Currency Swap

As we talked about the currency hedging in the Aspen’s case, a currency swap could be the good way of hedges. This is how the currency swap works. This is an exchange contract that two individual foreign companies make a contract that if company A needs to exchange into its local currency, then the company B swaps the currency in fixed rate. For example, the U.S company expands its market in Europe, and it is worried about fluctuations in Euro currency. The U.S company needs to find the European company which expands its market in the United Stats. If the U.S company makes huge profits in Euro, and the U.S company need the U.S dollar, but the current the U.S dollar currency market is so bad, then the U.S company can ask the European company, which already made a contract with the U.S company, to exchange currency into the U.S dollar with fixed rate. The European company performs in the United States, so the company would have enough U.S dollar to exchange with Euro. This is good for the both parties. Thus, I think this is the another good way to hedge in currency. However, when a company selects its a counterparty, the company should consider weather the counterparty is healthy and stable in financially.

http://en.wikipedia.org/wiki/Currency_swap

Heinz’s profits with currency hedging

Due to an economic depression, many people do not tend to eat outside. They prefer to eat in their houses. Heinz ketchup made huge profits in the economic depression season. The reason is that when people eat in their houses, they would probably consume more ketchups than the past. The most food companies’ biggest expenses are their ingredients cost. Therefore, the big food companies import their ingredients from other countries, which costs lower than in the United States. However, if the food companies were not aware of currency rates between the United States and counterparties, and then their profits could go down in case of the currency effect negatively. Nevertheless, Heinz had a good ability on forecasting the world’s currency market, and they hedged the currency. Thus, they would not get in any troubles in case of fluctuation currency market. I think this case is a little different case with an ASPEN technology case. For Heinz perspective, if the U.S dollar value is higher than Japanese yen, they could buy more ingredients or buy same amounts cheaper. However, ASPEN would make fewer profits if Japanese yen is higher than the U.S dollar because ASPEN made profits from Japan, and need to cash out into the U.S dollar. I think if companies hedge on their uncertainty factors, they would not make huge profits, but their probability of losing their assets in case of economic depression is very less.

http://www.forbes.com/2008/11/22/heinz-ketchup-closer-markets-equity-cx_lal_mlm_1121markets32.html

Poor cash returns spur appetite for risk

Individual savings accounts (ISAS) are only available in the resident of United Kingdom. They are designed for savings and invest purpose with tax benefits. They have two components of it, and one is cash component and the other one is a stock and shared component. Recently, people who have cash component which is similar to savings accounts want to change their component to stock and shared components because of huge interest rate cuts from the banks. Thus, they are seeking alternative way to grow their money, and that is a bond and a stock market. However, if they change their component to the other, they cannot take their money back to the original account. As we all know that the world’s economies are getting worse, so it is hard to invest in stock market even professional investors. However, fund managers who work for ISAS diversify their portfolios more than they did in the past. Thus, they are sure they would maintain their expected rate of returns even in the bad market. Lundie mentioned that clients need to keep 15 percent of their account in cash, and divide rest of money into five or six funds. I think keep the certain amount of cash is very good idea because if economies go extremely bad, diversifying would not work well. By the way, investing in corporate bonds is another good way to overcome this period. Corporate bonds give higher return of rate than savings accounts, and it is less risky than stock market. I recommend people to invest in bonds in this period because even if a company goes to bankruptcy the bonds holders will have priority over stock holders.


http://www.ft.com/cms/s/0/38e18852-f4b9-11dd-8e76-0000779fd2ac.html?nclick_check=1

Risk tolerance

When people invest into stocks or funds, they measure VAR to specific stocks, and they can estimate how much they could lose in the worst cases. If they have enough money to lose more money, we called they have high-risk tolerance. Risk tolerance is the how much you can accept loses. Thus, people need to know their current risk tolerance, and they need to choose right investing methods for their current situations. If they have high-risk tolerance, it means they can take higher risks, so they can invest more aggressively. If people have low-risk tolerance, of course they can take higher risks, but I do not recommend that because once they lose in higher risks, they would not afford to pay the amount of loses.
There is another part of risk tolerance, and it is emotional risk tolerance. It is related with financial risk tolerance because if you have more money, you are less likely to get stressed on losing. However, I recommend you to invest own your style, for example, if you have a lot of money, but do not want to take higher risk, then I recommend you to invest in corporate bonds otherwise you get stressed. I know many individual investors are watching their portfolios with computers almost eight hours a day, and do nothing. I do not want people to do like that especially if they are individual investors.
In conclusion, you need to know your risk tolerance financially and emotionally, then you should be fine on your invest.

