As a consequence each of the mentioned types of bank capital represents its own risk class. Investors clearly have to be compensated to carry the additional risks compared with senior bank bonds. Figure 4.3 shows that on average the spread differentials between senior bonds and Lower Tier 2, Lower Tier 2 and Upper Tier 2, and Upper Tier 2 and Tier 1 tend to be roughly equal. But one should note that spread volatility also increases significantly when moving to more subordinated types of bank debt. Again, this can be explained by the Merton model. Since Tier 1 and Upper Tier 2 bonds are designed to absorb losses before holders of senior bonds and Lower Tier 2 suffer a loss, the strike price of their embedded short put option is closer at the money than that of senior and Lower Tier 2 bonds. Hence, in absolute terms the delta of the short put is higher, causing larger changes of the value of the option and consequently spreads, when fundamentals change.
The tactical asset allocation in credit portfolios combines top-down- and bottom-up analyses in order to arrive at medium- to short-term investment decisions. In this step of the investment process three major subjects are tackled:
- Spread class selection,
- Sector allocation, and
- Credit curve positioning.
When making a decision about the allocation of resources to different spread classes, elements of the top-down analysis clearly have a substantial impact, since the assessment of the fundamental and technical environment for credit and the valuation relative to other asset classes have significant influence on the positioning within the credit asset class. Conversely, credit curve decisions are usually implemented on a sector or, probably even more frequently, on a single issuer basis. Although elements of the bottomup analysis clearly influence the positioning on the credit curve, there are also some economy-wide indicators that have to be considered. Therefore, and with respect to the time horizon of investment decisions and their potential impact on active portfolio performance, the three abovementioned issues should constitute an own step in a structured investment process for credit portfolios.
Overwhelmed by the prospect of buying individual stocks, you may turn to mutual funds. Mutual funds are marketed as a simple way to own a diversified portfolio managed by a professional. Unfortunately, mutual funds are confusing and complex.
Confusion is rampant. There are as many mutual funds as there are individual stocks. Just when you think you have a fund picked out, the fund manager changes, the investment style is altered, and a load is imposed to purchase the former no-load fund. There are hundreds of styles and types of funds: micro cap, small cap, medium cap, and large cap, value, growth, blend, income, leveraged, unleveraged, closed-end, open-end, and so on.
Taxes are a mess. Those who buy the fund the day before the tax date have to pay taxes on capital gains that occurred before they owned the fund. Those who sell that day avoid the taxes even though they owned the fund while the gains occurred. Those who buy a day after the tax date have no taxes but a different cost basis even though they paid the same price for shares as those who bought before. Multiple systems can be used to declare your taxes and adjust your basis when you sell shares.
Calculating returns and comparing returns to other funds is equally complex. Unless you bought on January 1 and reinvested all dividends and capital gains, your returns and those in fund reports, the paper, and the magazines will be different. Ask yourself: How much complexity and confusion am I comfortable with? On these two criteria alone, mutual funds are outside the comfort zone of many investors.
ACCOUNTS PAYABLE reviews are usually done once or twice monthly, although they can be done more frequently for special items such as postage, petty cash, or freight deliveries. The important thing, from a cash management standpoint, is to pay bills exactly on time and not early, to better maximize cash flow.
Despite the advantages of automation, there’s nothing wrong with a manual ACCOUNTS PAYABLE system. As long as the system performs the necessary tasks, such as assigning the right amount to the right account, tracking payments, and performing other basic accounting tasks, a manual system can be as effective as an automated one. But no matter how basic, each system must contain two primary components:
ACCOUNTS PAYABLE subledger summary Each ACCOUNTS PAYABLE system must contain a comprehensive set of vendor ledgers—whether they are recorded on index cards, in a ledger book, or on the back of candy wrappers stuffed in used envelopes—that track purchases and other financial obligations. Each record must be kept up to date with current purchases and total amounts, and they must all be sorted or categorized for easy access. After that, the format is up to your company’s accounting department.
Reach an agreement with the debtor on the amount owed. One of the key things the collections person can do is help the debtor overcome his or her internal resistance. With the exception of a disputed amount, most debtors know they must pay and, more often than not, most want to pay. Getting them to verbally acknowledge their debt—recording what they said and when— may put the company ahead of another of that customer’s creditors. The more a company can work with a debtor, the more likely it is that the company will see its money.
