Archive for the ‘personal finances’ Category

Payday loans – when the conflict of interests arises May 23rd, 2010

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185The purpose of creating a PQ Profile is to help benchmark Partnering Intelligence for you and your team or partners. It serves as a starting point for discussion around the Six Partnering Attributes and how you can begin to improve your partnering skills. Along the vertical axis of the PQ Profile is a scale from 1 to 6. A score for any of the six attributes below 2.5 is low; between 2.5 and 4.5 is medium; above 4.5 is high.

Based on our study population, which holds true for the general population, a difference of .4 or more between two scores indicates a statistically significant difference in the level of ability in that attribute of Partnering Intelligence. For example, if you score a 3.2 on Win-Win Orientation and your partner scores a 3.8, your partner is more likely to use a win-win style of conflict resolution than you are. The larger the gap between points on two or more profiles, the greater the opportunity for conflict.

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Traditional credit analysis is a bottom-up approach November 21st, 2009

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Traditional credit analysis is a bottom-up approach which focuses on the selection of companies. The credit quality/risk has to be determined and the two following questions have to be answered:

  • Is the issuer able to make the coupon payments?
  • Will the company value at maturity be large enough to pay back the principal?

During highs and lows of market cycles psychological and technical factors tend to push asset prices to extremely elevated or depressed levels. At those times it is appropriate to focus on credit fundamentals and detect companies where such moves were not justified. Credit analysis should be able to identify opportunities to add substantial yield by assuming only little higher credit risk at the same time. The following paragraphs describe a possible way of analyzing the credit risk and investing in corporate bonds.

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Sensitivity to parallel shifts of the credit curve November 17th, 2009

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While both strategies yield portfolios that have the same sensitivity to parallel shifts of the credit curve, they usually yield very different returns in real world scenarios. Not only will capital gains differ when the credit curve moves in a nonparallel way, but returns from carry differ also when the yield pickup from extending duration is not equal to the yield pickup from increasing the allocation to the sector. Of course, these presumptions are rarely met in reality. Increasing the allocation to a high beta sector like automotive usually generates more carry than extending duration. Therefore, over the long run, this strategy has proven more successful. The allocation strategy is also more intuitive with respect to the allocation of capital to different risk or spread classes.

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Credit curves of two issuers will converge November 15th, 2009

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If an investor only has a view that the credit curves of two issuers will converge, but is not sure whether this will happen at wider or tighter spread levels, he would like to construct the box trade in a way that makes it insensitive to parallel shifts of the credit curves. In order to achieve this goal the trade has to be proceeds neutral. It is worth noting that the spread-neutral box trade is almost independent of the spreads, except for the minor impact of spreads on duration.

Remember that this trade is designed to protect investors from spread changes that might adversely impact their credit curve trade. Yet, often portfolio managers not only have a view on the relative changes of the credit curve of the two issuers but also on the direction of spreads. In this case the spread-neutral box trade is not optimal. The investor would rather choose a longer or shorter duration, depending on his view on the direction of spreads.

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Shortcomings of the credit curve November 13th, 2009

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A way to avoid the shortcomings of the above-described credit curve trade are duration-neutral box trades. Essentially, the trade consists of two legs. The investor buys the long-term bond of issuer A and sells the longterm bond of issuer B. Additionally, he sells short-term bonds of the first issuer and buys short-term bonds of the second issuer. Consequently, the trade benefits from a flattening of issuer A’s credit curve and a steepening of issuer B’s credit curve. This trade, of course, can be constructed to be duration neutral. Yet, there are myriad possibilities to do this. Assuming that no borrowing and leveraging are allowed the duration of the combined trade will always lie between the durations of the second shortest and second longest bond. While the position is insensitive to changes in the yield curve, its performance in general depends not only on changes of the credit curve but also changes of the level of spreads.

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Benefit from a steepening credit curve November 11th, 2009

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There is an alternative way to benefit from a steepening credit curve. If an investor expects issuer A’s credit curve to steepen more than implied by forward spreads and issuer B’s credit curve to flatten at the same time, he could switch from company A’s long bonds into company B’s long bonds. Whenever company B has a bond outstanding with a longer maturity than the bond that is sold, the trade can be set up on a durationneutral basis. Crabbe and Fabozzi (2002) point out that the return from this strategy over a 1-year horizon is approximately equal to

Return = spread differential – duration * change in spread differential, assuming roughly equal durations for both bonds. But it should be noted that this trade is not a pure bet on an issuer’s credit curve. Even if the credit curves behave as expected and the trade turns out to be profitable, taking another position may have been more beneficial in absolute terms and with respect to the individual credit curves of the two involved issuers. This is true, for example, if the spreads of company A and B widen significantly across their credit curves. In this case the capital loss due to the spread widening can exceed the profit of the bond swap. Being positioned at the short end of the credit curve then would have been a better strategy from an absolute return perspective.

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When a steepening of the credit curve is expected November 9th, 2009

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When a steepening of the credit curve is expected that is not fully reflected in forward spreads a portfolio manager would have to sell the long bonds and buy short-term bonds. However, in order to keep duration constant, he would have to put more cash to work in the short-term bonds than he receives from selling the long bonds. Since real money managers such as mutual funds and insurance companies are not allowed to borrow and to leverage their positions, setting up a credit curve steepener involves taking a duration view, because the investor implicitly ends up being short duration.

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