Loan advice » Economics

Nature of Liabilities

admin — Sun, 09 Oct 2011 16:41:38 +0000

The nature of an institutional investor’s liabilities will dictate the general investment strategy to pursue. Depository institutions, for example, seek to generate income by the spread between the return that they earn on their assets and the cost of their funds. Life insurance companies are in the spread business. Pension funds are not in the spread business, in that they themselves do not raise funds in the market. Certain types of pension funds seek to cover the cost of pension obligations at a minimum cost to the plan sponsor. Most investment companies face no explicit costs for the funds they acquire and must satisfy no specific liability obligations, the exception being target-term trusts.
A liability is a cash outlay that must be made at a specific time to satisfy the contractual terms of an obligation. An institutional investor is concerned with both the amount and timing of liabilities, because its assets must produce the cash flow to meet any payments it has promised to make in a timely way. In fact, liabilities are classified according to the degree of certainty of their amount and timing.
The descriptions of cash outlays as either known or uncertain are undoubtedly broad. When we refer to a cash outlay as being uncertain, we do not mean that it cannot be predicted. There are some liabilities where the “law of large numbers” makes it easier to predict the timing and/or amount of cash outlays. This work is typically done by actuaries, but even actuaries have difficulty predicting natural catastrophes such as floods and earthquakes.
In our description of each type of risk category, it is important to note that, just like assets, there are risks associated with liabilities. Some of these risks are affected by the same factors that affect asset risks.
A Type I liability is one for which both the amount and timing of the liabilities are known with certainty. An example would be when an institution knows that it must pay $8 million six months from now. Banks and thrifts know the amount that they are committed to pay (principal plus interest) on the maturity date of a fixed-rate certificate of deposit (CD), assuming that the depositor does not withdraw funds prior to the maturity date. Type I liabilities, however, are not limited to depository institutions. A product sold by life insurance companies is a guaranteed investment contract, popularly referred to as a GIC. The obligation of the life insurance company under this contract is that, for a sum of money (called a premium), it will guarantee an interest rate up to some specified maturity date.

CEMC

admin — Tue, 05 Jul 2011 17:02:51 +0000

Most of the currency crises of the 1990s happened against soft currency pegs. In the wake of the Asian currency crisis, I made a stab at creating a model which focused on how exchange rates typically performed in the run to and after the break down of a pegged exchange rate regime. For good or ill, the Classic Emerging Market Currency Crisis (CEMC) model was the result. To be sure, the title is a mouthful, but for the most part it tells the story of most emerging market currency crises during the 1990s and thus may serve as a useful barometer should any such crises be experienced going forward. This can be broken down into five phases during which the currency crisis takes place:
1. Capital inflows and real currency appreciation
2. Fundamental deterioration and inevitable currency collapse
3. A positive current account swing and a liquidity-based rally
4. The economy hits bottom; a period of consolidation
5. The fundamental rally
A key aspect of these crises was the relationship between the real exchange rate and the external balance. In floating exchange rate regimes, economic imbalances are usually smoothed out over time. In pegged exchange rate regimes, they can build up to unsustainable levels, thus forcing the collapse of the exchange rate peg, if not checked by changes in macroeconomic policy.

THE SIGNAL GRID

admin — Tue, 30 Jun 2009 16:59:24 +0000

The four analytical disciplines of currency economics, flow analysis, technical analysis and long-term valuation which come together to make a currency strategy decision can be expressed in the form of a signal grid. To be sure, this is a very simple model. However, what is important here is having the discipline to create it. Only when all four analytical indicators are reading buy or sell together should one put out an official currency strategy recommendation. Granted, this is still no guarantee of success. It should however have a number of positive effects on one’s trading or analytical performance:
It should eliminate the bias created by relying only on one analytical type
By nature, four buy signals make up a more powerful buy signal than just one
The bottom line — it should improve one’s performance and total returns