Pozew.org

Floating-rate loan

admin — Mon, 29 Mar 2010 10:01:59 +0000

In the example above, the loan involved only a single payment and, therefore, we had only one setting of an interest rate to worry about. Many loans are floating-rate loans, meaning that their rates are reset several times during the life of the loan. This resetting of the rate poses a series of risks for the borrower.
Suppose a corporation is taking out a two-year loan. The rate for the initial six months is set today. The rate will be reset in 6, 12, and 18 months. Because the current rate is already in place, there is nothing the corporation can do to mitigate that risk. It faces, however, the risk of rising interest rates over the remaining life of the loan, which would result in higher interest payments.
One way to control this risk is to enter into a series of FRA transactions with each component FRA tailored to expire on a date on which the rate will be reset. This strategy will not lock in the same fixed rate for each semiannual period, but different rates for each period will be locked in. Another alternative would be to use futures. For example, for a LIBOR-based loan, the Eurodollar futures contract would be appropriate. Nonetheless, the use of futures to manage this risk poses significant problems. One problem is that the Eurodollar futures contract has expirations only on specific days during the year. The Chicago Mercantile Exchange offers contract expirations on the current month, the next month, and a sequence of months following the pattern of March, June, September, and December. Thus, it is quite likely that no contracts would exist with expirations that align with the later payment reset dates. The Eurodollar futures contract expires on the second London business day before the third Wednesday of the month. This date might not be the exact day of the month on which the rate is reset. In addition, the Eurodollar futures contract is based only on the 90-day Eurodollar rate, whereas the loan rate is pegged to the 180-day rate. Although many dealer firms use the Eurodollar futures contract to manage the risk associated with their over-the-counter derivatives, they do so using sophisticated techniques that measure and balance the volatility of the futures contract to the volatility of their market positions. Moreover, they adjust their positions rapidly in response to market movements. Without that capability, borrowers who simply need to align their interest rate reset dates with the dates on which their derivatives expire can do so more easily with swaps. Nevertheless, an understanding of how FRAs are used will help with an understanding of this application of swaps.

Payable On Death (POD) or Transfer On Death (TOD) Registration

admin — Mon, 13 Jul 2009 18:56:44 +0000

Savings accounts may be made payable on death of the owner to a named beneficiary, if living.11 Securities may be registered in beneficiary form that indicates the present owner and the intended beneficiary who will become the owner upon the death of the present owner.12 Sole owners or multiple owners with right of survivorship may use this form to designate a beneficiary to take ownership at the deaths of all owners. This form is created by using the words “transfer on death” or “TOD” or “pay on death” or “POD” after the name of the registered owner and before the name of the beneficiary. On proof of death of all owners and compliance with other requirements of the registering entity, the security may be reregistered in the name of the beneficiary. If no beneficiary survives the owner, the security belongs to the estate of the owner. Debts, taxes, and expenses of administration, including allowances to the surviving spouse and minor or dependent children take precedence over the beneficial owner’s interest if other estate assets are insufficient. Registering entities are not required to offer this form, but many do offer it.

Qualified Disclaimers

admin — Mon, 13 Jul 2009 18:55:47 +0000

With reference to the estate tax, gift tax, and generation skipping transfer taxes, if a recipient makes a qualified disclaimer with respect to any interest in property within the estate of decedent or donor, the property will be treated as if it had never been transferred to the recipient.
An example of when this might be used wisely is as follows: John Doe dies unexpectedly and his will leaves everything to his wife and the will was written 30 years ago. If the wife now owns considerable assets in her name, she might prefer that part of the property in her husband’s estate pass to their children instead. By properly disclaiming some of the property designated to pass to her, she could reduce her estate taxes at her death (see an attorney for details on how this can be done).

Survivor’s Homestead Rights

admin — Mon, 13 Jul 2009 18:51:49 +0000

Homestead rights in Oklahoma may consist of an estate in land and personal property as well as exemption from certain debts. The homestead of any family living in a rural area shall consist of not more than 160 acres. It may be in one or more parcels to be selected by the owner. The homestead in a city or town, or platted area, and occupied as a residence only shall consist of not more than one acre of land. The statute limits an urban homestead to a value of $5,000, but in no case will it be reduced to less than one-quarter of an acre. Some of the personal property not subject to administration proceedings are family pictures, church pew, lot or lots in a burial ground, Bible, school books, other books not in excess of a value of $100, clothing, food and fuel for one year, and household and kitchen furniture. This property is to be delivered immediately by the executor or administrator to the surviving spouse and children, if any.
Upon the death of either the husband or wife, the survivor may continue to possess and occupy the whole home-stead. It is not subject to administration proceedings until it is disposed of according to law. Also, upon the death of both the husband and wife, the children may continue to occupy the homestead until the youngest child reaches the age of majority. The homestead right is similar to a life estate. It comes into play when one spouse owns the homestead and dies. The surviving spouse may occupy the homestead until death. At the death of the surviving spouse, if there are no minor children, the property will pass to the heirs of the spouse who owned the homestead. The homestead rights are designed to prevent the spouse or minor children from being ejected from their home at the death of the spouse who held title to the property. The homestead is also not subject to the payment of any debt or liability contracted by either the husband or wife, except for liens such as mortgages on the homestead.

