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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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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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What’s the intrinsic value of a loan

Wednesday, March 10th, 2010

The time to maturity is determined in the option contract. Generally, the longer the time to maturity, the more valuable is the option. The reason for this relation is straightforward for the American-style option: the holder of the option can always exercise the option prior to maturity. In addition, there is the possibility to wait and exercise the option at a later point in time. The longer the time to maturity, the greater is the value of the possibility to wait.

For European-style options, the relation of time to maturity and option price needs further explanation. A start is made by showing that an early exercise does not make much sense. Assume that an investor holds a call option with a strike at US$ 100 and a two-year maturity on a nondividend paying stock. The price of the underlying stock is currently at US$ 90. Obviously, an early exercise makes little sense, since the out-of-the money option would be worth zero immediately. Suppose the stock rises to US$ 110 over the next year. If the investor were to exercise the option now, he or she would need to put down US$ 100 (the strike price) and get the stock worth US$ 110. The difference between the actual stock price and the strike price of US$ 10 would have been gained, called the intrinsic value.

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Succeeding with credit decisions

Thursday, October 15th, 2009

Mergers and acquisitions are increasingly important for many firms; this applies especially to medium and large undertakings and those operating in more than one market. In particular, liberalisation of trade and globalisation of business and financial markets have boosted activity in them. In 2001, merger activity reached a peak and then dropped dramatically as firms reacted to economic uncertainties and wild stockmarket fluctuations. Such cautious conservatism won’t last: an is such a potentially powerful route to growth and competitive advantage that as soon as economic confidence returns, so will mania. Even before then, plucky entrepreneurs and bold shareholders may see opportunities to pick up a bargain, such as a sound business that may have encountered short-term difficulties. However, problems are common following business mergers, with 48% of merged companies underperforming in their industry after three years, according to a 1997 report by Mercer Management Consulting. An enquiry conducted and published in the Harvard Business Review (November 1997) highlighted this point:

Fewer than 50% of mergers ever reach anywhere near the economic or strategic destination that was envisioned for
them. In fact, in many cases the mergers fail because the new company’s managers underestimated, ignored, or mishandled the integration tasks.

Anecdotal evidence from business analysts and commentators suggests that although this information is now some years old, it still holds true. Mergers are no more a guarantee of growth and prosperity today than they ever were.

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