I was discussing pay cuts and lay-offs with some family members and friends recently. One stated that her dad's company fired the senior employees and kept the newer employees because they could pay them less for their work. The company seems to have the right idea that in crucial times, they need to cut their costs. However, when they fire their senior, most experienced and probably some of their best workers, they could be harming their sales. People could get a bad impression of their company. Loyal customers that have been seeing the senior employee for years, will be more likely to remain loyal to the employee rather than the company. Also, work quality could slip when there are fewer experienced employees and more new employees. I do not understand why a company would ruin relations with a senior employee who has been working with them for a long time.
I think there are better ways to handle the crisis than firing employees. Sure, the companies can hire newer employees, such as ones just hired for a new project that will not be completed due to lack of funds. For example, a project could be to design a new product, but is best for a time of economic growth. The project could be delayed and the budget for that project cut.
In order to prevent drastic paycuts and lay-offs, especially of senior, experienced workers, the company could cut everyone's pay a little to absorb the budget cuts and losses. Giving everyone a paycut instead of firing some and keeping others, could allow everyone to keep their jobs. I know people do not like to see their money cut in a time of crisis, but a little salary is better than nothing. I would hope that this could be explained to the employees through meetings, emails, or formal letters.
After discussing pay cuts and lay-offs with my dad, he pointed out that the cuts cause hightened stress in the workplace. He said that his managers are receiving cuts and are getting fired, so they are constantly worried about who is next. Their stress is directly reflected in their harsh attitudes and impatience with their employees. These managers could be harming relations with customers as well as loyal employees and could cause even more trouble for the company. If the executives would simply discuss options with the workers, and allow everyone in the company to share the financial burden, attitudes and stress levels could be improved and lowered.
I cannot help but wonder if cutting everyone's pay is possible. It seems to me, if it was possible, companies would be adopting this strategy in order to keep its employees and improve their financial situation. But, maybe the companies cannot make universal pay cuts because of unions or contracts. I found that some salaries cannot be changed without contracts. I think that this strategy should be allowed and implemented, so the unemployment rate will improve. With AIG, the executives received paycuts and were only receiving salaries of $1, but were promised future bonuses to make up for this through contracts. Salaries of $1 are a little extreme, but using AIG as an example, other companies could make smaller pay cuts and promise future bonuses to be paid when times improve.
Sources and Further Discussion:
-Salary Cuts Across the Board or Just Execs
-"Rather than put more people on the street, Hewlett-Packard CEO Mark Hurd is cutting salaries by 5 percent or more across the board." Innovation Pay Cuts
-Job Cuts vs. Pay Cuts
Friday, April 17, 2009
Universal Currency
When I decided to respond to the blog about Universal Currency, I was responding to Gustav's bllog about currency. However, I went back and read Unique's blog and decided to pull some of her points, which I agreed with as opposed to Gustav's points. I do not agree with most of the points of Gustav's blog on Universal Currency. He states that a universal currency is not a good idea and would have a negative impact. He states in his blog that we are a barbaric society that should revert back to our ancestry's way of dealing with currency, and even if we wanted to change, we don't have someone powerful enough.
Yes, the world can be barbaric at times. For example, we have seen a lot of war, piracy, cruelty, invisible children fighting in Uganda, people ignoring other's rights, etc. But if we let that stop us from thinking we can make advancements, we wouldn't have gotten anywhere. For example, we wouldn't have made it past the crusades, the dark ages, or either of the World Wars, just to name a few. Sometimes after the crisis and during the clean-up is when most technological advances are made. For example, the industrial revolution occurred after the Civil War and Reconstruction. Sometimes, the barbaric actions can be a way out of crisis and lead to improvement: World War II got the United States out of the Great Depression because more jobs were available making weapons and preparing for war. -Wars and improvement in the US Also, the NY Times article Gustav sites is from 1858, which is outdated to even know about the improvements to come. The article does not know how much the world has changed.
On the topic of change, this year we elected a new president, President Barack Obama. His platform is bringing about change. He is the first African-American President, which came about even before the first woman president. He is knowledgeable of other cultures, so he relates to the rest of the world well. People think that he could improve relations with other countries, since they can see first-hand how the United States is becoming more diversified and open to change. Many leaders of other countries are willing to cooperate with Obama for these reasons; therefore, to me he could be the leader to implement this universal currency. -Obama and Change
A universal currency would be great to cut transaction costs and eliminate exchange rate risks when companies go international. -Favorable Factors of Universal Currency As we have discussed in many of our cases, such as Aspen Technology, when these companies try to expand their sales to other countries, they expose themselves to currency risk. They become long in some currencies and short in others. If they sell some software to China and don't collect all the money upfront, when the customer is paying incremental payments in Yen, over time, the exchange rate may change. The exchange rate change could mean a loss of money for the company. With all the risks that companies have to worry about hedging, it would be nice if their was one risk that could be eliminated for them and for all of international business. -Exchange Rate Risk
For these above reasons, a universal currency is possible and could be beneficial. However, I do have to agree with the point in Unique's blog that this creates universal interest rates and a universal bank, which could cause problems. As Unique states, no two countries are ever in the same economic state, which could hurt one or the other. Also, a universal bank gives a lot of power to a few people, which is scary. Using Europe as an example for adopting the Euro, I think that we need to weigh the benefits and costs of a universal currency. It seems to be working well for Europe. -Euro Success We will see what happens.
Yes, the world can be barbaric at times. For example, we have seen a lot of war, piracy, cruelty, invisible children fighting in Uganda, people ignoring other's rights, etc. But if we let that stop us from thinking we can make advancements, we wouldn't have gotten anywhere. For example, we wouldn't have made it past the crusades, the dark ages, or either of the World Wars, just to name a few. Sometimes after the crisis and during the clean-up is when most technological advances are made. For example, the industrial revolution occurred after the Civil War and Reconstruction. Sometimes, the barbaric actions can be a way out of crisis and lead to improvement: World War II got the United States out of the Great Depression because more jobs were available making weapons and preparing for war. -Wars and improvement in the US Also, the NY Times article Gustav sites is from 1858, which is outdated to even know about the improvements to come. The article does not know how much the world has changed.
On the topic of change, this year we elected a new president, President Barack Obama. His platform is bringing about change. He is the first African-American President, which came about even before the first woman president. He is knowledgeable of other cultures, so he relates to the rest of the world well. People think that he could improve relations with other countries, since they can see first-hand how the United States is becoming more diversified and open to change. Many leaders of other countries are willing to cooperate with Obama for these reasons; therefore, to me he could be the leader to implement this universal currency. -Obama and Change
A universal currency would be great to cut transaction costs and eliminate exchange rate risks when companies go international. -Favorable Factors of Universal Currency As we have discussed in many of our cases, such as Aspen Technology, when these companies try to expand their sales to other countries, they expose themselves to currency risk. They become long in some currencies and short in others. If they sell some software to China and don't collect all the money upfront, when the customer is paying incremental payments in Yen, over time, the exchange rate may change. The exchange rate change could mean a loss of money for the company. With all the risks that companies have to worry about hedging, it would be nice if their was one risk that could be eliminated for them and for all of international business. -Exchange Rate Risk
For these above reasons, a universal currency is possible and could be beneficial. However, I do have to agree with the point in Unique's blog that this creates universal interest rates and a universal bank, which could cause problems. As Unique states, no two countries are ever in the same economic state, which could hurt one or the other. Also, a universal bank gives a lot of power to a few people, which is scary. Using Europe as an example for adopting the Euro, I think that we need to weigh the benefits and costs of a universal currency. It seems to be working well for Europe. -Euro Success We will see what happens.
Monday, April 13, 2009
Having a Successful Business in the Crisis
According to Brian's post, there are three actions the firm should take in the economic crisis, and those are promoting employees, recruiting new employees, and preparing for an economic boom. I, however, disagree with these three statements. They may be ideal, but I don't think they are possible.
When the company is in financial crisis, it is difficult promote their employees well. They could possibly give them additional projects requesting their help and input on how to save money in the company. They could sign contracts promising them bonuses, such as those promised to the AIG executives. With those bonuses, however, the employees had to receive pay cuts. Their salaries were reduced to about $1 per year because the bonuses were supposed to make up for it. Then the company could end up in trouble like AIG and having to pay back the bonuses from government bailout and bankruptcy charges. Now the employees have been driven out of their jobs completely. Reports say the families and executives have been harassed by the public and have decided to resign. Promoting their employees certainly backfired. -AIG backlash
The second point of the blog states that it would be beneficial to hire new employees. When a company has been laying off workers and making pay cuts, how are they supposed to have enough money to pay new salaries and benefits to new recruits? A financial crisis is a difficult time in which to find a job. -Who's Hiring These Days Most jobs are seeing pay cuts or job losses. The only jobs I see that could be available are those in advising risk management strategies, those helping to cut costs for companies, and those of the FDIC, who takes over when banks fail. And banks have been failing a lot lately.
The third point states that the company should prepare for an economic boom. I desagree. The company should be trying to manage their risks and minimize their costs to ensure their economic situation does not get worse. The executives need to be studying the financial crisis in order to prevent another one from happening. Also, abcnews.com reports the crisis is far from over. -Crisis I think that preparing for an economic boom is completely ignoring the financial distress. Also, if the company is successful in an economic crisis, I'm sure they will have no problem being successful in a boom. In addition, the companies have worked in economic booms before, so they can simply revert to the previous methods of work before the crisis, but remembering to keep the risk management that has been implemented. This way, they can be successful, but also prevent future crisis.
When the company is in financial crisis, it is difficult promote their employees well. They could possibly give them additional projects requesting their help and input on how to save money in the company. They could sign contracts promising them bonuses, such as those promised to the AIG executives. With those bonuses, however, the employees had to receive pay cuts. Their salaries were reduced to about $1 per year because the bonuses were supposed to make up for it. Then the company could end up in trouble like AIG and having to pay back the bonuses from government bailout and bankruptcy charges. Now the employees have been driven out of their jobs completely. Reports say the families and executives have been harassed by the public and have decided to resign. Promoting their employees certainly backfired. -AIG backlash
The second point of the blog states that it would be beneficial to hire new employees. When a company has been laying off workers and making pay cuts, how are they supposed to have enough money to pay new salaries and benefits to new recruits? A financial crisis is a difficult time in which to find a job. -Who's Hiring These Days Most jobs are seeing pay cuts or job losses. The only jobs I see that could be available are those in advising risk management strategies, those helping to cut costs for companies, and those of the FDIC, who takes over when banks fail. And banks have been failing a lot lately.
