are cut up and become multifamily units eliminating all the parking and reducing values. Soon there will be a massive exodus from family neighborhoods as baby boomers retire and move to retirement communities. Interest rate changes also threaten home equity. Higher mortgage rates make homes less affordable, which hurts home values. When homeowners hear or read about the Federal Reserve, most wonder how this will affect the value of their home. Higher real estate taxes also hurt home values.

Home equity is often disappointing as a savings vehicle. It lacks the utility of other savings systems. Unmanageability is a common occurrence. Just when you need your savings the most, home equity is likely to fail you. Laid-off workers often find they cannot tap their home equity with a second mortgage or refinance because they have no income to support higher mortgage payments. Retirees are often disappointed to find that the sale of their home after Realtor commissions and expenses leaves a much smaller nest egg than hoped for. Reverse mortgages often produce insufficient income for retiree living expenses. Savers relying on home equity must be prepared for sadness and grieving if their retirement plans are unreachable.

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Beyond making a mortgage payment

Loans, Taxes | Posted by admin
Sep 07 2009

Most Americans have the majority of their savings tied up in their home. Beyond making a mortgage payment, few savers are able to put away excess income. The government encourages saving in homes. Mortgage interest is tax-deductible. Credit card interest is not. Profit on the sale of a residence is tax-exempt up to $500,000. Government programs support firsttime buyers and lower interest rates for low-income homeowners.

Realtors play up the savings aspect of homeownership. Savers are shown charts of home appreciation and tax savings compared to renters. This leads to overconfidence. Despite government support, a family home is an erratic savings vehicle.

The value of a dollar invested in a family home is not fixed. Home equity can swing up and down. When the local economy is bad, homeowners who lose their jobs often find out that they have lost all the savings in their home as well. In the late 1980s, the oil belt recession forced a massive loss of both jobs and homes. In the early 1990s, New England had a similar episode caused by the collapse of the real estate industry. The massive closing of military bases and defense plants a few years later caused thousands of Southern California residents to lose both jobs and homes. When a
home is worth less than the mortgage, even employed homeowners have lost all their savings.

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Do you have a saver personality?

Finances, Fiscal Regulations | Posted by admin
Aug 28 2009

Though there are emotional quirks with true saving instruments, the  frequency of trauma is low. Saving instruments are for investors who value  predictability and are not troubled by jealousy, resentment, or regret when  other investments produce spectacular returns and make headlines. Longterm  returns on savings instruments are lower than for other investment  classes. For those who value peace of mind, the price of lost returns is more  than reasonable.

Savings instruments are also good for investors who do not want to  spend time on their investments. Buy and ignore is a good philosophy for  savers. Someone who needs to be out of the country for five years should  leave her money in savings instruments. Blind neglect is often advocated  for stocks, but in fact, there are too many five-year periods when stocks  lose half their value.

Picking Treasury bonds requires a few hours each year. Higher yields  can be found in agency issues and older bonds. Call provisions must be  evaluated. The time requirements are minimal.

Investors looking for action should look elsewhere. If you enjoy lots of  research, or want to interact with people such as tenants, other investors, or  money managers, savings instruments are not for you. While you can create  excitement trading bonds, you cannot create profits. High-energy investors should stay clear. Disappointment will follow.

Treasury bonds are also the only insurance against deflation. Savers  who worry that current Japanese deflation may be exported to the United  States or that there will be a return to deflation of the 1930s will feel safe  here. Savers concerned with inflation will be comfortable with TIPs and  money market funds.

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Solution to your financial problems

Finances, Fiscal Regulations, Global Markets, Loans | Posted by admin
Aug 04 2009

Michael tinkers with his portfolio obsessively. In prior years, he read investment magazines and newspapers late into the night. Now he has a fast Internet connection and often signs off after midnight. Susan is freaked out by the paper gains and losses that routinely occur every month. The abstract nature of the account statements, reports, newspaper articles, and Web sites makes her nervous. Her mind cannot grasp what they really own nor does she understand why Michael is constantly playing with it. Ever since the decline of 1990, when they were new to the stock market, there has been a sense of impending doom over their financial security.

