• BI: World in new financial crisis due to debt per St. Louis Fed VP
• BST: Account fraud identification takes 151 days per tech analysis
• Daily Finance: Average savings 10yrs from retirement is $78k
• NFIB: Small business index indicates "a year with no real gains"
• CNBC: Shareholder activism places pressure on CEO pay levels
• CNN Money: Wealthy applying for need based financial aid
• Bloomberg: Overseas banks deny U.S. accounts due to tax law
• BBC: Portugal cuts 4 of 14 holidays for 5 yrs to increase productivity
• Reuters: Spanish government asks banks to raise $45 billion in reserves
• AP: Germany sticks to austerity despite French and Greek elections
Wednesday, May 9, 2012
Tuesday, May 8, 2012
How interest rate swaps work
Image attribution: Suicup; CC BY-SA 3.0
Interest rate swaps are a trading of interest based cash-flows. To illustrate an interest rate swap, if Company A has an initial floating interest rate of five percent on a $10,000 investment but prefers to have a fixed interest rate while still owning the investment, it can trade with another company that prefers a floating rate. This kind of transaction is called a plain vanilla swap per Natalie Moyen, Associate Professor of Finance at the University of Colorado.
When a plain vanilla swap exchange first occurs the swap is generally not profitable for either company; however, if the the variable rate changes one of the companies financial position improves. For example, if the variable rate drops to four percent, interest rate risk has effectively been avoided by Company A all other variables held constant. Also according to Moyen, negative cash-flows in the form of debt obligations can be traded for similar reasons i.e. to avoid increases in debt payment or potentially reduce debt obligations.
Fixed interest rate swaps may also be profitable if the exchange is made in competing currencies. To illustrate, if company a exchanges a cash-flow on $100,000 at seven percent in U.S. Dollars with company B's cash-flow on the Euro equivalent of $100,000 at seven percent, company A will profit if Company B's currency increases in value over the dollar.
Moreover, $100,000 at an exchange rate of .68 will require company B's initial equivalent currency investment to be valued at €68,000 and €4,760 at a seven percent interest rate. If that exchange rate becomes .55 but the initial investment doesn't change, then the interest cash-flow on that investment rises in value even though the original investment on which the cash-flow is based stays the same. In other words, when €4,760 is converted into dollars on day 1 it is equal to $7,000, but when the Euro strengthens against the dollar by .13 that same €4,760 becomes $8,654.54.
Interest rate swaps can be used to protect a company against what is known as currency risk as evident in the previous example. Moreover, if a company is concerned about the value of its investment in terms of import costs, it can hedge against this risk with a fixed interest rate swap. However, for this swap to effectively protect against currency risk the incoming cash-flow must increase in value over the outgoing cash-flow creating an element of risk as floating exchange rates generally cannot be predicted with 100 percent accuracy.
Several types of interest rates swaps exist. In the first example above, a plain vanilla swap took place. These are interest rate swaps that exchange a fixed for floating interest rate. The second example was a currency swap because the interest rates and principle investment were fixed but the exchange rate was floating. A third type of interest rate swap occurs via financial intermediaries or banks.
Fixed interest rate swaps may also be profitable if the exchange is made in competing currencies. To illustrate, if company a exchanges a cash-flow on $100,000 at seven percent in U.S. Dollars with company B's cash-flow on the Euro equivalent of $100,000 at seven percent, company A will profit if Company B's currency increases in value over the dollar.
Moreover, $100,000 at an exchange rate of .68 will require company B's initial equivalent currency investment to be valued at €68,000 and €4,760 at a seven percent interest rate. If that exchange rate becomes .55 but the initial investment doesn't change, then the interest cash-flow on that investment rises in value even though the original investment on which the cash-flow is based stays the same. In other words, when €4,760 is converted into dollars on day 1 it is equal to $7,000, but when the Euro strengthens against the dollar by .13 that same €4,760 becomes $8,654.54.
