Financial tipster

Establishing an Emergency Savings Fund

admin — Sat, 22 May 2010 19:03:46 +0000

Emergency savings accounts are crucial to a successful personal finance plan. Before you ever pay off your debt or look to invest, you should have a sizeable savings account dedicated to be used at a moment’s notice for an emergency. You never know when you will need to put a down payment on a new car, fix an old one or have an accident and need to pay hospital bills.

Emergency Fund Rules

Find the best savings rates you can and start building your emergency savings month over month. You should start contributing to it steadily and consider the money to be gone in a sense. This will help you stay disciplined if you’re ever tempted to tap into these funds. Always make sure that you keep your money in a high yield savings account. You’ll need the funds to be liquid so you can access it whenever you need.
Save up until you have about 6-8 months worth of expenses in your emergency savings. If you can get up to a year’s worth of expenses, that would be ideal. This means that you could basically survive for a year without working or needing to tap into other assets or funds. Most people are able to find a job within that time so it makes sense not to build a fund that’s more extensive than that.

Emergency Needs

There are a number of situations you can find yourself in where you wish you would have had an emergency fund. If you are involved in a serious accident or develop a health issue, an emergency fund could cover the costs along with your health insurance. Did you know that about 60 percent of new bankruptcy cases are due to high medical bills that people cannot pay? Don’t get caught in this situation.
If you drive an older car, that’s another reason you would want an emergency fund. You could also create one for your car specifically. Most people do not take the time to consider the cost of repairing a transmission or a new set of tires for their car.
Emergency savings accounts are a great idea for everyone because it makes sense to plan ahead for future costs that will come unexpectedly. When building up your fund, treat it like the most important thing you can do with your finances and sacrifice all other discretionary expenses until you reach your objective. You will feel much better knowing you have a safety net in case you need it.

Correlation

admin — Sun, 28 Mar 2010 16:07:59 +0000

Correlation can be loosely defined as the mutual relation between two or more variables. This is captured in a quantitative way in statistics by a measure defined as the correlation coefficient, usually represented by the letter “r ”. The linear correlation coefficient is used to examine whether there is any evidence of a linear relationship between two variables and defines two qualities:

Nature of relationship. A positive correlation coefficient means that the two variables tend to move in the same direction. If it is negative it implies that the relationship is inverse and that when the value of one variable rises the value of the other tends to fall. Strength of relationship. The value of correlation coefficient provides a measure of the strength of the relationship, if any exists. The correlation coefficient cannot be greater than +1 or less than –1:
Perfect linear relationship. A correlation coefficient of +1 means that there is a perfect linear relationship. If one variable rises then so does the other and the ratio of the rise or fall remains constant. If, for example, the price of one bond increases then the price of the other bond always rises. If the increase in price of the first bond for a given fall in yields is 1% and the price of the second rises by 2% then if the first bond falls in value by 3% the value of the second bond will fall by 6%. Perfect inverse linear relationship. A correlation coefficient of –1 means there is a perfect inverse linear relationship. In the above example a 1% rise in the value of the first bond would be associated with a 2% fall in the value of the second bond. If the first bond falls by 3% the value of the second bond increases by 6%. Independent variables. A correlation coefficient of zero suggests that no linear relationship exists and that the variables move independently of one another.
Note that these are expressed in absolute terms. A “trend line” has been added to the scatter graph. This is defined as the line of best fit and is the line about which the variation of values is minimized. Credit spreads and long-term risk-free rates appear to have an inverse relationship. When long-term risk-free rates rise credit spreads tend to narrow and when yields fall tend to widen.
The variation around the line of best fit is far greater than it is for the plot of change in credit spreads versus changes in long-term yields. There is a weak positive correlation.
In more technical terms the square of the correlation coefficient r2 defines the “goodness of fit” of the trend line. It measures the proportion of the values that can be explained by the inferred linear relationship. Methods exist to assess whether the results are statistically significant, whether it is likely that a linear relationship does in fact exist or whether the results can be explained by chance alone.
A widely used rule of thumb is that if the value for r2 is less than 0.4 (r = 0.63) the evidence for any linear relationship is very thin. A large value for r is not in itself proof that a relationship exists and a useful simple check is to calculate r over a range of time frames to determine whether its value remains stable.