Interestingly, Michael and Susan would both be happier with a portfolio primarily consisting of single-family homes. Michael’s tinkering could cut costs and improve rents and tenant quality. He has no guilt about being a landlord. He and Susan have a nice house they are proud to own. They are now living in their third home together. Together they were able to buy two cute cottages in attractive neighborhoods, which they sold for much more than the purchase price. Michael is fair with the many employees he supervises.

There is no reason he would be a poor landlord. Michael is also not likely to trade properties. While he is able to justify many small commissions to a discount broker, having never added them all up, the idea of giving 6 percent of his property to a Realtor every time he sells a building does not appeal to him. Susan could drive by and look at their properties any time she needed reassurance. The children could help out cleaning and fixing up between tenants. Though Michael may lose a major topic of conversation at the office, he would sleep better and be more productive at work. He would also be wealthier. If, in each of the last 10 years, he had bought a new single family home with $50,000 down, putting nothing in his 401(k) or anywhere else, he could potentially have equity of $1,000,000 today.

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Simple interest loans

Fiscal Regulations, Global Markets, Loans | Posted by admin
Jul 20 2009

Simple interest is, well, simple. To calculate simple interest, you would multiply your interest rate by the balance that you owe. Any payment you make, in excess of the interest calculated for that period, is applied toward your balance or “principal.”

Let’s look at an example. Bob takes out a simple interest loan of $1,000, at 12% per year. If Bob makes one payment, at the end of the year, $120 in interest ($1,000 multiplied by 12%) will be subtracted from his payment before it is applied to what he actually owes. If he sends in $500, his balance will drop to $620 ($1,000 balance minus $380 applied to principal).

If Bob waits another full year to make a payment, he will owe $74.40 in interest. That’s his $620 balance multiplied by 12%. Whatever payment he makes will have $74.40 subtracted from it for interest, before it is applied to his balance.

That’s it! It’s that simple! Most auto loans, many mortgages, and most personal loans from credit unions use
simple interest. As you’ll see in a moment, these are far more preferable than loans that use compound interest.

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How interest rates work

Finances, Loans, Taxes, Uncategorized | Posted by admin
Jul 06 2009

There are two basic types of interest that every person who uses debt or credit cards needs to understand: simple interest and compound interest. Over time, there is a significant difference between these two methods of calculating your interest on a debt. Part of your strategy to eliminate debt will probably involve getting rid of debts that use compound interest first.

Often, the rate you’re quoted on a loan or a savings account is not what you actually pay or earn. Depending on how often the actual interest due to you or the lender is calculated, your rate may be noticeably higher than the “nominal” or stated rate. APR stands for annual percentage rate, and refers to the actual cost of borrowing the money based on the frequency of the interest calculation. For example, a 6% loan may have an APR of 6.15%, depending on the calculation period. APY is identical to APR, except that it calculates the actual rate that our savings earns, instead of the interest we pay on a loan.

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Building in Market Risk

Finances, Loans, Taxes | Posted by admin
Jun 12 2009

We have yet to take into consideration market risk. Using a Black-Scholes model, a volatility of 50 percent (characteristic of DuPont and Dow stock today), and an overall chance of success of 10.4 percent, the value of the Polyarothene project is $3.57 million versus $1.67 million based on the decision tree alone.

This result does not consider the option to abandon at each of four stages; it is based on a straight 10.4 percent unique risk. So it is the rifle shot, but it takes into account the volatility of the marketplace. This result is also interesting—because of market volatility alone, it might still pay to do this rifle shot project, just as it would pay to drill the exploratory well in Chapter 5. NPV gave the wrong answer for another reason!
Of course, we should take into account both kinds of risk.