Interest rate swaps can be used to protect a company against what is known as currency risk as evident in the previous example. Moreover, if a company is concerned about the value of its investment in terms of import costs, it can hedge against this risk with a fixed interest rate swap. However, for this swap to effectively protect against currency risk the incoming cash-flow must increase in value over the outgoing cash-flow creating an element of risk as floating exchange rates generally cannot be predicted with 100 percent accuracy.
Several types of interest rates swaps exist. In the first example above, a plain vanilla swap took place. These are interest rate swaps that exchange a fixed for floating interest rate. The second example was a currency swap because the interest rates and principle investment were fixed but the exchange rate was floating. A third type of interest rate swap occurs via financial intermediaries or banks.
Image attribution: Suicup; CC BY-SA 3.0
In the book 'Modern Commercial Banking', Economist H.R. Machiraju describes additional swaps called base swaps and rate capped swaps. According to Machiraju, base swaps exchange floating rates of interest rather than fixed only or a combination of fixed and floating, and rate capped swaps place limits on how high a floating rate can change before the interest rate based cash-flow can no longer increase or decrease in value.
Financial News 05/08/2012
• CNBC: Fund manager says Fed engineered bull rally
• CNN Money: Average prepaid debit card costs near $300/yr in fees
• AP: Consumer debt increased by $21.4 billion in March
• Reuters: Government return on AIG bailout could exceed $15.1 billion
• BI: Warren Buffett supports retroactive tax penalty on wealthy
• NYT: Short-term profit ventures stifle long-term profits per economist
• FED: U.S. mortgage debt outstanding over $1.1 trillion lower than 2008
• UK Guardian: Anti-austerity contributing to political gridlock amid crisis
• BBC: HSBC Q1, 2012 profits fall 12% due to taxes
• Bloomberg: European intercontinental banking wanes on debt crisis
• CNN Money: Average prepaid debit card costs near $300/yr in fees
• AP: Consumer debt increased by $21.4 billion in March
• Reuters: Government return on AIG bailout could exceed $15.1 billion
• BI: Warren Buffett supports retroactive tax penalty on wealthy
• NYT: Short-term profit ventures stifle long-term profits per economist
• FED: U.S. mortgage debt outstanding over $1.1 trillion lower than 2008
• UK Guardian: Anti-austerity contributing to political gridlock amid crisis
• BBC: HSBC Q1, 2012 profits fall 12% due to taxes
• Bloomberg: European intercontinental banking wanes on debt crisis
Monday, May 7, 2012
What The Effective Interest Rate (EIR) Is
How Effective Interest Rate is Calculated
Image attribution: Petteri Aimonen; public domain
Effective interest rate, or EIR, is the interest that actually accumulates on a balance over multiple periods of time. In other words, since annual interest rates are charged periodically, the balance of a loan will accrue interest at a faster rate than if the annual interest rate had been charged just once when the loan becomes due in full.
To illustrate further, a $1000 loan with an annual APR of 12 percent will cost $120 to borrow. If that 12 percent is evenly charged periodically once a month over a year, one percent will be the monthly periodic interest rate. Moreover, with this periodic rate being charged monthly, the total interest on the loan will be $126.83 and not $120.
The calculation for the effective interest rate looks complicated but is actually quite simple. Moreover, according to William R. Tucker of the United Nations Capital Development Fund (UNDF), EIR is calculated using the following formula. EIR= (1+Periodic rate) to the exponent of the number of periods – 1. Essentially all this means is for each period charge the periodic interest rate on the balance plus the prior periods interest.
Using the above example to illustrate EIR = (1+1%)¹²-1 =12.68 percent. In this case 1+1percent is 1.01 percent. That number is multiplied by itself 12 times then 1 is subtracted. i.e. 1.01 x 1.01 = 1.021 x 1.01 =1.0303 and so on until the last of each calculation except the first has been multiplied by 1.01 eleven times. The resulting number is the total amount of interest that can be applied to the beginning balance to get the same result as when the original balance is charged the periodic rate twelve times.