Private property

admin — Wed, 22 Jul 2009 14:20:42 +0000

Private owners have an incentive to lower the chance that their property will cause damage to the property of others. Private ownership links responsibility with the right of control. Private owners can be held accountable for damage done to others through the misuse of their property. A car owner has a right to drive his car, but will be held accountable if the brakes aren’t maintained and the car damages someone else’s property. Similarly, a chemical company has control over its products, but, exactly for that reason, it is legally liable for damages if it mishandles the chemicals. Courts of law recognize and enforce the authority granted by ownership, but they also enforce the responsibility that goes with that authority. Because private-property owners can be held accountable for damages they cause, they have an incentive to use their property responsibly and take steps to reduce the likelihood of harm to others. A property owner, for example, has an incentive to cut down a dying tree before it falls into a neighbor’s house and to leash or restrain his or her dog if it’s likely to bite others.

Private owners

admin — Wed, 22 Jul 2009 14:19:52 +0000

Private owners have an incentive to conserve for the future-particularly if the property is expected to increase in value. People have a much stronger incentive to conserve privately owned property than they do commonly owned property. For example, when Steven was in college, the general rule among his roommates was that any food or drink in the house was common property-open game for the hungry or thirsty mouth of anyone who stumbled across it. There was never a reason for Steven to conserve food or drinks in the house because it would be quickly consumed by a roommate coming in later that night. When Steven first started living alone, he noticed a dramatic change in his behavior. When he ordered a pizza, he would save some for the next day’s lunch rather than eating it all that night. Steven began counting his drinks before he had one to make sure there were enough left for the next day. When Steven was the sole owner, he began delaying his current consumption to conserve for the future because he was the one, not his roommates, who reaped the benefit from his conservation.
Similarly, when more than one individual has the right to drill oil from an underground pool of oil, each has an incentive to extract as much as possible, as quickly as possible. Any oil conserved for the future will probably be taken by someone else. In contrast, when only one owner has the right to drill, the oil will be extracted more slowly. The same applies to the common-property problems involved in overfishing of the sea compared with fisheries that use privately owned ponds. ’’
Someone who owns land, a house, or a factory, has a strong incentive to bear costs now, if necessary, to preserve the asset’s value for the future. The owner’s wealth is tied up in the value of the property, which reflects nothing more than the net benefits that will be available to a future owner. Thus, the wealth of private owners is dependent on their willingness and ability to look ahead, maintain, and conserve those things that will be more highly valued in the future. This is why private ownership is particularly important for the optimal conservation of natural resources.

Tradable and Non-Tradable Goods

admin — Fri, 26 Jun 2009 21:21:40 +0000

There is a further point, which is that clear differentiation has to be made between tradable and non-tradable goods. PPP may not hold for non-tradable goods such as services. The dry world of economics is frequently best explained through example and anecdote. Thus, a haircut might be cheaper in New York than London (most things are and this is not one of the exceptions), but few people would be prepared to ﬂy to New York from London just to get that cheaper haircut. This is not just because to do so you would have to pay for a London–New York return ﬂight, which would negate any haircut-related gains you would make. Even supposing the air ticket was free would you really ﬂy 8 hours for a cheaper haircut? The PPP concept assumes there are no barriers to the arbitraging of price differentials, yet with non-tradable goods this may not be the case. Granted, there may always be some wayward individuals who would actually take that ﬂight!
PPP or the law of one price holds better of necessity for homogeneous commodities that are traded internationally, with arbitrage opportunities being quickly eliminated. However, even here, care is needed. While PPP may hold generally, prices even of homogeneous commodities may vary widely between countries depending on local supply/demand dynamics. Indeed, the very fact that the price of a McDonalds Big Mac, which is a homogeneous commodity, can vary between countries for even a short period of time proves this point.