In the early stages, the bad debt accrual does not appear on the books, since we don’t know which accounts will go bad. To accommodate this need, some companies, espe-cially those that are audited, set up accounts based on aging categories or on a certain rate multiplied by sales. To set up such an account in the amount of $5,000, for example, the accountant debits Bad Debt Expense for $5,000, credits Reserve for Bad Debt Expense for $5,000, and notes this transaction as “Records accrual for bad debts.”
The importance of position in framing plans (and creating value) is evident in the more complex strategies employed by the entertainment industry.
An entertainment industry myth is that owning a hit television show or movie is the key to a winning strategy. “Content is king” is an old catchphrase of the media and the entertainment world. At the extreme, it is true—but it is more a truism, no more a guide to strategy than is advice to only buy stocks that are about to rise. The largest value is derived not from ownership of any one media property, but from aggregating them (or, in the argot of the industry, “packaging” them). The package and the supporting infrastructure create the strategic position from which individual options (or plans) can be framed.
Owning rights to one future Disney movie or one Steven Spielberg movie is itself no guarantee of economic wealth. In fact, most of Disney’s animated movies and most of Spielberg’s movies have lost money when costs were measured narrowly against box office receipts.3 Why, then, have these films been creators of great corporate and personal wealth?
Although many plans begin as dreams, a dream is not a plan. The crucial distinction is that a plan deploys resources against an objective. Until the resources are in place, we are dealing merely with a dream.
The corollary of this statement is that plans do not need to be captured in writing. A strategic position itself is the source of flexibility, and a smart leader can build flexibility into his or her plans. We shall explore the view that position is a necessary, but not a sufficient, condition for the generation of a plan. The option may exist in principle, but it typically requires intelligence, information, and creativity to frame it and analytical skills to value it. These steps are the prerequisite to an actionable real option: namely, (1) frame, (2) analyze, (3) act.
To put it more simply, to make the distinction between plans and dreams, just ask if the plan is currently actionable. If so, you own a real option. The financial analogy is that to exercise a financial option, you first have to own it. To own it entails a cost or a premium. In the end, your profit will be the value of the option minus the cost of the option.
Real options derive from plans. But a real option is ambiguous in regard to the moment of ownership because full ownership may not arise from a single event. Let us explore this point for a hypothetical case.
Numerous studies have documented that, when it comes to equity and fixed-income mutual fund managers, there is little evidence of performance persistence, except in the case of particularly bad performance. These studies suggest good performance could be attributable to luck, rather than to skill, and bad performance can result from incompetence or excessive management fees.
Of course, CDO and mutual fund managers differ in their job tasks and skill sets. A high-yield mutual fund credit analyst with a sterling performance record might wither as a CDO manager when faced with the task of managing a set of liabilities. In fact, during the late 1990s several mutual fund companies with strong high-yield performance records branched into CBOs and discovered the hard way that success in the flexible world of mutual fund management did not help them when managing the numerous constraints of CBOs.
In late November 2008, the Treasury and the Federal Reserve announced a facility to finance the issuance of non-mortgage asset-backed paper in order to support lending to consumers and small businesses.
The consumer asset-backed securities market offers
- liquidity to lenders that provide loans to small businesses
- to consumers through auto loans, student loans and credit cards.
Because this assetbacked market stopped functioning, it has become difficult for consumers and businesses to obtain affordable and sufficient credit. The Treasury indicated that the lack of affordable consumer credit undermines consumer spending and weakens the economy. In an effort to make credit available, the Treasury will provide $20 billion in credit protection from EESA funds to the Federal Reserve in connection with the Federal Reserve’s $200 billion Term Asset Backed Securities Loan Facility (“TALF”). In addition, the Federal Reserve announced a program to purchase $600 billion in mortgage-backed securities and direct obligations of Fannie Mae, Freddie Mac and Ginnie Mae. These new programs exceed the $700 billion approved by Congress in October.
The Federal Reserve’s aim is to:
- reduce the costs
- increase the availability of loans for home purchases.
In turn, more home purchases would support the declining real estate market.
0