The third point states that the company should prepare for an economic boom. I desagree. The company should be trying to manage their risks and minimize their costs to ensure their economic situation does not get worse. The executives need to be studying the financial crisis in order to prevent another one from happening. Also, abcnews.com reports the crisis is far from over. -Crisis I think that preparing for an economic boom is completely ignoring the financial distress. Also, if the company is successful in an economic crisis, I'm sure they will have no problem being successful in a boom. In addition, the companies have worked in economic booms before, so they can simply revert to the previous methods of work before the crisis, but remembering to keep the risk management that has been implemented. This way, they can be successful, but also prevent future crisis.
Bailout Tab
I found an article discussing exactly how much money has been given away in the bailout. The figures are impossible to calculate because money just keeps getting given away. More recently, due to the AIG bonuses "issue", the government will hopefully take more care in investigating the bailout payouts, even though there were no rules against paying bonuses. But, where does all this money to bailout companies come from? The government apparently has a multiple trillion dollar budget, but where do they get this money. According to the article on the Bailout tab, the approximate amount of money spent so far is around $7.2 trillion. That is way more than the couple trillion budget. The country is in debt, makes taxes, but also has a lot of projects to cover. It seems unrealistic that there is money for them to spend. The money being created could potentially make the crisis worse. The government is creating money and adding more and more to the country's deficit.
Also, the government is depending on the loans being repaid, which is a stretch. The crisis was caused by people not being able to pay back loans. For example, the mortgage crisis is because people can't pay their mortgages. Every problem stems from a lack of money to pay people. The individuals who are taking out loans to pay are taking out many loans, which are even harder to repay. If the government actually receives repayments, it will be in a very long time. But the interest payments on all the loans people are taking out are going to overtake their income change which results from the loan help, and so the help and loan requirements will either end up cancelling out and not helping the person at all or the person will be stuck paying the loans back forever.
http://www.msnbc.msn.com/id/30115091/
Also, the government is depending on the loans being repaid, which is a stretch. The crisis was caused by people not being able to pay back loans. For example, the mortgage crisis is because people can't pay their mortgages. Every problem stems from a lack of money to pay people. The individuals who are taking out loans to pay are taking out many loans, which are even harder to repay. If the government actually receives repayments, it will be in a very long time. But the interest payments on all the loans people are taking out are going to overtake their income change which results from the loan help, and so the help and loan requirements will either end up cancelling out and not helping the person at all or the person will be stuck paying the loans back forever.
http://www.msnbc.msn.com/id/30115091/
Sunday, April 5, 2009
Are people making the crisis a bigger deal than it is?
It is a strange thought to have, but is this economic crisis as bad as we think? A FOX News report states that we are in the midst of the deepest recession since World War II and are in the aftermath of a meltdown that has left Wall Street gun-shy. But I was having a discussion with a salon worker on Friday and she disagreed with this assessment. She said that she has not seen a drop in her income from clients. She said people have continued to come in for treatments now that the weather is turning toward summer just as they usually would. She even said she waited in a long line at Starbucks as usual, when people could be saving money if they really needed to instead of buying $5 coffees.
Some people are still buying their luxury items, which is good actually to keep those industries in business. We don't want all business to fail and make the economic situation worse than it already is. Yes, car purchases and cell phone purchases are slowing, as I have stated in previous blogs. But, the items the salon worker was talking about were comforting to those people. A pedicure or manicure can make a woman feel better, for example in Legally Blonde. I know its a silly reference, but maybe in a time where the stress level is high, comforts such as manicures and getting your hair done make you feel better about yourself.
It is hard to argue that we are not in an economic crisis when you read facts such as a loss of 663,000 payroll jobs in March. March is the 15th consecutive month-to-month decline in payroll jobs, the fifth straight month in which payrolls have dropped by 600,000-plus jobs. Also, the unemployment rate increased to 8.5% -Job Report Sources estimate that things will only get worse, since cutting hours and wages are just the beginning to companies trying to improve their financial situation before cutting workers altogether, which we have also seen happening. The cutting of wages reduces income, which then reduces consumption, which also hurts the economy.
Its good that people aren't cutting out too much of their spending, so consumption doesn't fall too much further to hurt the economy more. But its also important that people are smart with their money and use it to pay their mortgages and bills. Because the ones hurting the most in the crisis are the banks trying to help people with loans because of their poor spending decisions. If these continue, the banks will be worse off as well. Many people have money tied up in banks, which could also cause more panic.
Some people are still buying their luxury items, which is good actually to keep those industries in business. We don't want all business to fail and make the economic situation worse than it already is. Yes, car purchases and cell phone purchases are slowing, as I have stated in previous blogs. But, the items the salon worker was talking about were comforting to those people. A pedicure or manicure can make a woman feel better, for example in Legally Blonde. I know its a silly reference, but maybe in a time where the stress level is high, comforts such as manicures and getting your hair done make you feel better about yourself.
It is hard to argue that we are not in an economic crisis when you read facts such as a loss of 663,000 payroll jobs in March. March is the 15th consecutive month-to-month decline in payroll jobs, the fifth straight month in which payrolls have dropped by 600,000-plus jobs. Also, the unemployment rate increased to 8.5% -Job Report Sources estimate that things will only get worse, since cutting hours and wages are just the beginning to companies trying to improve their financial situation before cutting workers altogether, which we have also seen happening. The cutting of wages reduces income, which then reduces consumption, which also hurts the economy.
Its good that people aren't cutting out too much of their spending, so consumption doesn't fall too much further to hurt the economy more. But its also important that people are smart with their money and use it to pay their mortgages and bills. Because the ones hurting the most in the crisis are the banks trying to help people with loans because of their poor spending decisions. If these continue, the banks will be worse off as well. Many people have money tied up in banks, which could also cause more panic.
Blockbuster/Virgin Megastore
This blog: http://kpatel53.blogspot.com/2009/03/blockbustervirgin-megastore.html discusses the business prospects of Blockbuster and the Virgin Megastore. The blog states that both of these companies are failing due to the fact that they did not adapt quickly enough to technological advances. These companies have outdated business models. The internet has added a new dimension into buying or renting media products. People are finding it convenient to buy products online with a cheaper price.
When I first read the blog, I did agree that purchasing music and downloading movies online had become so much easier with technology. I did not see how Blockbuster or Virgin could avoid bankruptcy for much longer, especially now with people spending less money on luxuries or outside entertainment due to the current financial crisis. However, I do not agree that Blockbuster has an outdated business model.
They have tried to keep up-to-date with the current technology. First, when NetFlix launched its online rentals up to 8 for as long as you want, Blockbuster had to retaliate. They adopted a "no late fees" strategy at its retail stores and offered a very similar online rental service starting in August 2004. -Reviews
I also found a chart comparing Blockbuster vs. Netflix side-by-side at this site. One advantage I found was that you can mail the movies back in or you can return the movie to your closest local store, if you happen to be in that direction. An online blockbuster member can also rent movies from the local stores for free. However, if you do this, once again you are subject to late fees.
Another perk I found that Blockbuster has tried to implement to combat Netflix and other online movie rentals, is that you get coupons each month for being a member. BlockBuster offers you two free in-store movie or game rentals every month. You're provided two printable coupons every month. You also receive other coupons, such as one for buying two previously viewed DVDs for just $15. -Perks
BlockBuster has a lot of competition and could one day go bankrupt if people become completely dependent on technology. But, I don't see that happening, at least not anytime in the near future. Families like to go to the movie store and send their kids in to pick a movie to watch. Sometimes you aren't planning on needing movies right then, or you get a sudden urge to watch a certain movie. If they don't have it available on OnDemand or Starz, what do you do? You drive to the movie rental store and find it, instead of ordering it online and waiting 5-7 business days. Overall, BlockBuster has tried to update to the current market situation and remain competitive in the business.
Virgin has a larger risk, in my opinion. Music is easily accessible online. Also, the fact that stereos and CD players have decreased in demand does not help either. Buying movies on Virginmega.com does not make sense either because they are just as expensive as they are in stores, and then you have to pay shipping and handling as well. -VirginMega I would buy the movie on Amazon.com because then at least you would get a deal. All of my opinions were proven correct when I found that the company will close its remaining stores in Denver, Orlando (Fla.), and Los Angeles over the next few months, and the assets of Virgin Entertainment Group North America (VEGNA) will be liquidated this summer. -Mega No More
I understand after reading statements from Virgin's chairman why they went under. They did not understand the current market situation. All of his opinions stated that kids weren't buying music because they were spending their money on cell phones, clothes, and electronics. He didn't say anything about online music access, such as iTunes. About 1500 music retailers have shut down because of iTunes and Napster, not including mass merchants or chain electronic stores. -Real Reason
Even in trying to liquidate and sell all remaining merchandise in a close-out sale, the company has not learned how to competitively price their merchandise to sell against online companies. One article states, "In terms of bargains, well … I didn't see many, at least not yet. Getting 30 percent off a $14.99 CD that's available for $9.99 on iTunes isn't much of a deal, and same goes for the overpriced $29.95 Blu-ray movies." -Closing Down
It is sad that people don't collect CDs or use CD players or stereos as much these days. But, iPods and MP3 players are taking over. There are even adapters to hook your iPod to your car stereo so you only need your iPod and may possibly use the radio. You can easily purchase music to be put straight onto your iPod with no need for CDs. And it is much cheaper to do so. While it may be sad to see Virgin Megastores go out of business, they just weren't keeping up with the times and did not adapt to the current competitive market situation.
When I first read the blog, I did agree that purchasing music and downloading movies online had become so much easier with technology. I did not see how Blockbuster or Virgin could avoid bankruptcy for much longer, especially now with people spending less money on luxuries or outside entertainment due to the current financial crisis. However, I do not agree that Blockbuster has an outdated business model.
They have tried to keep up-to-date with the current technology. First, when NetFlix launched its online rentals up to 8 for as long as you want, Blockbuster had to retaliate. They adopted a "no late fees" strategy at its retail stores and offered a very similar online rental service starting in August 2004. -Reviews
I also found a chart comparing Blockbuster vs. Netflix side-by-side at this site. One advantage I found was that you can mail the movies back in or you can return the movie to your closest local store, if you happen to be in that direction. An online blockbuster member can also rent movies from the local stores for free. However, if you do this, once again you are subject to late fees.
Another perk I found that Blockbuster has tried to implement to combat Netflix and other online movie rentals, is that you get coupons each month for being a member. BlockBuster offers you two free in-store movie or game rentals every month. You're provided two printable coupons every month. You also receive other coupons, such as one for buying two previously viewed DVDs for just $15. -Perks
BlockBuster has a lot of competition and could one day go bankrupt if people become completely dependent on technology. But, I don't see that happening, at least not anytime in the near future. Families like to go to the movie store and send their kids in to pick a movie to watch. Sometimes you aren't planning on needing movies right then, or you get a sudden urge to watch a certain movie. If they don't have it available on OnDemand or Starz, what do you do? You drive to the movie rental store and find it, instead of ordering it online and waiting 5-7 business days. Overall, BlockBuster has tried to update to the current market situation and remain competitive in the business.