Reasons for “Misalignments”

admin — Fri, 26 Jun 2009 18:20:41 +0000

Exchange rates which do not reﬂect the PPP value are said to be “misaligned” and it is assumed therefore that they have to revert towards PPP. Such misalignments are seen as being caused by temporary distortions, either to the price of the good or the exchange rate, which should quickly be eliminated by a rational, proﬁt-seeking market. In reality, such “misalignments” can last for months or even years. In other words, traders, investors or corporations who base short-term ﬁnancial decisions on the PPP model of exchange rate value do so at their own risk. The track record of the PPP model over the short term leaves a lot to be desired, to the extent it is known in the market as the “Pretty Poor Predictor”. How can such misalignments occur in a free market economy where the price adjustment mechanism should be immediate? If there is free trade between nations, a price differential in a good (or basket of goods) should create an arbitrage opportunity — you buy the good in the cheaper country. Such buying should push up the currency in the cheaper country relative to the more expensive one. Yet still, this is not necessarily what happens over the short term. Why?
We do not have perfectly free trade — Such a concept would imply zero import tariffs, zero export subsidies and perfect competition across all business sectors. Needless to say, this is not the case. Whatever progress we have made, we are not there yet. As a result, there remain signiﬁcant trade-related price (and therefore exchange rate) distortions.
The adjustment mechanism is not necessarily immediate — During periods of market volatility, corporations may delay setting prices and budget exchange rates until they have a better idea of where the appropriate levels should be to retain competitiveness and margin.
The price of goods may not be the most important exchange rate determinant — A basic PPP assumption is that the relative pricing of goods is the main driver of exchange rates. However, since the liberalization of capital markets, this may no longer be the case.
The good or basket of goods may not be exactly the same in different countries — The consistency of the good should not be taken for granted as the same good may vary between countries in terms of quality, cost and speed to market.
Base-year effects — There is also the question of when to start the PPP analysis. Logic might suggest starting from the end of the Bretton Woods exchange rate system in the 1971–1973 period, yet this took place at a time of very high inﬂation, thus signiﬁcantly distorting the results.

DEVELOPMENTS IN THE FINANCE SECTOR

admin — Thu, 25 Jun 2009 21:24:59 +0000

Risk is an everyday hazard that faces banks, funds and insurers. It can usually be mitigated, but it is rarely eliminated completely. There are some cases where a positive “hazard” is a very good thing to have – each business faces a risk or probability of making proﬁts. Millions of people buy lottery tickets each day facing the small risk that they will become instant multimillionaries. Business always encounters some form of risk.
It is good that we recognise that operational risks are present in our company. It is better when we can predict the risk event that will happen. It is best when we have reinforced the general resilience of our system through risk management countermeasures. The business operational risk shock is going to be absorbed by our company, so the company has to respond. Not all banks have put operational risk ﬁrmly on their corporate radar. Few banks seem to have detailed an operational risk map by making provisions for expected operational risk. Basel surveyed 89 banks, and only 33 had designated expected operational risk loss measures.
Therefore, we need a management structure to plan the continuing and increasing system resilience of the company.
Doing risk management, rather than merely talking about it, will separate the banks from the boys for Basel II implementation. The measures of pricing, reserving and expensing for OpRisk are already one signiﬁcant step ahead of risk managers simply answering:
We are risk-compliant because we have already submitted the Risk Compliance Report.
This reporting for the sake of reporting is a risk-ignorant form of control activity in a mindless ticking of boxes in a questionnaire. Will reporting and complying with the regulations catch out the next Enron?
The above techniques get us closer, may be, to a real-life model of risk management that we call ‘organic’. Basel II reaches for some risk silo integration, but real life is messier. Messy problems can be handled in a project management control structure, such as RAMP. An investment company, with its people and processes, its clients and their investment needs and preferences, is like a living organism. It can encompass every type of business risk, instead of just the ones we would like to handle. We see that there are many organic risk stakeholders at play in the market.