http://www.allbusiness.com/personal-finance/3878802-1.html

PADA risks focusing too heavily on costs

We learned simple math to calculate a firm’s net profits in class before, and it is revenue-cost. For example, company A invests for their new projects and makes better work place for their employees, those are all their cost. However, company A is expecting more revenues from their huge investments. Here is company B that it wants to maximize their profits by reducing all costs, and this approach is what PADA (Personal Accounts Delivery Authority), which provide pension plans, is concentrating on. A writer of this article Rodd Ruppert did not agree with concentrating too much on their cost, and I also agree with the writer. First, if a firm’s minimize their costs, they would also be minimized their diversification because diversifying their portfolio is also another costs. Thus, NAPA would not manage their risk. Next, they do not spend money for their employees’ educations and better communication systems. In short-term, the minimize costs for employees’ educations and set up the communications systems could bring them higher revenues. However, I think invest for their employees’ educations and set up the better communication system is not consider as cost because those will bring huge profits in long-term perspective. Therefore, I do not think minimize cost does not have any relations to maximize profits. I think the minimizing cost will bring more profits in short-term period, and the company should set the goal for the long-term period.


http://www.ft.com/cms/s/0/77bdc90a-8240-11dd-a019-000077b07658.html

Risk control central to hedging success

Ewan Kurk, who is a former partner of Goldman Sachs, launched his hedge fund corporation named Cantab Captial Partners in March 2007. Their return was about 50 percent in last year. Interesting thing is that Mr. Kurk wanted good mathematicians to lead their company in front. I was wondering why Mr. Kurk did not hire experienced people to lead their company. However, he wanted to focus on designing good hedge fund models. If they have good models, Mr. Kurk could operate their company easily. They have more than 20 models, and each model is expected by specific returns. In addition, they diversify their capital into those models, so they can maximize their profits by reducing risks. I think when investing firms invest their capital they usually divide their capital into risk free rate such as bonds and higher risk rate. However, Cantab Capital Partners wanted to hold more on securities of higher rate of returns if they think those are worth. Moreover, Mr. Kurk mentioned that if people lose their money in invest, they tend to blame their bad luck, and if they earn, they think their skills are good. Thus, Mr. Kurk also educate ethical attitude to their employees to not to have vanity. I think the ethical education is really needed for every company.


http://www.ft.com/cms/s/0/aedd9e84-fa03-11dd-9daa-000077b07658.html

Net Present Value

To maximize firms’ profits, the firms consider adding new projects sometimes. The new projects could increase of decrease firm’s profits. When the firms start their new project they need operational cost, initial cost, and etc. Thus, the firms usually spend lots of money in the beginning of the year. If the firms do not earn less than what they invested, they should not start their new projects. Thus, the firms need to assess the impact of the new projects. To calculate the impact of new projects, we need to use net present value function: net cash flows divided by the discount rates. To calculate net cash flow, we could simply subtract cash outflows, which are costs, from cash inflows, which are revenues. When we divide discount rate, the important factor is what interest rate we should use. Risk managers decide the rate of return as if they could earned from similar projects. Thus, if a firm adds a risky new project, its discount rate would be higher than the lower risk project. If the firm’s net present value is greater than zero, the firm can take the new project. If it is less than zero, the firm should not take it. If it is equal to zero, the firm may or may not take it. However, I do not recommend to add a new project if net present value is zero. The reason is that net present value equals zero means they are in borderline, so they could lose or earn profits. In addition, we do not know probability to lose or earn from that new project. Thus, I would not recommend investing if net present value equals zero. I have a concern that when we calculate net present value, the net cash flows and discount rates are not guaranteed factors. Those are only assumed by risk managers. Sometimes, a new project ends up with negative profits in the real field even though their net present value is positive. Therefore, if net present value is not high enough, I do not recommend taking the new project.

http://en.wikipedia.org/wiki/Net_present_value

The Unseen predator

As I talked about ERM earlier, it is the system that it takes care about all the risk such as internal and outside risks. Moreover, ERM finds the cause of the risks, amount of the losses, and find out the solutions for those losses of the risks. However, according to Risk Management magazine, many firms did not apply ERM system. The reason is the firms should spend money for build ERM systems, and the firms felt like that is not worth it. However, ruin of Enron makes the firms to consider the ERM should be the essential part of the firms. I think if firms did not catch their risks at the beginning, the risks would get riskier, and to recover firms from riskier problems, the firms should spend a lot of money or they would be faced with bankruptcy. There is a critical point of ERM; some risk managers started to educate the how ERM works, but it was hard to learn because there are no certain manuals on setting ERM and also, ERM is too broad. Thus, many risk managers were struggling to work on that. Many people think the job of risk management as a maintain firms’ profits, and they think CEO as take care of all firms’ risks. I partially agree that risk managers maintain firms’ profits, but they actually try to maximize firms’ profits. Some people did not even know whether each firm has a Chief Risk Officer. Through the historical data, risk managers warned the economic gets worse when the bubble economics pops. Therefore, majority people in industry are aware of importance of risk management compared to 20th century.

