Monthly Archives: August 2007

Real interest rates vs Interest rates

The title must be enigmatic for some and familiar to others. For the sake of those who would be wondering what is it all about, read ahead.

Interest rates are defined as just interest rates – the rate of interest which you earn on your investments, plain and simple.

The real interest rates are defined as the interest rates adjusted for inflation. In your investment portfolio, it is the real interest rates that should assume importance and not the simple interest rates. Why? Let’s see.

Suppose you invested $100 in one of the investment schemes for a period of 12 months. The return on your investment is 10%. It would mean that at the end of the investment tenure you have a investment return value of $110.

Say, the inflation rate for the same corrosponding period was 5%.

Effectively it would mean that while you got a return on your investment of 10%, the purchasing power of your $100 went down by 5%  i.e. the x item that you could have purchased in $100 is now costing $105.

So you have generated a wealth of $5 only at the end of the 12 month period. (against the $10 value that you might actually be thinking)

This is why, the real interest rate is a better guiding tool for the calculating the return on your investments.

Why stock markets will always give better returns than your fixed deposits

The fixed deposit rates are indicative of the risk free rate of return. Since such rates are guaranteed by the bankers/financiers they carry minimum or no risk tag on them.

This risk free rate of return is defined as the return earned on investments with negligible risk

For an enterprise to attract equity capital from its promoters / shareholders, it must promise and deliver returns higher than what the investors can secure by investing in the risk free domains. In other words the enterprise, to attract funds, must deliver higher returns than the risk free rate of return.

Let us understand through a hypothetical example:

There are 100 companies listed on the NASDAQ. Each one of these companies is fighting in the open market to acquire capital from the investors. The enterprise offering the best matrix of risk and return ratio would be winning the best of the investors. In other words the investors would put their money in the enterprise which offers the best combination. The market (investors) would never park their money in any of these enterprises unless they see a probability of earning a return higher than what the fixed deposits offer.

Return on Investments in market would then mean:

Risk free rate of return + risk premium = expected rate of return from the enterprise

The stock market is the combined representative of all enterprises. If the market, (enterprise), needs to attract funds, it must give a premium over the risk free rate of return or the fixed deposits. Otherwise the investors are well

off by parking their funds into fixed deposits.

The stock markets, in the long run, will always give a ROI (return on investment) better than the fixed deposits.

What are fixed and floating interests rates in the home loan market?

The interest component of the home loans is based on either of the two types of interests or a combination of them. A series of permutations and combinations, at times, might result in a very complex structure of interest calculation.

The fixed interest rate refers to the flat rate of interest on the loan. The fixed interest rates are protected from market volatility i.e. changes in the interest rates do not affect your repayment schedule.

The floating interest rates are a little complex than its predecessor. The floating interest rates are a combination of static rates and the prevailing benchmark rates of some indexes in the economy. Let us understand through an example:

The static rate of interest: 500 basis points

The variable rate of interest: LIBOR + 200 basis points

The static rate (500 points)  + The variable rate (LIBOR + 200 points) = The actual rate of interest charged

The LIBOR stands for the London Interbank Offer Rate and is the benchmark base rate for banks all over the world for lending money to each other. However, LIBOR changes with the market dynamics and is not stable all round the year. Taking into consideration the local market dynamics of demand and supply, the variable interest rates are jacked up by N basis points.

Now there’s a catch:-

The fixed interest rates can be revised by the bankers every 3 or 5 years (this clause is always mentioned in the fine print but not visbile to the naked eye). So the risk of the banker/financer is effectively not more than revision period.

There are also hybrid rate regimes like this one wherein for the first few years a fixed rate of interest is charged and then the repayment schedule shifts to the variable rate of interest regime.

Always exercise care while choosing the interest rate regimen of your home loan. Be informed and exercise the power of cuckee knowledge.

Have you insured the existence of chaos against the occurrence of routine?