Forensic accounting

admin — Wed, 24 Jun 2009 21:24:51 +0000

Forensic accounting is a potentially rich source of value-added in ﬁnancial environments. Part of forensic accountancy is an art, part science and the rest is detective work. There are three ways in which it can provide a valuable service in organisations:
1. Investigate a case post facto to see where a loss has occurred within the investment environment; sniff out the cause or possible rats, then set up the enquiry for full regulatory/judicial process and compensation/redress where possible.
2. Examine a business to spot current areas of weaknesses that may cause future losses. Shore up, ﬁre, retrain or recruit staff to reinforce the system.
3. Compile a list of weaknesses within the organisation and detail reasons for investment loss.
This exercise is a training tool for auditing and back-ofﬁce staff. Such forensic investigations must feed active front-ofﬁce trading personnel, compelling them to document signiﬁcant risk events for the beneﬁt of the back ofﬁce.
There is more incentive to promote this type of procedure under Basel II regulations for market transparency and discipline. Part of the Basel II philosophy of risk is predicated on the notion that top management want to grasp the nettle and actively manage OpRisk. The ﬁrst thing forensic accounting can provide is a corporate health check or a company risk audit.
They may use a variety of techniques to derive this audit:
Self-assessment of risk areas – running a checklist audit or workshop to identify the strengths and weaknesses of the company’s business environment, especially against potential stake- holder lawsuits.
Risk mapping – diagramming the various constituent business units and process ﬂows.
Each area and its associated risk are identiﬁed and documented, then the follow-up risk management action recommended. Risk mapping can be used within functional areas for key risk indicators (KRIs). Departments can deﬁne operational limit bands of functionality like a risk thermometer. Crossing these limits (e.g. asset-liability gaps) shows the company’s risk exposure here is “hot”. The responsible party or group designated with the risk origination can also be ﬂagged, and the risk management group alerted.
Business scorecards – these build on Kaplan and Norton’s seminal work in measuring and quantifying the performance of corporations.22 These are qualitative performance levels, but the resulting scorecard can identify areas of weakness that may be reinforced with additional capital and training.
Loss database – this keeps a historical log of above-threshold value ﬁnancial losses. Statistically signiﬁcant losses or high damages can be highlighted automatically for the attention of senior management.
We have developed advanced tools and techniques for:
Corporate governance.
Benchmarking and measuring performance.
Identifying areas of risk or weakness.
The problem is that an investor is an irrational animal and other inﬂuences often take over the driver’s seat. This is certainly true at the top executive level, and OpRisk groups have less to say about how strategic decisions are made.
The two main risk horizons remain for ﬁnancial institutions.
Strategic policy risk – the fundamental asset allocation and performance benchmark design. This has been the subject of much research, but behavioural factors do exert a strong inﬂuence. Strategic policy risk has the greatest inﬂuence upon bank and fund success. Governance and trustee deﬁned roles working under a multilayered control hierarchy can keep a better link between declared corporate objectives and the actions of managers.
Tactical implementation risk – investment manager structure and manager selection. Investment managers are generally recruited from a narrow band of skills and social backgrounds, so they can develop a tendency to socialise and to invest as a herd. This leads to a restricted range of assets chosen for investment. Careful interviewing and screening of recruits can reduce undesired wayward behaviour.

