Lost in Translation

April 9, 2008

I try not to post about school too much… but I can’t help myself today.

Yesterday I had an exam in Multi-National Corporate Finance… yep, a whole class dedicated to making money by doing silly, ethically debatable little tricks internationally with money (in Finance, we call this “arbitrage”).

In any case, it was probably the most difficult exam I have taken in my whole life. It was mostly concerned with hedging against transaction, translation, and economic risk using forward contracts, options, money market hedges, interest rate swaps, and currency swaps. A brief example:

You are a U.S. based company who sold a piece of equipment to a company based in the U.K. for 100,000 pounds. The company in the U.K. has to pay in 365 days… you face the risk of the British currency (the pound) depreciating before they pay (if the exchange rate is $2/pound, they currently owe you $200,000… if the pound depreciates to $1.75/pound, then they are only paying you $175,000, a loss of $25,000). Since this is a possibility, you can mitigate the risk by entering a forward contract that locks you in to a price of $2/pound, or you can use the money market to hedge the risk. For example, if the interest rate in the U.S. is 8%, and the interest rate in the UK is 5%, you could borrow 95,238 British pounds from a U.K. bank (with interest, in one year you will owe the UK bank 100,000 pounds), exchange it into dollars at $2/pound to get $190,476, and then invest the $190,476 in the US at the US interest rate of 8% to get $205,714. When the UK company pays you, you would use the 100,000 pounds to repay the British bank. As you can see, this is not difficult, but can be confusing.

As with the first exam of the semester, I feel that I did very well on the quantitative problems, but I have no idea how I did on the multiple choice stuff.

Anyway, to get back to the point of the post, as I was sitting there trying to keep everything straight and figure out some difficult quantitative problems, the fire alarm went off… we went outside and waited until they gave the “all clear”. After about 5 more minutes, the alarm went off again… we went back outside for about 5 minutes, then they gave the all clear. Upon getting started again, the alarm went off… again. This time we relocated to another building and took the exam in the noisy college cafeteria (it was dinner time).

So there you have it… I took the most difficult exam of my life in a college cafeteria… proof that when it rains, it pours.

Advertisements

Fed Funds? Discount Rate? Huh?

January 22, 2008

If you have looked at the news today, then you already know that the Federal Reserve announced that it is cutting the Federal Funds Rate from 4.25% to 3.5% and the Discount Rate (window) from 4.75% to 4%. As a matter of fact, you can’t visit yahoo.com, msn.com, cnn.com, or any major news TV station without seeing it, which made me wonder… how many people have the slightest idea what this means?

I’ve got to admit… until last year I had no idea what all of this government mumbo-jumbo meant either. Discount rates? Isn’t that what you get at Wal-Mart or Marc’s? Discount window? Isn’t that what that asshole on the info-mercial keeps trying to sell me at 2:30am?

This post is for anyone who is unsure of what the hell all of these terms mean. I by no means intend to cover all of the implications of this crap, but hopefully this will be insightful enough to make at least a little bit of sense.

The Federal Funds rate is simply the rate at which banks borrow money (funds) from other banks. In order to protect depositors (you and me) from banks lending all of our checking accounts and savings accounts out to other people (and hence us bouncing our checks), the Federal Reserve (the head-honcho bank) requires that banks keep a minimum amount of reserve funds at the Federal Reserve (currently 10%). So here is the deal:

If the bank wants to make a loan but doesn’t have enough reserves without going below their reserve requirement, they can borrow money from another bank with excess reserves at the Federal Reserve (the Fed from here on out). The rate that they will pay for the loan is called the Federal Funds Rate. Basically, the lower the Fed Funds Rate, the easier (cheaper) it is for banks to borrow money from each other to make loans, meet reserve requirements, etc… This has the effect of basically adding additional money to the economy (increases the money supply).

The other rate that was lowered was the discount rate or ‘discount window’. This is the rate at which banks can borrow not from other banks but directly from the Federal Reserve. It is usually about a percentage point higher than the Fed Funds Rate (naturally, the Fed doesn’t want to lend its money to banks, so it is cheaper for banks to borrow from each other).

You will hear these rates referred to as monetary targets for open market operations. Open market operations are simply the means by which the Fed controls the supply of money in the economy.

Note:

When these two key interest rates are low, it often signals ‘easy money’, and can lead to inflation. When inflation is high, the Fed usually raises these two key interest rates in an effort to ‘cool’ the overheating economy. When economic growth is low (like what we are seeing in the economy presently), the Fed will lower interest rates in an effort to make funds easier to obtain, hence stimulating a slow economy.

Here is the catch… what do you do if the economy is slow and inflation is high?

Think about it…


The Ultimate Status Symbol

January 18, 2008

While visiting my aunt and uncle about a year ago, I was shocked to see my uncle, a very well off, successful man that works for one of the biggest corporations in the world walking around the yard in green sweatpants and a purple t-shirt. At first I could not figure out why a very financially successful, middle aged man with two kids would be walking around in the same outfit that the crazy homeless guy outside the university’s entry way wears. Then it came to me: this was a sign that he has ‘made it’.

As times have changed, so have the ways in which men display their financial ‘status’ to those around them. In the middle ages being overweight was a status symbol, as only those who had plenty of resources had the means to become overweight (now being overweight likely means you have to work two jobs to make ends meet leaving you with no time to exercise). In the 50’s and 60’s, having a big house or fast car was a status symbol. As I have matured, however (or failed to as my girlfriend will tell you), I have become fascinated with the most subtle of all status symbols: sweatpants.

You heard me correctly. Sweatpants are the big house or Ferrari of the new millennium. Don’t believe me? I can tell you this much: right now, as a lowly graduate student with nearly no money, there is no way in hell that I can get away with wearing sweatpants. If I wore them around the house, my girlfriend would call me a loser. If I wore them in public, the consequences could be far worse. If I were particularly well off, however, I could certainly get away with wearing sweatpants in my free time. If my girlfriend didn’t like it, I could do what many wealthy men before me have done: sit down in a la-Z-boy, tune her out, and watch football. Once you have ‘made it’, there is really no need to impress anyone anymore, and I really can’t think of any attire more comfortable than sweatpants.

Once I am in a more financially sound position, I will wear sweatpants (the kind with the elastic around the ankle, to be exact) whenever I have the opportunity. I will most likely compliment them with a t-shirt or sweatshirt that has one of those nature murals on the front. You know, the kind that has some sort of airbrush painting of a wolf or moose or something like that. Once I am able to wear one of these outfits with no real consequences, I will know that I have finally ‘made it’.