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Make a reality check before a loan check

Sunday, May 23rd, 2010

164Our reality check should either reinforce the efficacy of our process or help us understand just where our process has broken down. We can learn to improve our planning in the first step. We can recommit to executing our plan better in the second step. Perhaps we should evaluate more frequently in the third step.What can we improve on? How can we do better? We study the results of our process, draw conclusions, and decide how we will act right now.What’s the best decision we can make at this moment?

Sometimes the action we should take is simply to abandon the activity. Suppose we discover that we do not play well together. This is the perfect time—before we have too much invested in the partnership—to acknowledge the fact, pick up our toys, and move on. Companies frequently find that their cultures or technologies are not as compatible as they thought they were. Rather than ontinuing down a path to nowhere, it’s best sometimes to acknowledge the fact and look for a new partner. This is a healthy sign of maturity and growth. Like couples dating, you learn something about your partner and, just as important, you learn something about yourself. You have just increased your Partnering Intelligence.

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Devising a credit plan that will work out

Thursday, April 22nd, 2010

The first step is to decide what actions we should take to accomplish a task. Breaking down a manufacturing or sales process or a performance procedure into its parts is not hard to do.We also need to plan our relationship. We need to single out the components of the relationship that we agree are important: the nature of the relationship and how we’ll resolve conflicts, make decisions, and communicate. Like the logical steps in accomplishing a task, these preparations can lead to an open, constructive relationship. Whether we’re working on a task or the relationship, we cannot proceed
without a plan.

We carry out our plan.We do the activity.We solve problems, make decisions, and communicate just as we had planned.

Did we follow our plan? Did we end up where we thought we would? Did the relationship work out as planned? The phrase “reality check” is popular in business discussions today—we can get so wrapped up in activity, in the busyness of working hard, that we forget to stand back and see how we’re doing. In this step, we should primarily observe how well we’ve implemented our plan. What new information do we need to consider in the partnership?

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The change in the underlying credit asset

Thursday, March 11th, 2010

130Since options depend on a number of input factors, they must change in value when an input factor changes in value. The strike price as well as the maturity date are deterministic; i.e. once they are set, they do not change any more. The other input factors, price of the underlying asset, volatility, interest rate and net yield, can change over time. For  example, the impact of a change in volatility on the option price, all else being equal, is the sensitivity of the option price to volatility.

Most important and obvious, the option price is sensitive to a movement in the underlying asset. The change in the option value divided by the change in the underlying asset is called the delta. The delta of a call option is between zero and one while the delta of a put option is between minus one and zero. The delta is an important parameter with regard to the replicating portfolio.

Since it measures the price change of an option due to a price change in the underlying asset, the delta actually is the exact number of underlying assets that must be held in the replicating portfolio. Somebody who intends to hedge an option should therefore hold a delta amount of underlying assets. This procedure is called delta hedging.

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Option value and volatility value of a credit

Wednesday, March 10th, 2010

Alternatively, the investor could wait another year (i.e. to maturity of the option), and observe where the stock price has gone. If the stock price has gone down to, say, US$ 80, he or she would be happy to have waited since a loss would have been avoided. If, on the other hand, the stock rose further to, say, US$ 130, the investor could still exercise the option and put down the strike price of US$ 100. If he or she had exercised earlier, a stock worth US$ 130 would be held. However, the later the strike price needs to paid, the more interest can be earned on that money. Therefore, also in this scenario, it was wiser to wait as long as possible, i.e. until maturity. It follows that a longer maturity is more valuable, i.e. results in a higher option price, even if the option cannot be exercised before maturity.

As just seen, the remaining time to maturity is valuable. Consequently, the option price must be worth more than the intrinsic value (i.e. the US$ 10 that are collected in the above example if exercised immediately). That additional value is related to time to maturity and volatility. Higher volatility makes it more valuable to wait and see, i.e. to have the chance of avoiding a large loss by not exercising early. This difference between the option value and its intrinsic value is thus often called the time or volatility value.

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