Understanding the Interest Rate Risk in Your Portfolio

interest rate riskInterest rates greatly affect many personal finance choices. From refinancing mortgages for more affordable payments to transferring credit card balances for faster payoffs; historically low interest rates are helping Americans improve their finances.

However, making investment decisions can be more difficult in a low interest rate economy.

It is important to understand the degree of interest rate risk in your portfolio and rebalance investments accordingly if needed.

While investment strategies run the gamut, most everyday investors own fixed income in the form of bonds, CDs or savings accounts.

Simply avoiding fixed income investments or taking excessive risks for yield can also be costly.

Below is a summary of interest rate riskand some tips to manage for it.

Interest Rate Risk:

When investors own bonds making lower interest payments than other fixed income of comparable credit, interest rate risk has been realized.

If you own a long maturity U.S. Treasury bond and higher yielding investments with good credit ratings become available, you have interest rate risk in your portfolio.

Bondholders may realize a loss if they decide to sell these low performing bonds for money to buy more attractive investments.

Low paying and illiquid certificates of deposits have little market risk, but have high opportunity costs if U.S. Treasuries or investment grade bonds with higher coupon rates become available.

CDs or other conservative investments may have a place in your portfolio, but the allocation should be based on an investor’s unique situation.

Current Economy:

Interest rates are at historic lows, making it unlikely that higher paying bonds will be issued in the near term.

Investment Managers such as Elliott Broidy have utilized various strategies to balance the risk and reward of low interest rates.

Bond investors who want higher yields may assume greater risk with lower rated debt or turn to fixed income choices in overseas markets.

If interest rates begin to rise, those holding bonds issued at low coupons may seek out higher paying alternatives.

Your Portfolio:

Do you know the potential impact of interest rate changes on your investments?

Are these risks acceptable to you?

Managing interest rate risk is not about market timing. Rather, it involves accepting potential risks based on your investment goals.

Chasing performance returns is ineffective, but periodic rebalancing of asset classes and investments is beneficial.

Fixed income investing involves several considerations that include your tax bracket, risk tolerance and time horizon, among others. Investors should first understand these factors to make more prudent decisions.

The Toyota Way: A Guide to Globalization

Welcome to the wonderful world of lean manufacturing and cost cutting initiatives, unfortunately this is here to stay as companies look to increase efficiency.  During my MBA program I took the course MGT 705-50 or Global Economic Climate for short.  One of the course objectives was to be able to evaluate a company that has been successful in going global.  Anyways here was the final assessment of the course we had to do a thorough analysis of a firm and its industry in terms of its actual and potential globalization, and the extent to which the firm’s competitors have global strategies.  Identify the major strategic groups and what the strategies of the firm should be.  We base this analysis on the concepts discussed in the course.

I chose to write a paper about Toyota, and come to find out after 35 pages later I learned a lot about the organization and its roots.  I am not going to take you through the analysis performed but if you would like to review the paper drop me an email and I can send it off to you.  The world is now our market place and we need to view it that way.  I have readers from all stretches of the globe reading what I publish.  To think that I only publish and only people from my small section of New York in the United States read it would be silly.  Companies need to look at the global landscape as well when they begin to offer products.

Toyota was one of the first companies to embrace the Kaizen model for continuous improvement.  This evolved into the Toyota way.  Kaizen was first implemented after the Second World War and has progressively spread throughout the world.  A similar type process was implemented at the organization that I work for, I work at a hospital and while not having direct care we are all caregivers.

The Five Elements of Kaizen are: Teamwork, personal discipline, morale improvement, quality, and suggestions to improve processes.  This method takes into consideration every person involved.  If a process is not working the process is reviewed with the necessary people and a suggestion for improvement is initiated.  All team members are looking for ways to improve operations.  The morale is improved because the lowest stakeholders feel they can impact process and operations.

The Toyota Production System model has been deployed all over the world and has been the subject of numerous case studies. The Kaizen approach has been one of the major contributors in helping the Toyota brand expand globally.

While I do not personally own a Toyota, I know a few that own them and also one who is a Toyota engineer.  What do you think of the Toyota brand?  Do you own one?  My global readers, what would you say the Toyota footprint is in your locale?

 Photo by: toyota uk

How Does My Korean Made TV Arrive in America?

led tv, old school tv, lcd tvChances are that nice television hanging in your entertainment room was not made in America.  During my MBA program I took some courses that focused on the globalization of the world economy.  There are many advantages to a global economy such as the free flow of capital and technology from one country to another helps with industrialization which in turn increases the global investment.

Pre shipment finance may have been used to bring that beautiful 52 inch LED Flat Panel to a store near me.  Sometimes the term may be referred to as packing credit.  A manufacturer of televisions may need working capital to meet the various expenses of the organization before the shipment of goods.  The working capital is provided by banks to the exporter prior to the shipment of goods.

