Currency swap: Contract that commits two counterparties to exchange streams of interest payments in different currencies for an agreed period of time and to exchange principal amounts in different currencies at a pre-agreed exchange rate at maturity.
A currency swap has three stages:
An initial exchange of principal: the two counterparties exchange principal amounts at an agreed exchange rate. This can be a notional exchange since its purpose is to establish the principal amounts as a reference point for the calculation of interest payments and the re-exchange of the principal amounts.
Exchange of interest payments on agreed dates based on outstanding principal amounts and agreed fixed interest rates.
- Re-exchange of the principal amounts at a predetermined exchange rate so the parties end up with their original currencies.
- Again this may be done to hedge risk, to speculate on changes in exchange rates, or to attempt to lower the cost of borrowing by borrowing in the currency in which the most favourable interest rates are available and then swapping into the currency that the firm needs to carry out its business. Whether this will be cheaper will depend among other things on the bid—offer spread.
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A eurobond is a debt security handled internationally by syndicates, groups of bankers and/or brokers who underwrite and distribute new issues of securities or large blocks of outstanding issues. It is typically in bearer (non-registered form) and is issued outside the country of the currency in which it is denominated.
Borrowers and lenders are spread around the world, while the intermediaries are spread across Europe, with the majority of business being done from London. The market was founded in the early 1960s and has provided a competitive source of funding for borrowers who can tap discreet but important sources of finance. Japanese banks, pension funds and insurance companies have become important lenders in recent years and there are still plenty of wealthy individuals who prefer the anonymity offered by bearer securities. The eurobond market is the world’s second largest securities market after the US bond market in terms of trading volume and the third largest after the US and Japanese bond markets in terms of debt outstanding. Read the rest of this entry »
Valuing Caps and Floors
The arbitrage-free binomial model can be used to value a cap and a floor. This is because, as previously explained, a cap and a floor are nothing more than a package or strip of options. More specifically, they are a strip of European options on interest rates. Thus to value a cap the value of each period’s cap, called a caplet, is found and all the caplets are then summed. The same can be done for a floor.
To illustrate how this is done, we will once again use the binomial interest-rate tree to value an interest rate option. Consider first a 5.2%, three-year cap with a notional amount of $10 million. The reference rate is the one-year rates in the binomial tree. The payoff for the cap is annual.
Exhibit 25-12 shows how this cap is valued by valuing the three caplets. The value for the caplet for any year, say year X, is found as follows. First, calculate the payoff in year X at each node as either zero if the one-year rate at the node is less than or equal to 5.2%, or the notional principal amount of $10 million times the difference between the one-year rate at the node and 5.2% if the one-year rate at the node is greater than 5.2%
Then, the backward induction method is used to determine the value of the year X caplet. Read the rest of this entry »
Nearly all of the mutual fund families offer multiple funds that are geared toward international investing. The different kinds of funds can be categorized into index funds, international funds, regional funds, country funds, emerging market funds, and global funds. International mutual funds have higher expense ratios than domestic mutual funds to cover higher trading costs and higher management fees. The funds also tend to have redemption fees to control frequent trading. Examples of funds offered by major mutual fund companies are given below.
* Index funds. These include Fidelity Spartan International Index Fund, Vanguard Developed Markets Stock Index, Vanguard Emerging Markets Stock Index, and Price International Equity Index Fund.
* International funds. These funds do not invest in the domestic market. Funds include Fidelity International Growth, T. Rowe Price International, Fidelity Overseas, Vanguard International Growth, Fidelity Diversified International, and so on.
* Global funds. These funds invest in all countries, including the domestic market, and include Templeton World, GT Global Worldwide, Dreyfus Global, Vanguard Global Equity, Price Global Stock, and so on. Read the rest of this entry »
The Problem
Since the beginning of 1997, the U.S.-sold Japan Fund has experienced substantial cash inflows and outflows from investors, and portfolio manager David Smith has voiced his concern recently about the volatility. He also noted that extremely large shareholder orders seem to coincide more and more with news affecting Japan, and cash flow management is taking up a large percentage of his time that might otherwise be spent selecting securities.
