Financial issues » currency

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.

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.

REER and FEER

admin — Thu, 25 Jun 2009 21:34:32 +0000

In line with the external balance approach, the Real Effective Exchange Rate (REER) is the trade-weighted exchange rate (NEER) adjusted for inﬂation. As with PPP, the purpose of using REER is to try to gauge an exchange rate’s over- or undervaluation relative to a given norm. As with PPP, using REER is far from an exact science and in fact PPP and REER run into similar problems. For instance, a major problem with PPP is which base year to choose. REER has the same problem and for similar reasons. Using a particular base year with which to begin one’s analysis can signiﬁcantly distort the results. On the face of it, it would seem logical to start both PPP and REER analyses in the 1971–1973 period when the Bretton Woods exchange rate system broke up, yet this was a highly inﬂationary and therefore distorting period as far as such analyses are concerned.
The transmission mechanism is again the current account balance. Signiﬁcant REER over-valuation relative to a given norm of 100 tends to produce a widening current account deﬁcit or “external imbalance” in the jargon of economists. In order to restore balance or equilibrium, there has logically to be a REER depreciation. This can be achieved either by a depreciation of the trade-weighted exchange rate — that is to say by a depreciation of the nominal exchange rate — or by a sharp decline in inﬂation.
So far, this seems relatively logical and deceptively predictable. However, signiﬁcant REER overvaluations can last for substantial periods of time. In some cases it can take several years before an adjustment process takes place to eliminate such overvaluation. A good example again is that of the Russian rouble, whose REER value was overvalued by around 60% for three years — depending on the base year used — before it ﬁnally succumbed to gravity. The REER values of both the Mexican peso and the Venezuelan bolivar have indicated signiﬁcant overvaluation for several years now, and in the case of the Mexican peso to a greater degree than before the 1994–1995 “Tequila” crisis. The lesson of REER is that it can be a useful tool for diagnosing over- or undervaluation and a consequent need for an adjustment to restore equilibrium — but what it cannot do is tell you when that will happen.
Another way to estimate a real exchange rate’s equilibrium is FEER, or Fundamental Equilibrium Exchange Rate, pioneered by the writer and economic scholar John Williamson in 1985. Recognizing the imperfections of the PPP concept, FEER reﬂects the exchange rate value that is the result of a current account surplus or deﬁcit that is in turn appropriate to the long-term structural capital inﬂow or outﬂow in the economy, assuming that the country does not have barriers to free trade and is also trying to pursue internal balance. Assessing the appropriate level of long-term structural capital inﬂow or outﬂow requires a considerable degree of value judgement. Even if it did not, it assumes that such capital inﬂows or outﬂows should persist simply because they have occurred in the past. Given this construction, it is not surprising that estimates of an exchange rate’s FEER value vary widely. This is not to say that it is not a useful model. Indeed, models based on the FEER concept have been widely used within the private sector for some time. However, it is to say that using such a type of exchange rate model puts a considerable degree of emphasis on the value judgement of the analyst concerned, thereby undermining the point of using a model in the ﬁrst place. Looking at exchange rate models in general that use some variation of the external balance approach, we see that considerable “misalignments” in the external balance — and therefore presumably in the exchange rate — can persist over signiﬁcant periods of time. The fact that this can happen suggests equally that for substantial periods of time the importance of the external balance to the exchange rate can be more than offset by capital ﬂows. Eventually, it appears that the misalignment in the external balance reaches a level which produces a loss of market conﬁdence and capital outﬂows. As capital outﬂows occur, this by necessity must reduce the current account deﬁcit. The problem of course is that this level, this trigger point which causes a loss of market conﬁdence, is not static but changes. Thus, as with all exchange rate models, those which focus on the external balance should be used for long-term exchange rate considerations rather than for the short term.