Virgin has a larger risk, in my opinion. Music is easily accessible online. Also, the fact that stereos and CD players have decreased in demand does not help either. Buying movies on Virginmega.com does not make sense either because they are just as expensive as they are in stores, and then you have to pay shipping and handling as well. -VirginMega I would buy the movie on Amazon.com because then at least you would get a deal. All of my opinions were proven correct when I found that the company will close its remaining stores in Denver, Orlando (Fla.), and Los Angeles over the next few months, and the assets of Virgin Entertainment Group North America (VEGNA) will be liquidated this summer. -Mega No More
I understand after reading statements from Virgin's chairman why they went under. They did not understand the current market situation. All of his opinions stated that kids weren't buying music because they were spending their money on cell phones, clothes, and electronics. He didn't say anything about online music access, such as iTunes. About 1500 music retailers have shut down because of iTunes and Napster, not including mass merchants or chain electronic stores. -Real Reason
Even in trying to liquidate and sell all remaining merchandise in a close-out sale, the company has not learned how to competitively price their merchandise to sell against online companies. One article states, "In terms of bargains, well … I didn't see many, at least not yet. Getting 30 percent off a $14.99 CD that's available for $9.99 on iTunes isn't much of a deal, and same goes for the overpriced $29.95 Blu-ray movies." -Closing Down
It is sad that people don't collect CDs or use CD players or stereos as much these days. But, iPods and MP3 players are taking over. There are even adapters to hook your iPod to your car stereo so you only need your iPod and may possibly use the radio. You can easily purchase music to be put straight onto your iPod with no need for CDs. And it is much cheaper to do so. While it may be sad to see Virgin Megastores go out of business, they just weren't keeping up with the times and did not adapt to the current competitive market situation.
Saturday, March 28, 2009
US Education System
I found the blog critiques of the US education system to be very interesting and thought provoking. http://jlewis45rmiblog.blogspot.com/2009/03/critique-public-education-system.html While I agree that our education system is lacking in some areas, I feel privileged to have received the education I have in my life. Our system lacks in creating bilingual students at a young age. It lacks in motivating students to do their very best along with staying in school as Jessica states. There are some areas that do not have as quality materials and teachers as other schools, but there will always be areas like that. There are bad areas in cities and states and unfortunately that is just the way it is. We can try to help as much as possible, but it is human nature that some are simply more motivated than others.
If education was like that of other nations or the same for everyone, I don't think you would have as many outstanding people. People need incentives to work harder. That is why when jobs are socialized and people get paid the same no matter how much they produce, everyone just produces what is required. I know when I was in high school our class ranking was provided at the bottom of our report card. I always wanted to compare mine with everyone else and see how I was doing. I always had to be the best. My motivation was the rankings and awards and knowing that I was doing my very best. While I agree that our education system could be improved in some areas, I have to also acknowledge the fact that the United States is the largest power in the world. We did not just get to that position by being slackers. We are obviously doing something right that we have outstanding leadership and technological advances that put us in that position. America has always been the "land of opportunity" and "the American Dream." In some countries, people do not even have the opportunity to receive an education at all. Some have to work at very young ages. The United States works through ministry programs and other philanthropic organizations to help provide educations to those nations. I think that would hardly be feasible if our own system was detrimental to our citizen's learning aptitudes.
This blog is difficult to respond to because I agree that we could use improvement, and it is impossible to ignore factual statistics that state the United States is below average in math and science studies, for example. http://en.wikipedia.org/wiki/Education_in_the_United_States However, the United States has an extremely high literacy rate, comparatively: Literacy Rate It is difficult to crack down more on the education program. There are already so many standardized tests to ensure our students are reaching optimum levels. We go to school for long hours and then require homework. The United States also has a large education budget. Even individual states give scholarship incentives to students with good grades. For instance, with the Georgia Hope Scholarship, students with above a 3.0 GPA can go to school for free. I don't know how it would be possible to improve. Other schools get breaks in places such as Finland: "These breaks provide a clear contrast between Finnish schools and their recess-starved counterparts in the United States" Compare President Obama is focused on improving the education system: Obama for education.“It is time to give all Americans a complete and competitive education from the cradle up through a career,” Mr. Obama said. “We have accepted failure for too long – enough. America’s entire education system must once more be the envy of the world.” President Obama challenged teachers unions, and renewed his support for a merit-based system of payment. He also said adult Americans needed to take responsibility for improving their own education, in addition to improve the education of their children.
I have seen teachers who have not helped students in ways they should or have not taught classes as well as they should. I have seen students drop out of school and then do nothing with their lives. I have seen students fail classes and students with apathetic attitudes. Parents of students even have apathetic attitudes and don't help their children in school or even know what their children are doing in school. It is important that parents help their children decide what they want to be when they grow up and help their children pick colleges and find scholarships. I agree with the blog that an attitude adjustment is necessary. If we do not address this problem, the poor economic state our nation is in could continue. Or in the future, we could become a nation which lacks in human capital.
These reasons are why it is hard to ignore the fact that improvement is necessary in some areas. However, is this improvement feasible? I agree with all the aspects of improving motivation in students so we have more shining stars, but unfortunately there will always be those who do better than others. That is why we have CEOs of companies who make millions and lower down employees who make less. It is the way the world works, survival of the fittest.
If education was like that of other nations or the same for everyone, I don't think you would have as many outstanding people. People need incentives to work harder. That is why when jobs are socialized and people get paid the same no matter how much they produce, everyone just produces what is required. I know when I was in high school our class ranking was provided at the bottom of our report card. I always wanted to compare mine with everyone else and see how I was doing. I always had to be the best. My motivation was the rankings and awards and knowing that I was doing my very best. While I agree that our education system could be improved in some areas, I have to also acknowledge the fact that the United States is the largest power in the world. We did not just get to that position by being slackers. We are obviously doing something right that we have outstanding leadership and technological advances that put us in that position. America has always been the "land of opportunity" and "the American Dream." In some countries, people do not even have the opportunity to receive an education at all. Some have to work at very young ages. The United States works through ministry programs and other philanthropic organizations to help provide educations to those nations. I think that would hardly be feasible if our own system was detrimental to our citizen's learning aptitudes.
This blog is difficult to respond to because I agree that we could use improvement, and it is impossible to ignore factual statistics that state the United States is below average in math and science studies, for example. http://en.wikipedia.org/wiki/Education_in_the_United_States However, the United States has an extremely high literacy rate, comparatively: Literacy Rate It is difficult to crack down more on the education program. There are already so many standardized tests to ensure our students are reaching optimum levels. We go to school for long hours and then require homework. The United States also has a large education budget. Even individual states give scholarship incentives to students with good grades. For instance, with the Georgia Hope Scholarship, students with above a 3.0 GPA can go to school for free. I don't know how it would be possible to improve. Other schools get breaks in places such as Finland: "These breaks provide a clear contrast between Finnish schools and their recess-starved counterparts in the United States" Compare President Obama is focused on improving the education system: Obama for education.“It is time to give all Americans a complete and competitive education from the cradle up through a career,” Mr. Obama said. “We have accepted failure for too long – enough. America’s entire education system must once more be the envy of the world.” President Obama challenged teachers unions, and renewed his support for a merit-based system of payment. He also said adult Americans needed to take responsibility for improving their own education, in addition to improve the education of their children.
I have seen teachers who have not helped students in ways they should or have not taught classes as well as they should. I have seen students drop out of school and then do nothing with their lives. I have seen students fail classes and students with apathetic attitudes. Parents of students even have apathetic attitudes and don't help their children in school or even know what their children are doing in school. It is important that parents help their children decide what they want to be when they grow up and help their children pick colleges and find scholarships. I agree with the blog that an attitude adjustment is necessary. If we do not address this problem, the poor economic state our nation is in could continue. Or in the future, we could become a nation which lacks in human capital.
These reasons are why it is hard to ignore the fact that improvement is necessary in some areas. However, is this improvement feasible? I agree with all the aspects of improving motivation in students so we have more shining stars, but unfortunately there will always be those who do better than others. That is why we have CEOs of companies who make millions and lower down employees who make less. It is the way the world works, survival of the fittest.
Will we experience a respite in technological advancement?
With the economy in the downturn, many people are eliminating purchases of luxury items, such as cell phones. This lull in new purchases has caused problems for the auto industry as discussed in my previous blog about GM: will we see these same problems occur in the cell phone and technology industries?
http://www.businessinsider.com/2008/5/economy-burns-cellphone-sales-down-22-in-q1
In the past 20 years we have seen technology turn from a large cell phone the size of a landline phone to a small blackberry computer that fits in your hand and pocket. Amazing technological leaps have been made in such a short time. As soon as one piece of technology is released, the companies work on new advances and better products, so that by the time the item goes on sale at a reasonable price for the average consumer, there is a new better product to be had. Our world is so fast paced with hundreds of emails going to individuals each day, text messages being sent, social webpages being checked, instant messaging, and regular phone calls being made. Technology makes it easy to communicate, but are people getting overloaded with messages and technology? I think it adds a lot of stress to people's lives having so much to keep up with, and would anyone be able to function if something happened to these connections? I've been on trips with my friends, camping for instance, and they have gone crazy without service or the internet. People went without it for a long time. I'm only 21 and remember dial-up, which would kick you off the internet if your house received a phone call. Now, if our computer takes more than 3 seconds to get to a webpage we freak out and lose patience. Plus, people barely have landlines anymore because everyone has a cell phone.
With this poor current economic situation, people are keeping their old phones, granted still advanced, but people have less money to spend on new high end advancements in cell phones. "The U.S and European markets are just about full-up on cell phones, which have become as ubiquitous in households as toasters or televisions. But with the struggling economy, cell phone consumers are hunkering down, often switching to flat-rate, lower cost models that allow them to keep a lid on monthly phone bills. It’s a prickly issue for Apple and Research in Motion, makers of the iPhone and the Blackberry, in particular" http://www.daniweb.com/blogs/entry3311.html The cell phone companies may not develop new cell phones as often during this time and may focus more on making money through new plans with lower end models and focus less on upgrades. I think this would be a nice break for our society. We always talk about not having enough time and going going going every day that this could be just the rest we need.
http://www.businessinsider.com/2008/5/economy-burns-cellphone-sales-down-22-in-q1
In the past 20 years we have seen technology turn from a large cell phone the size of a landline phone to a small blackberry computer that fits in your hand and pocket. Amazing technological leaps have been made in such a short time. As soon as one piece of technology is released, the companies work on new advances and better products, so that by the time the item goes on sale at a reasonable price for the average consumer, there is a new better product to be had. Our world is so fast paced with hundreds of emails going to individuals each day, text messages being sent, social webpages being checked, instant messaging, and regular phone calls being made. Technology makes it easy to communicate, but are people getting overloaded with messages and technology? I think it adds a lot of stress to people's lives having so much to keep up with, and would anyone be able to function if something happened to these connections? I've been on trips with my friends, camping for instance, and they have gone crazy without service or the internet. People went without it for a long time. I'm only 21 and remember dial-up, which would kick you off the internet if your house received a phone call. Now, if our computer takes more than 3 seconds to get to a webpage we freak out and lose patience. Plus, people barely have landlines anymore because everyone has a cell phone.