Simultaneous Death

admin — Mon, 13 Jul 2009 18:50:49 +0000

The will may provide that testator’s spouse shall be presumed to have survived the testator if both should die in a common disaster under circumstances that make it uncertain who died first. If the will does not contain such a simultaneous death clause, Oklahoma’s statute (Title 58, Oklahoma Statutes Annotated, Section 1001) directs that in event of such common disaster causing the simultaneous death of both husband and wife, it shall be ruled by the court that neither spouse shall have survived the other. The estate of each then would pass to his or her respective heirs or in accordance with their respective wills. The statute would disqualify the marital deduction savings on federal estate taxes if this provision is not included.

General Provisions Applying to All Wills

admin — Sun, 12 Jul 2009 17:25:22 +0000

General provisions that apply to all types of wills include:
• A spouse may dispose of all his or her separate estate by will, without the consent of the other spouse.
• A will cannot take precedence over:
1. A written antenuptial agreement. An antenuptial agreement is one made up between a man and woman prior to their marriage in which each agrees upon death of the other to take less property or different interest than which the law allows the surviving spouse.
2. A spouse’s elective share. The amount of property a spouse may receive under the laws of succession cannot be reduced by will without approval of the surviving spouse. If by chance this happened, the surviving spouse could elect to receive property under the state laws of succession which would, in effect, invalidate the distribution provisions to him or her under the will.

(In)Efﬁcient Markets

admin — Sat, 27 Jun 2009 13:02:35 +0000

As we know from earlier posts, economic theory approaches the issue of exchange rates by trying to ﬁnd a theoretical equilibrium level, against which one can measure over- or undervaluation relative to the actual exchange rate. Such theory relies on a number of important premises with regard to the information that might affect exchange rates:
Exchange rates reﬂect all available knowledge at any one time
There is perfect knowledge dispersal (such that no-one has an advantage)
While it is debatable whether or not these exist in other ﬁnancial markets, we do know that these are not the reality in the currency market. Many people think of the currency or FX market as the “perfect market”, being that in which knowledge dispersal is optimum and which responds with perfect efﬁciency to stimulus. This simply isn’t the case. Information is not perfect and some market participants can indeed gain a knowledge advantage over their counterparts. Why is this so?
The sheer weight of information affecting exchange rates at any one time is so huge that all currency market practitioners cannot possibly absorb all of it all of the time.
Knowledge dispersal is not perfect and some do have an advantage over others. Such advantages may include knowledge about speciﬁc ﬂows that may occur, a bank’s own “order book” and ﬁnally the ability to do larger currency market transactions than other market participants.
If knowledge is power, then such power in the currency market is not distributed equally. This is no accident. Indeed, it is the very intention of normal and healthy competition to try to gain advantage over other market participants. While news information has never been as freely available as now, at some point that very availability swamps the ability of the users of such information to absorb it all. To some, we appear closer to a state of perfect knowledge than we have ever been, yet I would liken this to the speed of transportation. In 1900, the average speed of the leading mode of transportation in the city of London (the horse) was 11 miles an hour. In 2000, the average speed of the now leading mode of transportation (the turbo fuel-injected car) was . . . 11 miles an hour. Progress begets more progress until you progress so far that you go nowhere. The more information that is available to us, the less we actually have the time (or the willingness) to read. If the good news is that we are closer to perfect knowledge than we have ever been, then the bad news is that we are never likely to get there!
Information costs money to deliver and therefore there is not “perfect” information delivery because not everyone gets it, either at all or at the same time. Even if it were free, “information overload” still means that not everyone reads and uses it at the same time. If you don’t believe me, just think of your e-mail inbox! In sum, there is neither perfect information nor perfect information dispersal — and there never will be. In response, an economist might argue that we have “good” information, if not perfect information. It would be tough to argue with this, but then “good” is not “perfect” and “perfect” is a necessary aspect of the equilibrium concept. Furthermore, this supposed equilibrium level is rarely ever reached. Real life is surely a constant state of ﬂux and imbalance, so why should ﬁnancial markets be any different? In turn, if one assumes that the economic fundamentals that can affect exchange rates are themselves in a constant state of ﬂux, one must equally assume that the equilibrium itself is in a constant state of ﬂux — which to an extent calls into question the idea of it being an “equilibrium” in the ﬁrst place. In truth, it is a signpost on a road. It points you in the right direction, but it gives you no idea of when you will get there or where you might have to turn off along the way.