Financial Statements

admin — Mon, 08 Jun 2009 18:55:52 +0000

We already know that the value of our ﬁrm is determined by its underlying projects. We already know that these projects have cash ﬂows that we use in our NPV analyses. So, why should you bother with learning about what companies say in their ﬁnancials? A rose is a rose is a rose, isn’t it? The projects and thus the ﬁrm have the same value no matter what we report.
Yes and no. There are many good reasons why you should understand ﬁnancial statements:
1. If you want to have an intelligent conversation with someone else about corporations, you must understand the language of accounting. In particular, you must understand what earnings are—and what they are not.
2. Subsidiaries and corporations report ﬁnancial statements, designed by accountants for accountants. They rarely report the exact cash ﬂows and cash ﬂow projections that you need for PV discounting. How can you make good decisions which projects to take if you cannot understand most of the information that you will ever have at your disposal?
3. It may be all the information you will ever get. If you want to get a glimpse of the operation of a publicly traded corporation, or understand its economics better, then you must be able to read what the company is willing to tell you. If you want to acquire it, the corporate ﬁnancials may be your primary source of information.
4. The IRS levies corporate income tax. This tax is computed from a tax-speciﬁc variant of the corporate income statement, which relies on the same accounting logic as the published ﬁnancials. (The reported and tax statements are not the same!) Because income taxes are deﬁnite costs, you must be able to understand and construct ﬁnancial statements that properly subtract taxes from the cash ﬂows projected from projects when you want to compute NPV. And, if you do become a tax guru, you may even learn how to structure projects to minimize the tax obligations.
5. Many contracts are written on the basis of ﬁnancials. For example, a bond covenant may require the company to maintain a price-earnings ratio above 10. So, even if a change in accounting rules should not matter theoretically, such contracts can create an inﬂuence of the reported ﬁnancials on your projects’ cash ﬂows.
6. There is no doubt that managers care about their ﬁnancial statements. Managerial compensation is often linked to the numbers reported in the ﬁnancial statements. Moreover, managers can also engage in many maneuvers to legally manipulate their earnings. For example, ﬁrms can often increase their reported earnings by changing their depreciation policies (explained below). Companies are also known to actively and expensively lobby the accounting standards boards. For example, in December 2004, the accounting standards board ﬁnally adopted a mandatory rule that companies will have to value employee stock options when they grant them. Until 2004, ﬁrms’ ﬁnancial statements could treat these option grants as if they were free. This rule was adopted despite extremely vigorous opposition by corporate lobbies, which was aimed at the accounting standards board and
Congress. The reason is that although this new rule does not ask ﬁrms to change projects, it will drastically reduce the reported net income (earnings) especially of technology ﬁrms. But why would companies care about this? After all, investors can already determine that many high-tech ﬁrms (including the likes of Microsoft a few years ago) may have never had positive earnings if they had had to properly account for the value of all the stock options that they have given. This is a big question. Some behavioral ﬁnance researchers believe that the ﬁnancial markets value companies as if they do not fully understand corporate ﬁnancials. That is, not only do they share the common belief that ﬁrms manage their earnings, but they also believe that the market fails to see through even mechanical accounting computations. Naturally, the presumption that the ﬁnancial markets cannot understand accounting is a very controversial hypothesis—and, if true, this can lead to all sorts of troublesome consequences.
For example, if the market cannot understand ﬁnancials, then managers can legally manipulate their share prices. A ﬁrm would especially beneﬁt from a higher share price when it wants to sell more of its shares to the public. In this case, managers could and should maneuver their ﬁnancials to increase their earnings just before the equity issue. There is good evidence that ﬁrms do this—and also that the ﬁnancial markets are regularly disappointed by these ﬁrms’ performances years after their equity issues.
Even more troublesome, there is also evidence that managers do not take some positive NPV projects, if these projects harm their earnings. Does this sound far-fetched? In fact, in a survey of 401 senior ﬁnancial executives Graham, Harvey, and Rajgopal found that 55% would delay starting a project and 80% would defer maintenance and research spending in order to meet earnings targets. Starting projects and doing maintenance and R&D are presumably the right kind of (positive NPV) projects, so not taking them decreases the underlying real value of the ﬁrm—even though it may increase the ﬁnancial image the ﬁrm projects.