RISK COUNTERMEASURES

admin — Wed, 24 Jun 2009 21:24:19 +0000

Once detecting operational risk conditions is in existence, we can think about deploying risk countermeasures. Could any CEO shark engineer himself some huge pay-off based on undisclosed benchmarks?
Frankly, yes and no. Yes, they could get away with it easily in the old days. General Motors was a classic example where the head of a modern corporation could do what he liked in the era of Roger Smith. Pressure from the board, CalPers and H. Ross Perrot eventually forced him out. More recently, NYSE chairman Richard Grasso was pressured into resigning after the resultant furore that erupted when his $140m pay package was made public. Was this a case of Kalashnikov risk management used successfully? Some would say with justiﬁcation that the aggrieved Western shareholders are amateurish when it comes to reining in the wayward behaviour of boards and CEOs. The professionals in the Japanese maﬁa do it so much better.
Western shareholders could well adopt this tactic as a last resort. The UK GSK and the US GM meetings do not even compare in skill. This is one of the positive role models of the Yakuza systematically ignored in the Western world. They could teach shareholders how to level the corporate playing ﬁeld by disrupting the AGM. If they get continually fobbed off, then they could always shoot the directors one supposes.
Badgering and damaging leaders’ reputation certainly can have effect. Corporate governance is coming along slowly. It would arrive faster if we could borrow some of the Yakuza’s tactics in Western companies. In the meantime, we have the regulatory cogs slowly grinding around the Combined Code, Higgs Report and Sarbanes–Oxley to protect us.
The covering up of negative ﬁnancial reports and losses are examples of corporate misgovernance to head off risk of reputation damage.12 The eventual cost on ongoing business may be greater where the fundamental causes of the original loss have not been remedied, but merely swept under the carpet until recurring later.
This behavioural trend increases systemic risk where greater eventual damage is vested upon the wider industry. We have already seen this in Lloyds insurance, where a nepotistic code of doing business with “our sort of chaps” represents a sclerosis risk that nearly blew the UK insurance industry. The more we ignore it, the more it can blow up in our faces.
These hidden losses and weaknesses make it more difﬁcult to value a company and its assets. The persistent ramping of a company’s value, and the love of M&A to increase company size instantly, creates additional problems for investors in Western ﬁrms. It is a problem rooted in the modern business culture, much inﬂuenced by the USA.
The weaknesses inherent in embedded value methods are repeated and added to in US GAAP reporting. These need to be anticipated, adjusted for and fully understood before reliance should be placed on the results.
How to discourage the executives from acting in an irresponsible fashion?

General Observations

admin — Sun, 21 Jun 2009 18:37:58 +0000

The stock market is likely to be on firmer footing when strength in the daily- and, weekly-based advance-decline lines confirm strength in the various indices that reflect different sectors of the stock market. In other words, new highs in indice such as the Standard & Poor’s 500 Index should be confirmed by new highs in the weekly- and daily-based advancedecline lines, and vice versa.
Stock market technicians frequently take negative note of periods in wluch market breadth readings fail to confirm new highs in market indices such as the Standard & Poor’s 500 Index and the Dow Industrials, but bear markets have starled during periods that market breadth readings have remained stronger than readings of popularly followed market indices. For example, the 1981-1982 bear mark € started with more apparent weakness in major market indices than in the advance decline limes, but eventually the declime spread across the entire stock market universe.
The stock market prefers strength in all of its areas. Although it is probably better if measures of breadth lead market indices than vice versa, universal strength best.
It is more bullish for stocks when peaks in major market indices are confirmed by new peaks in the advancedeclime lines, or when new lows in market indices are unconfirmed by new lows in the advance-decline lines.
Again, unanimous strength is best. But if you have to choose, breadth strength in generally the most decisive, especially if your portfolio includes a fairly high percentage of broadly based, smaller company-oriented mutual funds that tend to track with market breadth measurements.
Market breadth data is available for Nasdaq-based as well as New York Stock Exchange-based markets. The advance-decline line of the Nasdaq Composite Inde often provides clues and cues that are not apparent in the price action of the Nasda
Composite Index alone.
The price level of the Nasdaq Composite Index is frequently more influenced by a relatively smaller group of companies than the price levels of either the New York Stock Exchange Index or the Standard & Poor’s 500 Index. Certain mutual fund and ETFs reflect larger-capitalization companies such as Microsoft and Intel the trade on the Nasdaq, but mutual funds that invest in emerging companies usually more closely reflect the Nasdaq advance-decline line in their price movement. The level of strength in the advance-decline limes of the various market sectol can be tracked with rate of change measurements that rdect changing paftems i the strength of market breadth.