CURRENCIES ARE DIFFERENT

admin — Sat, 27 Jun 2009 12:02:20 +0000

The ﬁrst thing to say about the currency market is that it possesses and obeys a different set of dynamics to other ﬁnancial markets. Unlike in the case of equity or ﬁxed income markets, the vast majority of currency market practitioners are speculators of one sort or another. Global merchandise trade going through the currency market makes up around 1–2% of total volume. Let’s say we more than double that to allow for foreign direct investment, making a volume contribution of around 5%. Asset market volumes have risen sharply over the past 20 years as barriers to capital have fallen. Having made up only a small proportion of currency market volume before the end of the Bretton Woods exchange rate system, they probably now make up as much as 35% of total currency market volume on a daily basis. That still leaves 60% of daily currency market volume, which has to ascribe to “speculation”. Granted, these are very rough, back-of-the-envelope ﬁgures, but they give a good idea of the proportions that are involved. Given this, is it any wonder that many of the traditional exchange rate models that are based on the current account and therefore on trade ﬂows are poor predictors of exchange rates over the short term?! Equally, this gives some clue as to why the portfolio balance approach to exchange rates also achieves unsatisfactory results.

Productivity

admin — Fri, 26 Jun 2009 21:35:10 +0000

Last but not least, we look at how productivity growth can affect the equilibrium real exchange rate. What is productivity? We have a vague concept of this in our work place, but it has a precise deﬁnition — output per man hour. Rising productivity growth causes increased supply of a good. Supply/demand dynamics require that increased supply relative to demand leads to a fall in price. The principle of Purchasing Power Parity requires however that falling prices in one country relative to another lead to an offsetting exchange rate appreciation under the law of one price. Thus higher productivity growth in tradable goods should lead to exchange rate appreciation to restore equilibrium to the current account.
The issue of productivity growth was much in debate in 2001 as economists sought to explain the US dollar’s inexorable rise against the Euro. Indeed, both the Federal Reserve Bank of New York and the Bank of England produced reports on the issue of whether higher US productivity growth explained the US dollar’s strength and indeed whether or not the US did in fact produce higher productivity growth. Despite the presence of such eminent scholarship, the jury is still out. There does however seem to be greater clarity at least as regards the broader issue of whether or not productivity growth should produce exchange rate appreciation. Just as PPP is not a good short-term predictor of exchange rates, so productivity growth should not be used as a short-term trading model. However, both are profoundly useful in predicting medium- to long-term exchange rate trends. Here, the fact that the US has had consistently higher productivity growth in the wake of the “re-engineering” drive within the US economy in 1994–1995, and the fact that the US dollar has been on a long-term uptrend ever since, should not be seen as coincidence. Similarly, Japan during the 1970s and 1980s had consistently higher productivity levels than either the US or Europe, and this should be seen as at least one of the major reasons why we saw trend appreciation of the Japanese yen during that period.
Yet, at some point productivity growth becomes unsustainable. After all, it deals with the issue of increased supply, presuming that there is always demand for that increased supply. At some point, the levels of supply will exceed demand. When that happens a hitherto unforeseen “inventory overhang”, as per the economists’ jargon, appears. The natural dynamics of supply and demand suggest that the excess supply should instantly be eliminated to restore “equilibrium” supply levels relative to demand. Yet, we know from painful experience that this is not what happens. If we view productivity as supply and wages as demand, the standard economic model suggests that higher productivity growth automatically results in higher wages. Yet, during periods of major technological change, which tend to produce the strongest levels of productivity growth, the fact that competition is greatly increased produces such downward pressure to prices to the extent that the only way some can compete is to cut wage growth. At the very least, wage growth does not keep up with productivity growth. In other words, demand does not keep up with supply — which brings us back to the idea that this excess supply will rather quickly have to correct automatically to match the level of demand.

Terms of Trade

admin — Thu, 25 Jun 2009 21:35:01 +0000

Another important aspect of the external balance approach to exchange rate determination is the so-called “terms of trade”, which is the relationship between a country’s export and import prices. A country’s terms of trade can be an important determinant of its long-term equilibrium real exchange rate. We ﬁnd this particularly the case for countries that are major commodity exporters and therefore whose economies are particularly sensitive to swings in commodity prices. An improvement in a country’s terms of trade, that is a rise in its export prices relative to import prices, should lead to a rise in the real exchange rate equilibrium value. Rising export prices should be reﬂective of rising global demand for that country’s exports, both on an absolute basis and relative to domestic demand levels. Consequently, one should assume that an improvement in the terms of trade should lead to an improvement in the current account balance, which in turn requires a real exchange rate appreciation to restore equilibrium. Equally, a deterioration in the terms of trade leads to a current account deterioration, which requires a real exchange rate depreciation to restore equilibrium. For the sake of clarity, we can express this transmission mechanism using the following simple diagram:
Change in terms of trade -> Change in current account balance -> Real exchange rate change to restore equilibrium
Taking oil as an example, the terms of trade concept is an important determinant of the long term real exchange rate equilibrium value for the countries of the Gulf, Mexico, Venezuela, Colombia, Nigeria, Indonesia, Russia, the UK and Norway. Note that these are just the exporters. The terms of trade concept also works for the importers as well, which is why when the international price of oil experiences a signiﬁcant uptrend, this causes a terms of trade deterioration for the major oil importers, leading to current account balance deterioration. All else being equal, this should require a real exchange rate depreciation to restore equilibrium.