Pre shipment financing may be used for any of the following:

-purchase of raw materials to produce or manufacture the goods.
-pay for packaging, labeling or marketing product
-storage facilities until goods are shipped.
-anything to do with the actual cost of shipment of the goods whether it be export documentation, freight charges, or customs.

Companies small and large use this type of financing from banks.  One of the caveats is that you and the companies that you do business with need to have good borrowing records with banks.  This is important as you are leveraging the contracts to provide your organization with working capital.

Has your organization ever done this type of arrangement or had any experience with any other type of financing to secure capital to ensure there is no disruption in your supply chain?

 Photo by: videocrab

WTF (Wait That’s Finance) Part II: The Down and Dirty on the Naked Put

call option, options picture, futures marketOk not really about the naked put, but now that I have your attention we are going to talk about put options in general.  Go ahead and check this post out on derivatives to get up to speed.  Wait make sure that you come back.   Are you up to speed now?  Today I decided to take an in-depth look at the put option and try to explain it in layman’s terms.  Sure I cannot cover every possible scenario in this post but I hope to explain it to you and give you a better understanding so next time you hear it you will be able to chime in with your 2 cents. 

The put option is a strategy that is seldom talked about among individual investors, but it is a strategy that is popular among savvy investors and options traders.  The put buyer pays a premium to the seller for the option to purchase the underlying security. (no pun intended, ok it was!)

What is a put option? 

A put option simply is an option that gives the buyer the right, but not an obligation, to sell the underlying security at a certain price and certain time.  If the buyer decides to exercise the seller of the put option has to purchase the underlying security at the strike price if the buyer exercises the option.  The put option is sold in 100 share increments.  American put options can be exercised any time prior to the expiration date.  The expiration date for American put options is the third Sunday of every month.  Confused? Great I will provide an example later. 

Why would you enter into a put option?

A buyer thinks the price of the security will decrease by the exercise date.  The buyer pays a premium.

A writer/seller thinks that the price of the underlying security will increase and collects the premium

Example of a Put Option:

Groupon is currently selling for $11.96

With all the bad press recently that Groupon has received, we expect the price of the shares to decline.  We buy a put option with a strike price of $11.00.  We would start to make a profit once the price of the shares falls below $11.00.  We are trying to catch the profit off the downward movement of the underlying security. 

Trading this type of financial instrument we are using leverage, while this situation we anticipate a positive outcome, there can be severe consequences using any type of leverage.  It is best to seek out a financial advisor before using options on your own. 

Class are you ready to explore put options on your own?  Have you had any practice trading options on your own? Were you successful at it?

PHOTO BY: yojspew

Congratulations: You won $1,000,000 you can claim today or in 5 years, which do you choose?

time value of money, publishers clearing house, one million dollar, big check, future value of money, present value of money

Sure we would all choose take it today, but there is a finance theory behind why you may want to take it today.  Ever heard of the expression a dollar today is worth more than a dollar tomorrow but less than a dollar yesterday.  Well if not, now you have today we look at the time value of money.  What the time value of money calculation and the principle means is that a dollar today is not equivalent in value to a dollar tomorrow or a dollar yesterday.   It is a very simple principle to understand, but can have big ramifications in your retirement planning.

Now what do I mean it can have big implications in your retirement planning.  For starters you want to make sure you are putting away as much as you possibly can live without.  Start as early as you can, if you can start in high school and stick with it PERFECT!!  If you start investing younger you can invest smaller amounts to see the magnified returns later in life, remember compounding?  But if you wait till you are later in life you can sock away 4 times as much and still not catch up to the returns that the young person saw.  Start early and you can put time value of money to work right away, as you are able to increase the future value of your dinero (the extent of my Spanish after 5 yrs of classes) either through some type of investment vehicle or some type of interest bearing account.  Don’t get scared by what I am going to show you next!

present value of money, future value of money,

 

 
PV  or present value= the value at time 0 or now
FV or future value= the value at time n (see below)
i = the discount rate, or the interest rate at which the amount will be compounded each period
n = the number of periods could be years or could be months.   

Let’s do a quick calculation to see what the value of the cool million dollars that we won is in 5 years assuming 6% interest rate and discounted annually. 

PV = ?    
FV= $1,000,000
i = 6%
n = 5 yrs
PV = 1,000,000 x (1+0.06)-5
PV = 747,258.17               

The cool million that we would receive in 5 years would be worth $747,258.17 in today’s dollars!  I hope you would still take the million today and run.

Financial concepts can be fun when you look at in perspectives like this or with your retirement.  Save early, save often, save what you can!

Tomorrow I will be hosting a blog swap with a fellow pf blogger.  Make sure to come check out the best investment advice my fellow blogger has ever received.

PHOTO BY: Mike Bash