With this poor current economic situation, people are keeping their old phones, granted still advanced, but people have less money to spend on new high end advancements in cell phones. "The U.S and European markets are just about full-up on cell phones, which have become as ubiquitous in households as toasters or televisions. But with the struggling economy, cell phone consumers are hunkering down, often switching to flat-rate, lower cost models that allow them to keep a lid on monthly phone bills. It’s a prickly issue for Apple and Research in Motion, makers of the iPhone and the Blackberry, in particular" http://www.daniweb.com/blogs/entry3311.html The cell phone companies may not develop new cell phones as often during this time and may focus more on making money through new plans with lower end models and focus less on upgrades. I think this would be a nice break for our society. We always talk about not having enough time and going going going every day that this could be just the rest we need.
Monday, March 23, 2009
Critique of AIG bonuses
I read this blog and decided to critique how the bonuses and case with AIG are being handled.
http://kpatel53.blogspot.com/
Obama anger at AIG bonus payouts
The blog states that it is AIG's responsibility to know in this current economic state that taxpayers money should be going in the right places and not into high paying executives. I believe the government should only intervene if they feel AIG is not being responsible with their bailout package. The government has intervened because AIG has used bailout money to pay bonuses. So according to the blog, this is right.
In my opinion, the government should have researched better where the bailout money for AIG was going to go. The government also knew about the bonuses beforehand, according to the Republican view. In my opinon, whether the Republicans are correct or not, the government should have figured out whether there were bonuses to be paid or other "frivilous" uses for the money were to be made. There is no restriction against paying bonuses with bailout money in the stimulous package: as ABC News' Capitol Hill Correspondent Jonathan Karl reported, in February, the Senate unanimously approved an amendment restricting bonuses over $100,000 at any company receiving federal bailout funds, but during the closed-door House and Senate negotiations the provision was stripped out and replaced with a measure by Dodd exempting bonuses agreed to prior to the passage of the stimulus bill on February 11, 2009. In my opinion, there should be a provision that bailout money is not used for bonuses, but there is not restriction against it. Therefore, the AIG executives should get the bonuses the government gave them indirectly through the bailout money. The bonuses should not have to be repaid because the government made the mistake of not researching where such a large amount of money was going.
Another opinion is that maybe if the government did know about the bonuses, the amount of money given wass such a small proportion of the governmental budget that it did not matter. Also the amount paid in bonuses was small compared to the actual amount AIG received (top individual bonus was more than $6.4 million, and the top seven received more than $4 million each. The Obama administration proposed a budget in the trillions of dollars. AIG only paid a few million to the executives in bonuses. I don't think that small percentage is going to make a difference in the budget or the deficit for that matter if they are paid back. And by the way, they will never get paid back. It will be impossible for them to pay it back because I guarantee you they actually do not have the money to pay back. So the government is going to spend all this extra money on a lawsuit when they could just admit they made a mistake and potentially break even rather than spending even more on lawsuits. The government could have been fine with the small percentage being paid to executives in bonuses, but the fact that the public found out and is now enraged, has made the government try to make it better. Their way of making it better is pretending like they didn't know about it in the first place.
It was impossible to prevent the contractual bonuses from being paid and said it may be difficult to recoup the payments. The government would "impose on AIG a contractual commitment" to repay the 165 million dollars to taxpayers.---http://www.business-standard.com/india/news/aig-boss-faces-grilling-in-angry-congress/56835/on
These bonuses were also guaranteed through contractual agreements, which were due even if bankruptcy occurred. Therefore, the executives should be paid these bonuses. They were promised before hard times occurred and were guaranteed. http://www.msnbc.msn.com/id/29739834/ Contracts written last March guaranteed employees 100 percent of their 2007 bonus amounts for 2008.The company and some federal regulators have said it was obligated by contract to make the payments. There is no restriction against paying bonuses with bailout money, I will state again. "It is also noteworthy that everyone who is complaining obivously didn't read the bill they voted for. This nation is in real trouble when congress passes laws to punish private citizens. Those bonuses were legal contracts made before the government bailout and legally must be fulfilled, like it or not" --http://blogs.abcnews.com/politicalpunch/2009/03/obama-adminis-1.html These bonuses are guaranteed to these executives at anytime, whether in good economic standing or poor. “These bonuses are payable regardless of performance and are calculated at 100 percent of 2007 compensation for all employees except senior management, who receive 75 percent of 2007 compensation. The amount is payable unless they are fired with good cause, resign without good reason or fail to meet performance standards. For those hoping that these employees could now be fired, “good cause” is defined in the agreement as a very high standard. This is normal for these agreements.“ There is no cause. And “failure to meet performance standards is another hard test to meet. If you could meet this latter standard, the contract provides that the employee still keeps his or her 2008 payments, just not next year’s. So even if the employee fails to meet performance standards this past year, they still keep the money paid this past weekend.”--http://dealbook.blogs.nytimes.com/2009/03/18/dissecting-the-aig-bonus-contract/
http://kpatel53.blogspot.com/
Obama anger at AIG bonus payouts
The blog states that it is AIG's responsibility to know in this current economic state that taxpayers money should be going in the right places and not into high paying executives. I believe the government should only intervene if they feel AIG is not being responsible with their bailout package. The government has intervened because AIG has used bailout money to pay bonuses. So according to the blog, this is right.
In my opinion, the government should have researched better where the bailout money for AIG was going to go. The government also knew about the bonuses beforehand, according to the Republican view. In my opinon, whether the Republicans are correct or not, the government should have figured out whether there were bonuses to be paid or other "frivilous" uses for the money were to be made. There is no restriction against paying bonuses with bailout money in the stimulous package: as ABC News' Capitol Hill Correspondent Jonathan Karl reported, in February, the Senate unanimously approved an amendment restricting bonuses over $100,000 at any company receiving federal bailout funds, but during the closed-door House and Senate negotiations the provision was stripped out and replaced with a measure by Dodd exempting bonuses agreed to prior to the passage of the stimulus bill on February 11, 2009. In my opinion, there should be a provision that bailout money is not used for bonuses, but there is not restriction against it. Therefore, the AIG executives should get the bonuses the government gave them indirectly through the bailout money. The bonuses should not have to be repaid because the government made the mistake of not researching where such a large amount of money was going.
Another opinion is that maybe if the government did know about the bonuses, the amount of money given wass such a small proportion of the governmental budget that it did not matter. Also the amount paid in bonuses was small compared to the actual amount AIG received (top individual bonus was more than $6.4 million, and the top seven received more than $4 million each. The Obama administration proposed a budget in the trillions of dollars. AIG only paid a few million to the executives in bonuses. I don't think that small percentage is going to make a difference in the budget or the deficit for that matter if they are paid back. And by the way, they will never get paid back. It will be impossible for them to pay it back because I guarantee you they actually do not have the money to pay back. So the government is going to spend all this extra money on a lawsuit when they could just admit they made a mistake and potentially break even rather than spending even more on lawsuits. The government could have been fine with the small percentage being paid to executives in bonuses, but the fact that the public found out and is now enraged, has made the government try to make it better. Their way of making it better is pretending like they didn't know about it in the first place.
It was impossible to prevent the contractual bonuses from being paid and said it may be difficult to recoup the payments. The government would "impose on AIG a contractual commitment" to repay the 165 million dollars to taxpayers.---http://www.business-standard.com/india/news/aig-boss-faces-grilling-in-angry-congress/56835/on
These bonuses were also guaranteed through contractual agreements, which were due even if bankruptcy occurred. Therefore, the executives should be paid these bonuses. They were promised before hard times occurred and were guaranteed. http://www.msnbc.msn.com/id/29739834/ Contracts written last March guaranteed employees 100 percent of their 2007 bonus amounts for 2008.The company and some federal regulators have said it was obligated by contract to make the payments. There is no restriction against paying bonuses with bailout money, I will state again. "It is also noteworthy that everyone who is complaining obivously didn't read the bill they voted for. This nation is in real trouble when congress passes laws to punish private citizens. Those bonuses were legal contracts made before the government bailout and legally must be fulfilled, like it or not" --http://blogs.abcnews.com/politicalpunch/2009/03/obama-adminis-1.html These bonuses are guaranteed to these executives at anytime, whether in good economic standing or poor. “These bonuses are payable regardless of performance and are calculated at 100 percent of 2007 compensation for all employees except senior management, who receive 75 percent of 2007 compensation. The amount is payable unless they are fired with good cause, resign without good reason or fail to meet performance standards. For those hoping that these employees could now be fired, “good cause” is defined in the agreement as a very high standard. This is normal for these agreements.“ There is no cause. And “failure to meet performance standards is another hard test to meet. If you could meet this latter standard, the contract provides that the employee still keeps his or her 2008 payments, just not next year’s. So even if the employee fails to meet performance standards this past year, they still keep the money paid this past weekend.”--http://dealbook.blogs.nytimes.com/2009/03/18/dissecting-the-aig-bonus-contract/
Risk Tolerance Confusion
With the recent AspenTech case, the class had some confusion on the definition of risk tolerance. I know I was one of those class members who had the trouble. So I decided to research this subject more.
http://www.investopedia.com/terms/r/risktolerance.asp
According a definition I found on investopedia, risk tolerance is the degree of uncertainty that an investor can handle in regard to a negative change in the value of his or her portfolio. An investor's risk tolerance varies according to factors such as age, income requirements, and financial goals. For example, a 70-year-old retired widow will generally have a lower risk tolerance than a single 30-year-old executive, who generally has a longer time frame to make up for any losses she may incur on her portfolio. Risk tolerance is how tolerant you are of risk. If you are tolerant of risk you can afford to take more risk. For example, if the Beta of your company is low, you can take on more risk if you want to. You don't have to, however.