This requires us to work backward from the end result, using the probabilities of success cited in the previous section. First, value an option of entering stage 4 with an 83 percent chance of successful commercialization, using Black-Scholes. With this value in hand, go back a stage: Value the option of entering stage 3 with a 75 percent success rate and the reward (underlying security) being the value of the stage 4 option, discounted for the probability of success.

Do it twice more until you are back to the beginning of the process, stage 1. We have created a series of linked, nested, compound options. Although the detailed calculations are beyond the scope of this book, the result is interesting: $4.75 million.

In effect, we have now moderated the negative impacts associated with unique risk using multiple options to abandon and have taken full advantage of the positive values associated with market risk.

To summarize, without the option to abandon, the project has an NPV of –$2.60 million. With four options to abandon, which relate only to unique risk, it is worth $1.67 million. Adding market risk to the equation improves the value to $4.75 million. In relative terms, each step in risk management represents an enormous increment in value. Note also that these results depend critically on the systematic reduction of risk at each stage and the acceleration of costs from stage to stage. But that is how R&D should be managed.

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Hedging as a Risk Management Tool

Finances, Global Markets, Taxes | Posted by admin
May 23 2009

A second critical tool in risk management is hedging, which is greatly facilitated by the global banking system. In the commercial world, if one wishes to buy a fermentation plant from a Swiss supplier with 10 percent down and 90 percent due on delivery 12 months hence, one considers a currency hedge. If the price is quoted in U.S. dollars, the Swiss manufacturer may buy a forward option on dollars. If it is quoted in Swiss francs, the U.S. customer may buy a forward option on Swiss francs. In either case, for a small price, their business plans are not exposed to currency risk. When I joined W. R. Grace & Co. in 1982, I found just such a contract on a fermentation pilot plant in place. In fact, the dollar strengthened dramatically, so we bought the plant far more cheaply than expected, while being fully protected if the currency had moved in the opposite direction.

The bankers offering these hedges can reduce their risks substantially, for example, by finding a counterparty, perhaps a Swiss firm buying computers from a U.S. supplier in the same time frame. This activity is classic hedging. Note that the hedge is against market risk.

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WHAT IS FINANCIAL CDO EQUITY?

Loans, Taxes, Uncategorized | Posted by admin
Apr 29 2009

CDOs are privately placed securities backed by pools of financial assets. CDO equity represents a residual claim on the cash flows from the assets collateralizing a CDO. Those assets could be leveraged loans, corporate bonds, residential mortgage loans, commercial mortgage loans, or something else (e.g., emerging market debt and trust-preferred securities).

A CDO redistributes cash flows from a set of assets to a series of notes. The cash flow structure is the most common type of CDO and will receive the bulk of this report’s attention. With this structure, cash flow coverage tests are based on asset par amounts. With the less common market value structure, coverage tests are based on asset market values. Synthetic structures, many of which forego coverage tests, are also quite common.

In funded synthetic CDOs, the collateral is a combination of credit default swaps (CDS) and high-quality assets. In cash flow structures, the mechanism that determines the allocation of cash flows is called a waterfall. Equity payments are last in priority, after liability payments, management fees and taxes. The residual cash flows available to pay equity can be diverted if interest and par coverage ratios fall below prescribed limits. Collateral losses due to default and trading losses will result in equity principal losses.

Because a CDO is collateralized by a pool of assets, a long equity position is similar in risk to a long position in the collateral and a short position in the senior notes. The senior note investors typically receive a fixed spread above LIBOR. Hence, equity is a matched funded position when the collateral is floating rate. The term funding structure implies that equity is also a nonrecourse, leveraged investment. Nonrecourse means the investment does not require additional funding other than what is originally tendered, regardless of how poorly the assets perform. Leveraged means the investor borrows money to purchase the security, presumably at a lower interest rate than the expected return on the investment. This allows investors to increase the potential return (but also the risk) of their investment.

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