http://www.rmmagazine.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=332&AID=3831&Volume=56&ShowArticle=1

Invest through what we have learned so far

I think I could invest a stock or bond based on what I have learned so far in our class. There are three technical signs that you should know, and they are VaR, alpha, and beta. VaR gives the loss amount of the worst cases. For example, if a portfolio of stocks has a one-day 99% VaR of $2 million, it means that probability that you can lose more than $2 million is only 1%. Therefore, people could estimate budgets for their investment. However, VaR cannot detect Katrina or 911 events because VaR is generated based on historical data. After you estimate your budgets by VaR, you need to know alpha. We could think of alpha as how people reach their goals. For example, two people run 100 meters in Olympic, and the both people set their goals to finish in 10 seconds. One person is finished at 9.5 seconds and the other person is finished at 11 seconds. If I measure the two people by alpha, I can give positive number to person who is finished at 9 seconds, and give negative number to other person. In the real field, if a firm has positive alpha, its managers perform better than their CEO and shareholders expected. If it is negative, the managers did not reach what CEO and shareholders expected. Last, people should consider beta because it measures volatility to the markets movement. For example, if a beta of market is 1.0 and a firm has a beta .5, it means the firm does not depend on market. Thus, if the market crashes, the firm is less likely to crash down than other firms which have higher beta than the firm. Therfore, if you want to invest safer way, you could invest in less beta firms. However, if you are seeking for higher returns, you may invest in higher beta firms. In conclusion, you can make your own portfolios by the combination of VaR, alpha, and beta.


http://www.forbes.com/2008/08/18/alpha-beta-vanguard-pf-education-in_cp_0818investopedia_inl.html

http://www.forbes.com/2008/06/12/oneok-natuzzi-bp-pf-guru-in_jr_0612guruscreen_inl.html

Using Risk Management to Beat the Downturn

As we all know, big firms have healthy risk management systems, so if they manage their risk management department well, they are less likely to having problems in depressions. However, some small firms cannot afford to set up risk management departments, so this article talks about how small firms can manage their risks. It is obvious that nobody likes risk, and people are worried about risks. However, risks could be opportunities if you think other side. Many small firms do not want to spend money on risk management because their business did not have those big problems without risk managing. As I talked the earlier post, most firms, which were facing insolvency, did not prepare in good season. Thus, I think the firms should spend enough money on risk management. If small firms want to analyze their risk without hiring consultants because it is costly they could find intern program from the risk management department of local university, or Society of Actuaries can find a professional for that firms, and those costs are much less than hiring a consultant. Those people could perform basic risk analysis. Therefore, small firms should check their firms often with those low cost, and if they know they are having problems, they should higher a professional consultant to solve their problems.

http://www.businessweek.com/smallbiz/content/jan2009/sb2009018_717265.htm

Risk managers' Stock is rising

Risk managers' role become more important in Wall Street. Stan O’Neal, CEO from Merrill Lynch resigned at October, and Charles Prince, CEO from Citibank also resigned. In addition, both firms are facing bankruptcy. I think it is hard to say that it is all their faults. However, I think they were in charge of those firms, so they resigned or were resigned because they have a responsible for that result. In Merrill Lynch case, risk managers from Merrill Lynch already warned about their risks before that sub prime mortgage crisis period. However, Merrill Lynch was making huge profits from sub prime mortgage, so they could not hear what the risk managers said. Moreover, they expected the U.S economies too optimistically because almost everyone in the U.S did not expect that the U.S economy would be depressed. This is the reason why many big firms are facing bankruptcy today. Nevertheless, some companies also crashed down their business even though those companies follow their risk managers' directions. Some people might think their risk managers did not perform their tasks well, and it could be true. However, I think the risk managers did not gather information well from traders because if the traders and risk managers did not create good relationships, that could happen. Therefore, CEOs should make the good relationship between traders and risk managers, then the risk managers will give CEOs better and clear advise when the firms have problems.

http://www.businessweek.com/bwdaily/dnflash/content/jan2008/db20080128_327302.htm