When you are risk tolerant, you can pursue more risk for higher returns. A risk tolerant investor will pursue higher potential reward investments even when there is a greater potential for a loss. A risk tolerant individual might not sell his stocks in a temporary market correction, while a risk averse person might panic and sell at the wrong time.
http://www.investopedia.com/articles/financial-theory/08/three-risk-types.asp
However, just because you can take risk does not mean that you should. For instance, gambling could potentially lose all your money. You have the money to lose, but do you really want to lose it? The measure of risk tolerance for judging an investment is not enough. When taking on investments 2 questions to ask are Question 1: How much risk can you handle psychologically? and Question 2: How much risk should you take on? These are 2 completely different questions as I hinted at before. Question 1discusses risk tolerance, and question 2 potentially deals with asset allocation in your portfolio. A blend of three factors should be considered when creating a long-term investment strategy: risk tolerance, the financial capacity for risk and the optimal risk. You should combine these risks and make your risk tolerance match an efficient financial portfolio as well. Higher risks provide higher returns. If you are after higher returns, you must take on higher risks. But, not everyone has the ability or capacity to take on such risks. This is your risk tolerance. The higher returns, the more risk, and the more capital you would need to invest and could lose. Be careful to assess your risk tolerance before making investments. However, do not just use risk tolerance as your one measure. Assess risk in other measurements such as VaR and other risk measures.
http://www.investopedia.com/terms/r/risktolerance.asp
According a definition I found on investopedia, risk tolerance is the degree of uncertainty that an investor can handle in regard to a negative change in the value of his or her portfolio. An investor's risk tolerance varies according to factors such as age, income requirements, and financial goals. For example, a 70-year-old retired widow will generally have a lower risk tolerance than a single 30-year-old executive, who generally has a longer time frame to make up for any losses she may incur on her portfolio. Risk tolerance is how tolerant you are of risk. If you are tolerant of risk you can afford to take more risk. For example, if the Beta of your company is low, you can take on more risk if you want to. You don't have to, however.
When you are risk tolerant, you can pursue more risk for higher returns. A risk tolerant investor will pursue higher potential reward investments even when there is a greater potential for a loss. A risk tolerant individual might not sell his stocks in a temporary market correction, while a risk averse person might panic and sell at the wrong time.
http://www.investopedia.com/articles/financial-theory/08/three-risk-types.asp
However, just because you can take risk does not mean that you should. For instance, gambling could potentially lose all your money. You have the money to lose, but do you really want to lose it? The measure of risk tolerance for judging an investment is not enough. When taking on investments 2 questions to ask are Question 1: How much risk can you handle psychologically? and Question 2: How much risk should you take on? These are 2 completely different questions as I hinted at before. Question 1discusses risk tolerance, and question 2 potentially deals with asset allocation in your portfolio. A blend of three factors should be considered when creating a long-term investment strategy: risk tolerance, the financial capacity for risk and the optimal risk. You should combine these risks and make your risk tolerance match an efficient financial portfolio as well. Higher risks provide higher returns. If you are after higher returns, you must take on higher risks. But, not everyone has the ability or capacity to take on such risks. This is your risk tolerance. The higher returns, the more risk, and the more capital you would need to invest and could lose. Be careful to assess your risk tolerance before making investments. However, do not just use risk tolerance as your one measure. Assess risk in other measurements such as VaR and other risk measures.
Friday, March 13, 2009
Response to The Auto Industry
http://enterpriserisk-jonf.blogspot.com/
The Auto Industry blog from Jon F discusses the request for bailout funds by auto companies such as GM and Chrysler. On one hand denying the bailout money would cause these auto companies to go bankrupt, costing thousands of people their jobs in a time of increasing unemployment. His other viewpoint is that if the US government does provide bailout money, they will be helping these companies that seem to be failing regardless of their numerous attempts to cut costs. In a system of survival of the fittest companies, the help could be useless. The blog states, "If you were a manager at a company still attempting to sell gas guzzling SUVs, within the past 5 years I have a feeling that the you and the other managers of your company failed to look around and analyze the current market." I understand that the auto company bailout will be saving companies that are failing and will continue to fail in the future, but many jobs are at stake. I agree with the idea that it seems wrong to help a failing company when it is going to continue to fail and drain taxpayers money, but I do not think the company is in bankruptcy for avoiding the needs of the current market. I think GM and Chrysler should be given bailout money and maybe be encouraged to use some of the money to switch a few production lines or design a few more mid sized cars.
Too many jobs are at risk with these major auto companies. An article in Forbes backs my opinion that allowing America's largest auto manufacturer, the employer of hundreds of thousands of people, to fold could start a recession all by itself.
-Saving GM
I think in just 5 years it would be extremely difficult to change your company product line. You can add new compact cars but you cannot completely abandon the makes and models of SUVs that have been a part of the company since conception. Chrysler has been around since 1925. GM was created in 1908. It is challenging to change the strategy of old companies like them. The auto companies would have to get new equipment to build cars and not mostly SUVs. Jobs would be affected in this way as well because people on the assembly lines have different specialties.
Because these companies are so old, they also have older employees who have seniority and special pensions that can be very expensive to the company. This is another reason for GM's bankruptcy which has nothing to do with avoiding the current market. GM has been in business a long time, meaning it has lots of old workers and retirees, which means doctor bills and pensions. If it had started 15 years ago, it wouldn't have this problem. GM has an $86 billion pension fund. If just half of this amount could be spent on developing new cars or engines, GM would have been able to begin to prepare for the current crisis.
-http://www.forbes.com/global/2005/0314/029.html?boxes=custom
The costs of changing the company's products from SUVs to environmentally friendly cars that are good on gas mileage could put the auto company into bankruptcy as well, maybe even more quickly than the loss of car purchases due to people no longer having a preference for SUVs. If they had changed their strategy to making compact cars, they would incur the costs of that change. I researched approximate costs of switching your manufacturing to cars and found Ford as an example. Ford decided to start to switch due to increased gas prices and SUVs remaining on lots longer. Ford decided to switch a few of its truck plants into car plants. The switchover is going to cost the automaker $75 million bucks just for a new bodyshop. The total cost to retool the plant will be in the hundreds of millions.
- From AutoCar
Also, car purchases are decreasing in general, not just SUV car purchases. Due to the economic crisis, people are trying to save money and one way to do so is to keep the car you already have, keep a lower or nonexistent car payment on the car you already own. People have been deciding they can make do with the car they already have. There is no need to make a large new car purchase when they are hurting financially. Luxury items are the first to go when in a financial crisis. Moreover, increasing unemployment is another reason for the decline in car sales. Spain is experiencing the same problem as in the US. Due to job cuts, people are unable to purchase cars. Decreasing disposable income is also reducing the car sales.
-Car Sales on the Decline
We see these same reasons affecting car purchases in the United States. What are auto industry companies supposed to do to prepare for fewer purchases? This reason is not GM or Chrysler's fault. GM has been trying to analyze the current financial situation, but maybe they think it will get better. Gas prices have gotten lower, but I'm sure they will change again.
Many reasons, not to the fault of the auto companies, have caused them to need bailout money. Too many jobs are at risk to neglect these major companies. Hopefully, after the crisis when money is more readily available for these companies, the auto industry's risk managers can assist the companies in changing their product lines to better prepare for a future financial crisis.
The Auto Industry blog from Jon F discusses the request for bailout funds by auto companies such as GM and Chrysler. On one hand denying the bailout money would cause these auto companies to go bankrupt, costing thousands of people their jobs in a time of increasing unemployment. His other viewpoint is that if the US government does provide bailout money, they will be helping these companies that seem to be failing regardless of their numerous attempts to cut costs. In a system of survival of the fittest companies, the help could be useless. The blog states, "If you were a manager at a company still attempting to sell gas guzzling SUVs, within the past 5 years I have a feeling that the you and the other managers of your company failed to look around and analyze the current market." I understand that the auto company bailout will be saving companies that are failing and will continue to fail in the future, but many jobs are at stake. I agree with the idea that it seems wrong to help a failing company when it is going to continue to fail and drain taxpayers money, but I do not think the company is in bankruptcy for avoiding the needs of the current market. I think GM and Chrysler should be given bailout money and maybe be encouraged to use some of the money to switch a few production lines or design a few more mid sized cars.
Too many jobs are at risk with these major auto companies. An article in Forbes backs my opinion that allowing America's largest auto manufacturer, the employer of hundreds of thousands of people, to fold could start a recession all by itself.
-Saving GM
I think in just 5 years it would be extremely difficult to change your company product line. You can add new compact cars but you cannot completely abandon the makes and models of SUVs that have been a part of the company since conception. Chrysler has been around since 1925. GM was created in 1908. It is challenging to change the strategy of old companies like them. The auto companies would have to get new equipment to build cars and not mostly SUVs. Jobs would be affected in this way as well because people on the assembly lines have different specialties.
Because these companies are so old, they also have older employees who have seniority and special pensions that can be very expensive to the company. This is another reason for GM's bankruptcy which has nothing to do with avoiding the current market. GM has been in business a long time, meaning it has lots of old workers and retirees, which means doctor bills and pensions. If it had started 15 years ago, it wouldn't have this problem. GM has an $86 billion pension fund. If just half of this amount could be spent on developing new cars or engines, GM would have been able to begin to prepare for the current crisis.
-http://www.forbes.com/global/2005/0314/029.html?boxes=custom
The costs of changing the company's products from SUVs to environmentally friendly cars that are good on gas mileage could put the auto company into bankruptcy as well, maybe even more quickly than the loss of car purchases due to people no longer having a preference for SUVs. If they had changed their strategy to making compact cars, they would incur the costs of that change. I researched approximate costs of switching your manufacturing to cars and found Ford as an example. Ford decided to start to switch due to increased gas prices and SUVs remaining on lots longer. Ford decided to switch a few of its truck plants into car plants. The switchover is going to cost the automaker $75 million bucks just for a new bodyshop. The total cost to retool the plant will be in the hundreds of millions.
- From AutoCar
Also, car purchases are decreasing in general, not just SUV car purchases. Due to the economic crisis, people are trying to save money and one way to do so is to keep the car you already have, keep a lower or nonexistent car payment on the car you already own. People have been deciding they can make do with the car they already have. There is no need to make a large new car purchase when they are hurting financially. Luxury items are the first to go when in a financial crisis. Moreover, increasing unemployment is another reason for the decline in car sales. Spain is experiencing the same problem as in the US. Due to job cuts, people are unable to purchase cars. Decreasing disposable income is also reducing the car sales.
-Car Sales on the Decline
We see these same reasons affecting car purchases in the United States. What are auto industry companies supposed to do to prepare for fewer purchases? This reason is not GM or Chrysler's fault. GM has been trying to analyze the current financial situation, but maybe they think it will get better. Gas prices have gotten lower, but I'm sure they will change again.
Many reasons, not to the fault of the auto companies, have caused them to need bailout money. Too many jobs are at risk to neglect these major companies. Hopefully, after the crisis when money is more readily available for these companies, the auto industry's risk managers can assist the companies in changing their product lines to better prepare for a future financial crisis.
Insurance Contracts
In class we have been discussing insurance policies. I decided to research insurance contracts and discovered Investopedia.com. The webpage has articles about how insurance was developed. It was developed to spreak risk among many people that could handle the risk. There is also a link to a page about personalizing your risk tolerance, which is what we determined for the AspenTech case.