Anything that disrupts the routine is considered as a hazardous risk and is attempted to be insured. But ever wondered that in a world which is increasingly becoming more chaotic, we could some day try to attempt to insure the routine from interfering with the daily chaos that we have become so used to

Funny as it may sound, it actually is not. Disruption of life in the hands of death is a risk that we insure with the help of life insurance. But as medical science takes its leap into futuristic medical solutions the life expectancy of the Homo Sapiens would increase. Suddenly, life that seemed to be the routine would itself become the disruption – the disruption to a peaceful routine death. An increased life expectancy might also mean an extended routine working life. An extended routine life would then be the disruption to the early retirement.

Are you ready to be deprived of the chaos that you have become used to? Have you insured the chaos against the routine !! ??

Money, elections and corruption !!

All election campaigns of the world have one thing in common. Funds. The larger is the size of the corpus available for spending, the larger is the indulgence and extravaganza.

A lot of money changes hands during the election campaigns. In some of the countries such amount of funds that are spent are accounted for whereas in some its not. But where does all the money flow from? I am sure they don’t use the minting machine.

Almost 90% of the wealth during the election campaign is from the ‘philanthropic’ donations of individuals and corporations. So when the Democrats and the Republicans in US, the Labor and the Conservatives in the UK, the Congress and the BJP in India and all other major political outfits in their own monastery are in requirement of funds, their respective secretaries dial ‘S’ (supporters).

But none of these funds donated to the political outfits is philanthropic and generous. Every penny spent in the world in the form of political donations is the investment of those supporters in their political connections. Investment which they believe would fetch very high returns. And once in power, they want to milk the cow for the grass that they had fed.

The political ideologies who win the elections and go on to form the government are always under the pressure to oblige the financial supporters of theirs. So there are some favors that are doled out. Some supporters manage to get the official policies tweaked in their favor, while some simple want the pie of the action – contracts at terms and conditions which otherwise would not have been possible. Those who have more than enough money want to bask in the glory of the electorate – hence they want to occupy seats of power.

When efficiency takes a back seat and favorism is in control of the process, corruption takes birth. Many things will happen in the due course of the time that should not have happened. The national interest of the exchequer would be compromised in many more instances that none of us would ever come to know of. Most of the knowledge of such instances would forever be confined to the walls of the Presidential and the Prime Ministerial houses.

The process of electing a party or an ideology to the seat of power is rigged with the tag of money and corruption.

To all my fellow electorates of this planet, think and devise a way out of this monster that we have created.

Where to invest in the United States and why ?

Look out for opportunities to invest in institutions that are in the business of super technology rather than investing in the contemporary business sectors.

The global economies have opened up and the geographical maps have been rendered redundant by the organizations who aspire to make their mark on the lives of individuals cut across various civilizations and cultures.

In their zest to expand to outer boundaries, productivity is being jacked up. As a result of which a lot of activities are getting transferred to the nations with low cost labor and technology. This phenomenon is often referred to as the Business Process Outsourcing – BPO by the world leaders now.

As more and more routine activities move out of the US, the civilizations would indulge themselves in creating technologies that do not exist today. It’s not a question of survival that would force entrepreneurs and the workforce of the US to shift to new technologies but the urge to repeat the history – to set out to do things that no one in the world has achieved, to create the next wave of technology superiority. Having shifted the daily routine activities the great minds that have created the present today, would automatically shift towards doing more premium and niche activities like the one mentioned before – technological advancement.

This paradigm shift in the skill set of the US workforce will have far reaching effects on the economy and the future of the superpower. By the end of the next decade do not be surprised to see the NASDAQ and DOWJONES doted with companies with super specialization in technology that is unheard of in present times. The time has come for the United States to move on to the next level of development.

Raise a toast to the power and creativity of business enterprises and be on the look out for such pockets of excellence in the making. Invest with a foresight. You won’t be let down.