Another way to calculate effective interest rate is to use an online interest calculator such as the one at MoneyChimp. The result of using that calculator yields the effective interest in the form of the original balance plus total interest for a 'future value'. The original amount of the loan must be subtracted in order to find the EIR. For example, Effective interest=$1,126.83 - $1,000 = $126.83. To convert the effective interest into the effective interest rate, it must be divided by the original loan i.e. $126.83 divided by $1,000 = 1.2683 percent.
In summary effective interest rate is the amount that is really charged on a balance when that balance is charged the annual percentage rate in installments. The interest charged in those installments is known as the periodic rate and is compounded or charges interest on a balance that has been charged interest. After the total amount of periodic interest rates have been charged, a new balance with interest is determined but this new balance is higher than had the APR only been charged once.
Financial News 05/07/2012
• Money News: Corporate 3.9:1 negative outlook ratio worst in more than decade
• BI: Lowered purchasing power for food & energy exacerbates poverty in U.S.
• CNBC: Low stock market volume due to investors leeriness of stock market
• Fox: 15-1 odds overcome by Kentucky Derby horse and jockey
• Daily Finance: Core Euro-Zone countries being shorted by hedge funds
• RT: Corporations insufficiently funded to confirm patent violations
• Bloomberg: Young to be negatively affected by Congressional gridlock
• AP: Congress at odds over how to fund a student loan interest-rate freeze
• CNN: Rolling blackouts in Japan possible after loss of major energy supply
• Reuters: French and Greek election results fuel economic uncertainty
• BI: Lowered purchasing power for food & energy exacerbates poverty in U.S.
• CNBC: Low stock market volume due to investors leeriness of stock market
• Fox: 15-1 odds overcome by Kentucky Derby horse and jockey
• Daily Finance: Core Euro-Zone countries being shorted by hedge funds
• RT: Corporations insufficiently funded to confirm patent violations
• Bloomberg: Young to be negatively affected by Congressional gridlock
• AP: Congress at odds over how to fund a student loan interest-rate freeze
• CNN: Rolling blackouts in Japan possible after loss of major energy supply
• Reuters: French and Greek election results fuel economic uncertainty
Friday, May 4, 2012
Will Facebook Shares Be Worth Buying?
Image attribution: Tesmec S.p.A; CC BY-S.A. 3.0
Facebook, Inc. (FB) is scheduled to become a public corporation on May 18, 2012. Its IPO price per share is valued at $28-$35. Whether or not the corporation is actually worth this much depends on its future earnings, its capacity to maintain its brand and its ability to leverage assets and compete in a dynamic and ever changing marketplace.
Complete article link: http://www.helium.com/items/2322261-are-facebook-shares-a-good-deal
Financial News 05/04/2012
• BLS: 115k net jobs created in April, participation rate drops to 63.6
• Bloomberg: Facebook wants to charge investors 99 x profit via its IPO
• BI: Federal employment at over 60 year lows
• ISM: Non-manufacturing index shows business activity slowed in April
• Daily Finance: St. Louis, MO is a spend-thrifts dream town: COLS 91.2
• CNN Money: "Aqui-hire protection" safeguard startup employees/founders
• CNBC: Credit rating downgrades cost banks billions
• SMH: Australian central bank cuts 2012 GDP forecast to 3% from 3.5%
• Reuters: European recession amplified in April per regional PMIs
• BBC: Euro-zone April PMI shrank to 46.7 indicating contraction
• Bloomberg: Facebook wants to charge investors 99 x profit via its IPO
• BI: Federal employment at over 60 year lows
• ISM: Non-manufacturing index shows business activity slowed in April
• Daily Finance: St. Louis, MO is a spend-thrifts dream town: COLS 91.2
• CNN Money: "Aqui-hire protection" safeguard startup employees/founders
• CNBC: Credit rating downgrades cost banks billions
• SMH: Australian central bank cuts 2012 GDP forecast to 3% from 3.5%
• Reuters: European recession amplified in April per regional PMIs
• BBC: Euro-zone April PMI shrank to 46.7 indicating contraction
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