When the class was asked how we choose an insurance policy, we said based on which policy is the cheapest. This seems like a logical way to choose since you try to minimize your bills, but the insurance company could not be very reliable, or they could even be tricking you in some other way. I looked on Investopedia.com to learn more about insurance, how to choose it, and what you are getting from a policy. I found that Under-Insurance and Excess are things to look out for when choosing an insurance policy. Under-Insurance is when you have a house which is valued at $100,000 but the insurance only covers $80,000. If there is a partial loss to your house, the insurance company will pay only a portion of the $80,000. An example of excess is when you are insured at a value of $5000. Then your car has damage of $7000. The insurance company will pay you the full $7000 which is great, but if there is partial damage less than $5000, the insurance company will pay nothing. These are just a few of the important terms you should learn about when deciding on an insurance policy. A lot of times, people just get a cheap policy and then put it in a pile with all their other bills and paperwork and know nothing about it. But, I think we should learn more about our policies. As a soon to be senior in college, I will be on my own soon with my own career. I would like to know how to choose my policies to get the most coverage and benefits for a bargain. I think everyone should learn about the risks associated with choosing companies without learning about them first.
Here is the link to the Investopedia webpage to learn more about insurance.
http://www.investopedia.com/articles/pf/06/insurancecontracts.asp
I also found this cool website Insurance 101 with information about every type of insurance policy you are able to purchase and which ones you could do without.
http://www.investopedia.com/features/insurance-101.aspx
I found an article, Five Insurance Policies Everyone Should Have
by Lisa Smith, which states the 5 insurance policies everyone should have are long-term disability, life insurance, health, home, and auto insurance. I agree with this list because these are the basic needs and assets which most people own. The list provides basic coverage because you never know what will happen to you. People think that "This will never happen to me," but sometimes accidents happen, and you need insurance. The insurance will ensure that you can cover your costs and will not have to go bankrupt. Insurance is there to ensure you remain in the same financial situation you were in before the accident.
When the class was asked how we choose an insurance policy, we said based on which policy is the cheapest. This seems like a logical way to choose since you try to minimize your bills, but the insurance company could not be very reliable, or they could even be tricking you in some other way. I looked on Investopedia.com to learn more about insurance, how to choose it, and what you are getting from a policy. I found that Under-Insurance and Excess are things to look out for when choosing an insurance policy. Under-Insurance is when you have a house which is valued at $100,000 but the insurance only covers $80,000. If there is a partial loss to your house, the insurance company will pay only a portion of the $80,000. An example of excess is when you are insured at a value of $5000. Then your car has damage of $7000. The insurance company will pay you the full $7000 which is great, but if there is partial damage less than $5000, the insurance company will pay nothing. These are just a few of the important terms you should learn about when deciding on an insurance policy. A lot of times, people just get a cheap policy and then put it in a pile with all their other bills and paperwork and know nothing about it. But, I think we should learn more about our policies. As a soon to be senior in college, I will be on my own soon with my own career. I would like to know how to choose my policies to get the most coverage and benefits for a bargain. I think everyone should learn about the risks associated with choosing companies without learning about them first.
Here is the link to the Investopedia webpage to learn more about insurance.
http://www.investopedia.com/articles/pf/06/insurancecontracts.asp
I also found this cool website Insurance 101 with information about every type of insurance policy you are able to purchase and which ones you could do without.
http://www.investopedia.com/features/insurance-101.aspx
I found an article, Five Insurance Policies Everyone Should Have
by Lisa Smith, which states the 5 insurance policies everyone should have are long-term disability, life insurance, health, home, and auto insurance. I agree with this list because these are the basic needs and assets which most people own. The list provides basic coverage because you never know what will happen to you. People think that "This will never happen to me," but sometimes accidents happen, and you need insurance. The insurance will ensure that you can cover your costs and will not have to go bankrupt. Insurance is there to ensure you remain in the same financial situation you were in before the accident.
Sunday, March 8, 2009
Risk Maps
In class we discussed creating risk maps for different companies and industries. Professor Grace said his graduate students must create risk maps. We asked what is an example of a risk map, but Professor Grace does not give examples because he would receive a carbon copy of exactly what he provided. He said there are many ways to create a risk map, whether it be a chart with different sized dots on it representing the risks of the company or something like a graph with the risks represented by the bars. I do not know very much about risk mapping and was confused when the question arose about how to create a risk map. I decided to research more about types of risk maps and how they help companies.
I found this pdf file explaining how to use maps to show risk and how to calculate the risk.
http://www.agenarisk.com/resources/Using_Risk_Maps.pdf
These are 4 steps to define a risk map.
1. Consider set of events from given
perspective
2. For each event identify triggers and
controls
3. For each event identify consequences and
mitigates
4. Define probabilities for risk nodes
Companies use risk heat maps and calculate the risk by multiplying the likelihood by the impact. There are also causal models which show all the possible causes of the risk and link them together based on which have a stronger correlation. The only problem I see with this approach is some things that may be classified as causes may not be actual causes. The season and car fatalities could be seen as correlated or could also not be correlated. The only correlation I see is with weather not the season. For instance, snow and ice are characteristics of winter and they can cause plenty of accidents, but I would say the aspect with more correlation is weather. Looking at other seasons, I don't see how they could cause accidents or fatalities:just the weather, snow, sleet, rain, storms, etc.
Risk maps have many applications for assessing risks. Here is a website I found to build your own risk map.
www.agenarisk.com
I found this pdf file explaining how to use maps to show risk and how to calculate the risk.
http://www.agenarisk.com/resources/Using_Risk_Maps.pdf
These are 4 steps to define a risk map.
1. Consider set of events from given
perspective
2. For each event identify triggers and
controls
3. For each event identify consequences and
mitigates
4. Define probabilities for risk nodes
Companies use risk heat maps and calculate the risk by multiplying the likelihood by the impact. There are also causal models which show all the possible causes of the risk and link them together based on which have a stronger correlation. The only problem I see with this approach is some things that may be classified as causes may not be actual causes. The season and car fatalities could be seen as correlated or could also not be correlated. The only correlation I see is with weather not the season. For instance, snow and ice are characteristics of winter and they can cause plenty of accidents, but I would say the aspect with more correlation is weather. Looking at other seasons, I don't see how they could cause accidents or fatalities:just the weather, snow, sleet, rain, storms, etc.
Risk maps have many applications for assessing risks. Here is a website I found to build your own risk map.
www.agenarisk.com
What caused the crisis?
I have never heard of risk management being discussed on a daily basis in regular conversation. The only way I hear is talked about is when I am trying to explain my major to people who do not know what Actuarial Science is. To my surprise, I heard risk management brought up in conversation on Thursday before Spring Break. I gave a speech for scholar's day to persuade prospective scholarship recipients to choose Georgia State. After I spoke, President Becker gave a speech as well and happened to come across the current crisis. He was talked about our renowned risk management program at GSU and how they have grown from a small program to one of the most well known and successful programs in the United States. Georgia State is a large research university and the professors participate in research as well.
Here is part of the risk management website to find all the accomplishments of GSU and all the RMI professors' published work.
http://robinson.gsu.edu/news/99/rmi_ranking.html
President Becker continued with the thought that before the crisis, not many people thought of risk management as a major or profession. Now with the crisis, we see that risk management is the problem. I started to get a little frustrated with the statement since we have discussed in class that risk management is key to maximizing profits when done correctly. Therefore, risk management is not the problem, it is people and companies that think they can do without risk management or do so much management that they have negative profits. To my delight, President Becker continues with, "the lack of risk management, I should say, is the problem." I find this much better because now people realize they need to take risk management seriously.
Here is part of the risk management website to find all the accomplishments of GSU and all the RMI professors' published work.
http://robinson.gsu.edu/news/99/rmi_ranking.html
President Becker continued with the thought that before the crisis, not many people thought of risk management as a major or profession. Now with the crisis, we see that risk management is the problem. I started to get a little frustrated with the statement since we have discussed in class that risk management is key to maximizing profits when done correctly. Therefore, risk management is not the problem, it is people and companies that think they can do without risk management or do so much management that they have negative profits. To my delight, President Becker continues with, "the lack of risk management, I should say, is the problem." I find this much better because now people realize they need to take risk management seriously.
Aspen Technology Case
We recently researched the Aspen Technology case. Aspen Tech sells its software in the US but also abroad in Germany and China to name a couple. When companies sell their products in other countries they come in contact with currency exchange risk. Countries have different currencies which depreciate or appreciate against other currencies. With the US crisis, the dollar is not doing very well against other currencies. Europe tried to eliminate some currency exchange with the Euro. It helps with exchange rates and people losing money with exchanges in Europe, but the rest of the world still has issues with trading currencies. I know when I went to Costa Rica if I paid for anything with American dollars I could buy it cheaper because the locals only wanted dollars and they would do anything to get them. They could trade the dollars for more money for themselves. The dollar had more purchasing power for them.
In Aspen Tech's case, they were short on some currencies and long on others. For instance they were short on US dollars because most of their expenses were declared in US dollars. Another problem they had with currencies is when people made purchases in their native currencies, which they were more likely and willing to do. For instance, if someone bought the software with yen, but paid the money in installments rather than all in the beginning, Aspen Tech ran the risk of the yen losing value against the dollar. Therefore, it is important for Aspen Tech to hedge against currency risk.
Here is a website that defines currency hedging.
http://www.wisegeek.com/what-is-currency-hedging.htm
Wikipedia also discusses currency hedging.
http://en.wikipedia.org/wiki/Hedge_(finance)
In Aspen Tech's case, they were short on some currencies and long on others. For instance they were short on US dollars because most of their expenses were declared in US dollars. Another problem they had with currencies is when people made purchases in their native currencies, which they were more likely and willing to do. For instance, if someone bought the software with yen, but paid the money in installments rather than all in the beginning, Aspen Tech ran the risk of the yen losing value against the dollar. Therefore, it is important for Aspen Tech to hedge against currency risk.