Smith suspects some shareholders are trying to increase their profits by “timing” the market—quickly moving their money from one fund to another within the complex. Furthermore, he speculates that these investors might be attempting to profit from the methodology that the fund complex uses to compute the daily NAV of the fund by trading on stock price information that may become available between the time when the Japanese markets close and the time the fund values its holdings. Read the rest of this entry »
When your neighbor, friend, relative, or colleague makes a bundle through investing, remind yourself to manage the envy you naturally feel. If you don’t manage this envy, you’re likely to copy his strategy or type of investment. It’s possible (though unlikely) that copying it may be effective in the short-term, but it is no way to meet long-term objectives.
Viewed without any context or history, a buddy’s great investment is not always what it appears. He may have been investing in food-related companies for years without much success, but he happened to be holding one food company stock that shot skyward because of some hugely successful product introduction. You are not privy to the years of futility as he pursued this approach; all you see is that a food company investment paid off handsomely. If you try and duplicate his “strategy,” you’re doing so without seeing the whole picture. If you possessed this broader perspective, you would never attempt to use his flawed approach.
Diminish your fervor to copy other successful tactics and techniques by asking your neighbor or colleague the following questions: How long have you had this particular investment? How has it done over the last three years? Have you ever had a similarly spectacular success in the past ten years? Have you been disappointed by your investing approach over the last five years? How were you disappointed? The answers are likely to make you less covetous.
Realistically, greed is such a powerful force at times that it’s difficult to find that coolly rational place that allows you to stop your investing reflex. You come across a stock that you’re convinced is going to take off, and you feel every second you delay represents many dollars lost. In these situations, it’s all you can do not to sell the house and use the proceeds for this investment.
Developing a disciplined mindset can help you deal with these tempting situations. By disciplined, I mean you must be in a highly conscious, analytical state when you make an investment decision. Even as your greed is pushing you to rush forward or buy more, your discipline provides you with more rational alternatives. How do you develop discipline? I’ve suggested a few techniques earlier, such as imposing a 5 percent limit and gathering sufficient information before acting. Here are some additional ways to do so:
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USE A METHOD OR A PROCESS BEFORE MAKING AN INVESTMENT DECISION
Whether it’s going through a mental checklist of things you need to do before taking action or employing a series of questions that must be answered to your satisfaction, a process ensures that you won’t act based only on an overwhelming desire to make money quickly. Read the rest of this entry »
BACKGROUND AND PURPOSE
The primary purpose of regulations is to protect investors, and the roots of governmental regulation of mutual funds in the longer-established markets are often associated with major scandals and market crashes.
In the USA, the stock market crash of 1929 prompted an extensive investigation by Congress into the securities industry. It revealed that overselling, or ‘ramming’ of shares, particularly radio company shares, had created unrealistic expectations and false, overvalued markets. The investigation resulted finally in the Investment Company Act 1940, which established the Securities and Exchange Commission (SEC) - this Act remains the cornerstone of US mutual fund regulation - and the Investment Advisers Act 1940. Along with two Acts passed into Federal law in the 1930s - the Securities Act 1933 and the Securities Exchange Act 2934 - these four Acts provide the bulk of federal powers over the activities of US investment companies. In fact, the only addition to US legislation affecting all companies since 1940 is the Sarbanes-Oxley Act of 2002 and that has only an indirect bearing on mutual funds themselves, being more concerned with accounting, auditing and disclosure practices of trading companies, following the Enron and Worldcom scandals. Read the rest of this entry »
Japan - funds analogous to investment trusts existed in Japan in 1937 in the form of investors’ associations, which, like the UK’s Foreign & Colonial Company’s original investment trust, faced challenges of legality and were dissolved in 1940, to be replaced in 1941 by undertakings that, modelled on the UK’s unit trust, found legal support. Post-war confusion led to these funds becoming closed to new investment in August 1945 and final dissolution in February 1950. Read the rest of this entry »