A beginner's guide to hedging

I am interested in hedging since we wrote a first case study in the class. Thus, I wanted to find out more articles about hedging. This article says if you are not familiar with word "hedging", and then you can think of insurance. However, I do not agree with that.Under insurance, there are no chances to occur unexpected events (random variable). For example, he or she is injured from a car accident, and then he or she will get benefits, which specified amounts in an insurance contract from the insurance company. In case of bankruptcy of his or her insurance company, he or she still can get benefits because every insurance company should re-insure to other insurance companies. Therefore, insurance makes people to estimate their expected loss or benefits more accurately.Under hedging, people cannot guarantee how much they will make profits or whether hedging can help them in the specific seasons. Therefore, hedging is less likely to accurate estimating their expected loss or benefits. However, some types of hedging have similar aspects of insurance, and that is an option. For example, he or she buys stock A for long-term investment, and he or she is worried about short-term loss and buys a put option, hedging or a derivative, for $30 per share. In case of dropping stock price to $15, he or she who bought a put option can sell those stocks at $30. Therefore, shareholders could estimate their expected loss in the worst case accurately. Another example we can simply find at an airline. Due to oil crisis, many airlines have huge impact on oil expenses. If an airline A made a contract, which locking oil prices for 6 months or more with oil distributors, the airline A would not have any impact on oil crisis.In conclusion, insurance and hedging also have a cost, so hedging might not be the best choice sometimes. Thus, I recommend people to consider whether they take hedging or not.

http://www.investopedia.com/articles/basics/03/080103.asp

Introducing roth 401(k)

As I mentioned last journal, the 401(k) is one of the best investing method. Basically, there are two different types of 401(k), the one is traditional 401(k), and the other one is Roth 401(k).This is a similar concept as IRAs. People get tax deduction on the contribution, if they put money into a traditional 401(k). For example, people whose tax brackets are in borderline between 25% and 30%, and they put money into the traditional 401(k), then the amounts they put into the traditional 401(k) are deducted from their tax. Thus, they could be in lower tax brackets. However, they should pay taxes when they withdraw from the traditional 401(k) because those taxes are deferred. Even though government cannot collect taxes at the moment, government would collect more taxes by compounding interest when investors withdraw from their accounts.People who invest into Roth 401(k), they put money which, already paid taxes, into the Roth 401(k). In addition, when they withdraw from the Roth 401(k) account after 59.5 years old. Some people take the Roth 401(k) because they think future tax rate is higher than present, so they want to keep the lower tax rates.If I have to choose one of those, I would choose traditional 401(k). The reason is I may get lower tax bracket. Even though the amounts earned from that account is taxable after withdrawing the net income still larger than Roth 401(k) because more money works for me for a long time with compounding interest.
However, people who prefer a safety plan just like hedging, and then they probably take Roth 401(k) because the amount earned from the Roth 401(k) will be tax-free. Thus, they do not have to worry about future tax rates. In conclusion, a traditional and Roth 401(k) have advantages and disadvantages, so people should consider whether they get tax-free or tax-deduction.

http://www.investopedia.com/articles/retirement/05/introRoth401k.asp

Six ways to maximize the value of your 401(k)

Most people are worried about their future. To secure their unknown future, they need to have enough money to secure their life, especially, when people get old.A 401(k) is one of the best ways to secure their life financially. To maximize the value of 401(k), there are six basic rules.First, people should participate in a 401(k). If you do not put anything in it, you will get nothing. Thus, you need to take courage to make money.Second, you should take the company match. Many people do not know how much they should invest into the 401(k), and the best answer is as much as company matches them.Third, there are different types of 401(k), stock, and bonds. If you are young, you can take a risk, so try to invest for higher returns. The reason is young people have enough time to recover losses if they are failed from the investing.Fourth, you should spread and reduce your risk. For example, you buy stock for Oil Company, and then you need to buy stock that goes opposite direction to Oil Company because when Oil Company’ stock goes down, the other stock that goes opposite direction to Oil Company will go up. Thus, people should spread their risk. Fifth, do not invest with loaned money. Some people invest with loaned money. This is very risky. As we all know, people cannot guarantee the return of invests. However, when people loan money, the interest is fixed. Therefore, these could bring you to pay higher interest rate, while you are collecting lower returns from invest. Last, do not withdraw your 401(k) account in any cases. Some people withdraw their 401(k) when they change their jobs, but is is a bad strategy. When you put your money into it longer, you will get more. Therefore, I recommend you to roll that over to IRA or keep it. In conclusion, if you have an opportunity to take 401(k), I recommend you to take that and invest as much as the company matches you. This is the most important thing that longer you put in, money works for you harder.

http://www.investopedia.com/articles/retirement/05/6WaysMax401.asp