Here is a website that defines currency hedging.
http://www.wisegeek.com/what-is-currency-hedging.htm
Wikipedia also discusses currency hedging.
http://en.wikipedia.org/wiki/Hedge_(finance)
Tuesday, February 24, 2009
Foreclosures
I have been more curious about the current situation with the mortgage crisis and foreclosures. On the news the financial situation of the Octomom has been discussed. She had sextuplets first and just recently had octuplets. She has no job, lives with her parents, and received insemination from her insurance company and there is even speculation of her receiving plastic surgery. Where does she get the money to pay for these large expenses? It was recently discovered that their house is being foreclosed on. She has been going on the web requesting money and a bailout. This situation can relate to my discussion on the frivolous use of government aid. Our taxes are going to go to pay for this woman’s home, when she could probably pay for it herself if she wasn’t so careless. She should not have had 14 kids knowing she could not afford them. Also, no one should have given her the insemination knowing she could not afford it or the cost of the children once born. She also had plastic surgery and gets periodic manicures with money she doesn’t have. I think these situations are the ones that frustrate taxpayers the most. Our money goes to pay for people who are not planning financially. This website gives information on the Octomom foreclosure.
http://www.tmz.com/2009/02/18/octomom-nadya-suleman-foreclosure/
I think more people should be educated on the proper way to handle finances. People need to learn to save. This is one reason Social Security is having trouble being eliminated. People do not know how to save on their own. More classes on financial planning should be required, and they should be required in schools before the legal drop out age of 16. Here is a link to Morningstar.com where you can learn about stocks, bonds, and investments.
http://www.morningstar.com/Cover/classroom.html
My grandmother and I had a discussion about the massive amount of foreclosures and how taxpayer’s money would be going to assist people with their mortgages. After hearing this story, the plan of assistance makes me angry. However, from another point of view, the banks holding the houses and the houses depreciating rapidly in value as they are not being cared for does not help the system either. Helping people get financially stable should be priority but you can’t just give needy people stuff for free when there is a lesson to be learned. People will think that when times get tough, someone will just bail them out. Financial education is necessary for the economy to improve. People keep blaming risk management strategies, but what about individuals who don’t exactly hire a risk manager? As individuals, we still have to manage our risk, and financial knowledge is a start.
http://www.tmz.com/2009/02/18/octomom-nadya-suleman-foreclosure/
I think more people should be educated on the proper way to handle finances. People need to learn to save. This is one reason Social Security is having trouble being eliminated. People do not know how to save on their own. More classes on financial planning should be required, and they should be required in schools before the legal drop out age of 16. Here is a link to Morningstar.com where you can learn about stocks, bonds, and investments.
http://www.morningstar.com/Cover/classroom.html
My grandmother and I had a discussion about the massive amount of foreclosures and how taxpayer’s money would be going to assist people with their mortgages. After hearing this story, the plan of assistance makes me angry. However, from another point of view, the banks holding the houses and the houses depreciating rapidly in value as they are not being cared for does not help the system either. Helping people get financially stable should be priority but you can’t just give needy people stuff for free when there is a lesson to be learned. People will think that when times get tough, someone will just bail them out. Financial education is necessary for the economy to improve. People keep blaming risk management strategies, but what about individuals who don’t exactly hire a risk manager? As individuals, we still have to manage our risk, and financial knowledge is a start.
Diversification
Diversification is a risk management strategy to hedge against risk. To protect from risky investments, investors diversify their portfolios. Not everyone has well diversified portfolios. Professor Grace mentioned in class that the state of Georgia does not allow itself to be sued because it is well and perfectly diversified. This statement was made in a sarcastic tone I might add. The majority of people do not have well diversified portfolios, which refutes one of the assumptions of the Capital Asset Pricing Model. Most people have all their money invested in one large asset, such as their home. However, some businesses and some rare people with sound financial and RMI knowledge can have well diversified portfolios. We watched a video from the Morningstar website about proper diversification. The advice was to invest in about 15 securities. You invest in some risky and some stable to neutralize your risk and maximize your returns.
Some people also diversify more with an active management strategy. They are constantly trading securities when risks increase and decrease. However, I have learned that a passive strategy is more efficient. You would think, why would you sit aside and do nothing to encourage your investments? I have learned that an active strategy is difficult and more expensive. I do not have the time to sit around and actively watch my stock and trade it at anytime. Also, it has been found that passive gain is no less than the average active gain once you account for the large number of transaction costs with each extra trade. The passive managers can get a free ride on the active managers. Diversification and managing your securities is beneficial to your investments. If you feel you do not know enough information about investing or your finances, Morningstar is a helpful website with videos about tips and the current financial crisis.
http://www.morningstar.com/Cover/Tools.html
Some people also diversify more with an active management strategy. They are constantly trading securities when risks increase and decrease. However, I have learned that a passive strategy is more efficient. You would think, why would you sit aside and do nothing to encourage your investments? I have learned that an active strategy is difficult and more expensive. I do not have the time to sit around and actively watch my stock and trade it at anytime. Also, it has been found that passive gain is no less than the average active gain once you account for the large number of transaction costs with each extra trade. The passive managers can get a free ride on the active managers. Diversification and managing your securities is beneficial to your investments. If you feel you do not know enough information about investing or your finances, Morningstar is a helpful website with videos about tips and the current financial crisis.
http://www.morningstar.com/Cover/Tools.html
Monday, February 23, 2009
Homework Exercise
Q: Suppose a firm's new expected revenue is 106. The cost of capital is 0.05. And we want to use the 99% confidence level for CaR (use Zc=2.326). Assume everything else the same, should the pharmaceutical company invest in the new drug?
A: The cash flow at risk for this new drug is calculated as follows at the 99% confidence level (1%):
2.326*20=46.52 for new
2.326*25=58.15 for current
2.326*35=81.41 for combined (calculated by finding the variance of the cash flows,
taking the square root, and then multiplying by Zc=2.326)
Then the present value of cash flows:
New drug=106/(1+.05)-100=0.9524
We also need to account for the fact that the new drug increases firm risk as well. We must adjust our calculation to account for this increase:
106/(1.05)-100-0.11*(change in CaR from new to old)
=106/(1.05)-100-0.11*(81.41-58.15)
= -1.6062
When using the calculation of NPV without adjusting for firm risk, the new drug's present value of future cash flows was barely positive. When choosing new projects or investments, any project with positive cash flows, NPV, should be chosen. So using this calculation, even though the firm would only earn a little extra cash, the new drug would become a new investment. However, when adjusting for firm risk, the NPV of the new drug became negative. Therefore, the new drug should not be invested in because the net present value of future cash flows is negative, which would increase risk to the firm.
A: The cash flow at risk for this new drug is calculated as follows at the 99% confidence level (1%):
2.326*20=46.52 for new
2.326*25=58.15 for current
2.326*35=81.41 for combined (calculated by finding the variance of the cash flows,
taking the square root, and then multiplying by Zc=2.326)
Then the present value of cash flows:
New drug=106/(1+.05)-100=0.9524
We also need to account for the fact that the new drug increases firm risk as well. We must adjust our calculation to account for this increase:
106/(1.05)-100-0.11*(change in CaR from new to old)
=106/(1.05)-100-0.11*(81.41-58.15)
= -1.6062
When using the calculation of NPV without adjusting for firm risk, the new drug's present value of future cash flows was barely positive. When choosing new projects or investments, any project with positive cash flows, NPV, should be chosen. So using this calculation, even though the firm would only earn a little extra cash, the new drug would become a new investment. However, when adjusting for firm risk, the NPV of the new drug became negative. Therefore, the new drug should not be invested in because the net present value of future cash flows is negative, which would increase risk to the firm.
Monday, February 16, 2009
Errors in the Crisis
I have discussed in previous blogs the problems and causes of the financial crisis. I keep finding more to learn about. The article below talks about errors with the crisis:
http://www.nytimes.com/2009/01/25/business/economy/25view.html?ref=business
People are wondering how the crisis happened and why we didn't learn from mistakes in the past. Risk management is supposed to prevent past problems from occurring again. I think as I stated before, however, that people don't think bad things will happen to them. We think of the Great Depression as a mistake of the past that could not possibly happen again. Risk management needs to investigate the causes of the crisis to implement preventative measures.
One of the problems mentioned involves mortgages and foreclosures. The government has not helped prevent foreclosures. More money keeps being lost, jobs have been lost, and people cannot pay for their homes. As discussed in class, most people have all their value and investments in their home. This was a point brought up to refute the CAPM assumption that people have well diversified portfolios. Most people's most expensive asset is their home. But what people don't realize is that when they keep taking out mortgage loans on their house, the house is decreasing in value. Then they are increasing their risk of loss. This article below shares personal experiences of many people who are losing their homes. I don't understand how having a lot of empty houses that just sit there unkempt and rotting helps the financial situation. Kicking people out of their homes and having nothing better to do with the houses does not help. At least when the people live in the houses the house receives some upkeep and the bank receives some money.
http://www.nytimes.com/2007/09/02/business/yourmoney/02village.html?scp=3&sq=mortgage%20crisis&st=Search
Another problem talks about governmental aid, which I think was used improperly and perhaps carelessly and thoughtlessly. The former treasurer used the money to bail out companies who asked not having an agenda to help the companies that could help the overall economy by improving themselves. For instance, the porn industry asked for money from the TARP. What good would helping the porn industry do for the overall economy? Do people really need porn? I don't think helping them would encourage enough commerce to improve purchasing and buying powers. The money was spent so quickly that now with the new Obama administration not much money is left to be spent to help. Here is an article about the Troubled Asset Relief Program so we know how the money has been spent:
http://topics.nytimes.com/topics/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html
http://www.nytimes.com/2009/01/25/business/economy/25view.html?ref=business
People are wondering how the crisis happened and why we didn't learn from mistakes in the past. Risk management is supposed to prevent past problems from occurring again. I think as I stated before, however, that people don't think bad things will happen to them. We think of the Great Depression as a mistake of the past that could not possibly happen again. Risk management needs to investigate the causes of the crisis to implement preventative measures.
One of the problems mentioned involves mortgages and foreclosures. The government has not helped prevent foreclosures. More money keeps being lost, jobs have been lost, and people cannot pay for their homes. As discussed in class, most people have all their value and investments in their home. This was a point brought up to refute the CAPM assumption that people have well diversified portfolios. Most people's most expensive asset is their home. But what people don't realize is that when they keep taking out mortgage loans on their house, the house is decreasing in value. Then they are increasing their risk of loss. This article below shares personal experiences of many people who are losing their homes. I don't understand how having a lot of empty houses that just sit there unkempt and rotting helps the financial situation. Kicking people out of their homes and having nothing better to do with the houses does not help. At least when the people live in the houses the house receives some upkeep and the bank receives some money.