Invest in the Emerging economies

Emerging economies or the rapidly developing economies as they are more popularly known are the investment flavor of the decade. What makes them so attractive a destination for investment?

The emerging economies are marked by high and sustainable GDP growth rate coupled with increasing opportunities available for investments. Much of this growth is fuelled by internal consumption across various sphere of economy like infrastructure, manufacturing, services and agriculture.

The now famous BRIC report was one of the first researched papers on emerging markets. The report is abbreviated after the four emerging markets in the world – Brazil, Russia, India and China.

The International Business Report has also suggested Pakistan, Turkey, Mexico and Indonesia as the other emerging markets of the world.

The sectors to watch out for in these markets:

  • Construction and Infrastructure
  • Health Services
  • Banking and Finance
  • Retail Merchandising
  • TCE – Telecom, Communication, Entertainment

All of such investments in emerging markets must be on a time horizon of 5-10 years. The lock in period is necessary in order to surpass the gestation period typical of high value projects and investments. In an emerging economy the benefits accrue only when your investment is for a longer period. This is because, in the initial years, much of the money flows into the economy as capital investments required to create a platform for building further scales. It is only after the first few years that the investment bears fruit and returns start to materialize.

The long term fundamentals of these emerging economies are strong and most of them are not as susceptible to the global trends as the other markets. (Complete immunity is ruled out).

More Hedge Funds might go down as the US subprime saga unfolds

The likelihood of more hedge funds cropping up their necks with heavy losses has gone up with the recent Goldman Sachs top up of $ 3 billion into one the hedge fund managed by them.

The hedge fund industry, in the recent past, has seen a growth trajectory unheard of in any other financial markets. However all this seems to be changing now with the US sub-prime mortgage blowing into the face. By the beginning of the next financial year the failure rate of the hedge fund industry is expected to hit around 15-16% – up from current 8%.

With greater redemption pressure from the investors, the markets ahead might see even more turbulent trading weeks.

Watch out for more on this at cuckee.com in days ahead.

Discount rate and Fed Fund Rate US Fed Reserve

The Discount rate is the rate of interest at which the Fed Reserve lends money to other commercial bankers.

The Federal Funds rate is the rate at which the commercial banks lend overnight money to each other.

The commercial banks borrow money from the central bank against a host of collateral like commercial papers, mortgage based securities, and asset based securities.

However most of the banks are reluctant to approach the central bank discount window for borrowing funds. This is because the commercial bankers do not want to send a signal to the market that they are not solvent enough to attract funds from the open market.

What is a forward booking in Forex what is it & how does it help

Forward bookings are like forward contracts, the same as in futures and options (derivatives market).

It is an effective tool for mitigating the risks of exchange rate volatility. There are forward forex booking companies which book contracts with their clients for a fixed exchange rate for a particular currency. Such contracts are to be executed within a given time frame. They (the companies) charge a fixed percentile of the contract value as per the agreed terms and conditions between them and their clientele.

Effectively these companies (risk agents) transfer the risk from their client to themselves.

Example

Mr. A (in US) has purchased cars from Mr. B (in Japan). As per the agreed terms and conditions Mr. A would be making payment of 115,000 Yen to Mr. B on a specified date.

Currency for US: USD

Currency for Japan: : Yen

Current exchange rate:115

Now if on the actual date of payment the exchange rates of Yen/USD are stable then that’s no problem to either of the party. But if the exchange rate surges to 118/USD, Mr. A will benefit by paying less USD for making payment of 115,000 Yen.

The cost for Mr. A would be 115,000/118 = 974.58 USD

However if the Yen/USD exchange rate plunges to 112 Mr. A would pay higher than the budgeted amount.

The cost for Mr. A would be 115,000/112 = 1026.78 USD

To safeguard against any such volatility Mr. A could enter into a forward contract with a Risk agent for a nominal fee. By doing so, the forex risk would be transferred to the risk agent and Mr. A would be guaranteed the Yen/USD exchange rate of 115 for the specified time period.