http://www.nytimes.com/2007/09/02/business/yourmoney/02village.html?scp=3&sq=mortgage%20crisis&st=Search
Another problem talks about governmental aid, which I think was used improperly and perhaps carelessly and thoughtlessly. The former treasurer used the money to bail out companies who asked not having an agenda to help the companies that could help the overall economy by improving themselves. For instance, the porn industry asked for money from the TARP. What good would helping the porn industry do for the overall economy? Do people really need porn? I don't think helping them would encourage enough commerce to improve purchasing and buying powers. The money was spent so quickly that now with the new Obama administration not much money is left to be spent to help. Here is an article about the Troubled Asset Relief Program so we know how the money has been spent:
http://topics.nytimes.com/topics/reference/timestopics/subjects/c/credit_crisis/bailout_plan/index.html
Money Problems
All the talk about money loss is hard to comprehend. Where does all the money go? This article discusses money loss and creation in beginner's terms:
http://baselinescenario.com/financial-crisis-for-beginners/
What I don't understand is if people are losing money, the money has to be going somewhere, but everyone seems to be in a tough financial situation. Someone or some company has to be receiving money from the losses, but who? Is the money just disappearing? I think the problem can be explained using the mortgage crisis. People have houses that are supposed to have a certain value. The value however, has been falling but the payments are still the same and may even be charging more expensive rates because of default. The default is a result of the losses people have incurred and have caused them not to have money to pay. Prices have increased on gas, groceries, etc., and people have been getting laid off. There is no money for people to pay with. The value is taken out of the home and the money built into the mortgage value disappears. What creates value is the ability and willingness of someone to buy something. When the ability as in this financial crisis is gone, the value does not exist. This article discusses the mortgage crisis causes and also touches on my last point of too much government intervention in monetary assistance:
http://www.americanthinker.com/2008/10/what_really_happened_in_the_mo.html
I also do not understand where the money is coming from to bailout companies or money for welfare type programs is coming from. The government keeps signing bills to help companies with more and more money being spent. On CNN the other day, it was talking about the actual magnitude of one trillion dollars. People used to not have a concept of a trillion. Now the deficit keeps getting larger and larger. The government is creating millions and billions of dollars out of nowhere to help these companies and making the deficit, or overall economy worse. The article below gives insight on the concept of a trillion dollars:
http://www.museumofhoaxes.com/hoax/forums/viewthread/8765/
http://baselinescenario.com/financial-crisis-for-beginners/
What I don't understand is if people are losing money, the money has to be going somewhere, but everyone seems to be in a tough financial situation. Someone or some company has to be receiving money from the losses, but who? Is the money just disappearing? I think the problem can be explained using the mortgage crisis. People have houses that are supposed to have a certain value. The value however, has been falling but the payments are still the same and may even be charging more expensive rates because of default. The default is a result of the losses people have incurred and have caused them not to have money to pay. Prices have increased on gas, groceries, etc., and people have been getting laid off. There is no money for people to pay with. The value is taken out of the home and the money built into the mortgage value disappears. What creates value is the ability and willingness of someone to buy something. When the ability as in this financial crisis is gone, the value does not exist. This article discusses the mortgage crisis causes and also touches on my last point of too much government intervention in monetary assistance:
http://www.americanthinker.com/2008/10/what_really_happened_in_the_mo.html
I also do not understand where the money is coming from to bailout companies or money for welfare type programs is coming from. The government keeps signing bills to help companies with more and more money being spent. On CNN the other day, it was talking about the actual magnitude of one trillion dollars. People used to not have a concept of a trillion. Now the deficit keeps getting larger and larger. The government is creating millions and billions of dollars out of nowhere to help these companies and making the deficit, or overall economy worse. The article below gives insight on the concept of a trillion dollars:
http://www.museumofhoaxes.com/hoax/forums/viewthread/8765/
Financial Crisis Shock
In reading articles about the current financial crisis, I have simply been focusing on the causes and not what is actually happening to people and businesses. I think from a risk management standpoint it is good to study the causes to implement preventative measures for the future. However, the effects the crisis has had on people struck me this weekend. I found out one of my friends father was laid off. One of my other friends lost his job. Another of my friend's grandmother lost her job. I had a conversation with a person about his father losing his job as well. You think bad things won't happen to you, but they can. This same concept is why companies do not implement proper risk management policies. They may implement the bare minimum because they think bankruptcy could never happen to them. This article is about things that have changed or will change with the crisis:
http://www.culture11.com/node/32274?from=feature
Prices have increased to ridiculous costs for people, and in the mean time, they are losing their jobs, which does not help the situation.
This video explains how grave the situation we are currently in is, and is the trailer for a Frontline episode which goes into more detail about the crisis, or as they call it, the Second Great Depression.
http://www.pbs.org/wgbh/pages/frontline/meltdown/
http://www.culture11.com/node/32274?from=feature
Prices have increased to ridiculous costs for people, and in the mean time, they are losing their jobs, which does not help the situation.
This video explains how grave the situation we are currently in is, and is the trailer for a Frontline episode which goes into more detail about the crisis, or as they call it, the Second Great Depression.
http://www.pbs.org/wgbh/pages/frontline/meltdown/
VaR for Beginners
One of my last entries discussed the VaR principle. In class, we have been discussing Value at Risk in more detail. We have used the normal distribution to calculate estimates of Value at Risk. I was exploring the financial crisis links on the class website and decided to learn more about VaR. The discussion I found is VaR for beginners:
http://baselinescenario.com/2009/01/04/risk-management-var/
Another article that discusses VaR in the New York times is much more dense. The beginners article helps clarify the NY Times:
http://www.nytimes.com/2009/01/04/magazine/04risk-t.html
Value at risk uses a normal distribution to predict the confidence level for a company. This confidence level reveals how much money the company needs to keep on hand to cover their losses. At the 99% confidence level, VaR tells the company the maximum amount they will lose 99% of the time. VaR calculated using a normal distribution ignores fat tails that could arise in a distribution. These fat tails are high risks that may occur seldomly, but still could cause huge losses to the company. In my previous blog, I discussed that this was the problem with using only one risk calculation to determine the risk of an investment. The beginner article discusses other problem found with VaR. Using the normal calculation just to make prediction easier causes mathematical error. Not all events occur in patterns like a distribution either. The world changes. Just like how we showed the CAPM assumptions are unrealistic, it is unrealistic to assume this perfect world normal distribution. Just as the CAPM assumptions cause error, the VaR normal distribution assumption also causes error.
http://baselinescenario.com/2009/01/04/risk-management-var/
Another article that discusses VaR in the New York times is much more dense. The beginners article helps clarify the NY Times:
http://www.nytimes.com/2009/01/04/magazine/04risk-t.html
Value at risk uses a normal distribution to predict the confidence level for a company. This confidence level reveals how much money the company needs to keep on hand to cover their losses. At the 99% confidence level, VaR tells the company the maximum amount they will lose 99% of the time. VaR calculated using a normal distribution ignores fat tails that could arise in a distribution. These fat tails are high risks that may occur seldomly, but still could cause huge losses to the company. In my previous blog, I discussed that this was the problem with using only one risk calculation to determine the risk of an investment. The beginner article discusses other problem found with VaR. Using the normal calculation just to make prediction easier causes mathematical error. Not all events occur in patterns like a distribution either. The world changes. Just like how we showed the CAPM assumptions are unrealistic, it is unrealistic to assume this perfect world normal distribution. Just as the CAPM assumptions cause error, the VaR normal distribution assumption also causes error.
Friday, February 6, 2009
Risk Mismanagement
In risk evaluation you can use numbers to measure risk such as beta and Value at risk, but you can also use patterns from past events. Trends in markets occur, and sometimes trends in disasters occur. You can use the trends from the past to predict future crisis. Value at risk is a common measurement of risk that puts a dollar amount on the level of risk, how much capital a company should keep on hand to cover their risks. These tools and measurements are not as accurate when used alone, as my previous blogs have mentioned. The value at risk calculation can be combined with analyzing past trends to predict risk more accurately. The crisis caused confusion about risk management and whether it is useful or wrong. Risk management worked in the case of Goldman Sachs, so what is the problem then with risk management? It is in the uses of risk management and not being aware of the holes. If you are not looking for risks or disasters you won't see them when they are coming, and therefore, will not be prepared. As in my previous blogs, the value at risk calculation assumes a normal distribution. People take the calculation as is and ignore possible fat tails and outliers far away from the mean that cause higher risks. People use only the value at risk number, but do not realize it is short term and could change easily every day. Value at risk also does not take into account put options that could put a company at large risk if prices fall below the agreed price.
This reason is why people need to understand that problems can happen and you should be prepared. Crisis make people aware that bad things can happen. Using past events make people realize it could happen. Models are not the only tools that should be used to calculate risk because some risk cannot be hedged. There are diversifiable risks and non-diversifiable risks that can happen outside of a normal distribution. Risk management and VaR calculations help the firm be prepared. There is margin for error, but at least the firm has their eyes open. The VaR calculations 2 years ago stated things were getting bad, but no one used the warnings to prepare for the current crisis.
http://www.nytimes.com/2009/01/04/magazine/04risk-t.html?_r=2&emc=eta1&pagewanted
This reason is why people need to understand that problems can happen and you should be prepared. Crisis make people aware that bad things can happen. Using past events make people realize it could happen. Models are not the only tools that should be used to calculate risk because some risk cannot be hedged. There are diversifiable risks and non-diversifiable risks that can happen outside of a normal distribution. Risk management and VaR calculations help the firm be prepared. There is margin for error, but at least the firm has their eyes open. The VaR calculations 2 years ago stated things were getting bad, but no one used the warnings to prepare for the current crisis.
http://www.nytimes.com/2009/01/04/magazine/04risk-t.html?_r=2&emc=eta1&pagewanted
RIP: Modern Theory of finance
This article also discusses the current financial crisis and whether risk management is to blame. The article is a defense for risk management but criticizes the modern theory of finance. The article describes certain risk management strategies, identifying risk and calculation the risk with financial models. Beta is used as the most valid calculation of risk. However, our lessons in class will tell you that there are many calculations of risk and using them together gives you the best analysis of risk. On a sample exam question Value at risk and Beta were both used to compare the risk of two companies. One company had a Beta of 1, while the other had a Beta of 2. The one with Beta=2 had VaR= $2 million and the other had VaR= $2 billion. The Betas are fairly close, and when using only Beta comparisons, the company with a beta of 2 looks more risky. However, when taking the VaR into account, you would see that the VaR of $2 billion is way more to risk than $2 million. Therefore, the company with the more stable Beta turns out to be the riskier company.
These models and their interpretations are the problems causing the crisis. The problem stated once again as we discussed in class is that not all risks follow a normal distribution. The assumption for financial theory in the ideal world models such as CAPM and Modigliani and Miller is that risks follow a normal distribution. But, analysts ignore the fail tails of the distribution. Riskier investments have fatter tails. These fat tails are times when the market is a boom or a bust, which can happen unpredictably. The main cause of the crisis is taking these models as truth and using no other analysis.
http://www.thehindubusinessline.com/manager/2009/02/02/stories/2009020250321000.htm
These models and their interpretations are the problems causing the crisis. The problem stated once again as we discussed in class is that not all risks follow a normal distribution. The assumption for financial theory in the ideal world models such as CAPM and Modigliani and Miller is that risks follow a normal distribution. But, analysts ignore the fail tails of the distribution. Riskier investments have fatter tails. These fat tails are times when the market is a boom or a bust, which can happen unpredictably. The main cause of the crisis is taking these models as truth and using no other analysis.
http://www.thehindubusinessline.com/manager/2009/02/02/stories/2009020250321000.htm
Constellation Energy compared to American Barrick
Constellation Energy Group. Inc. just sold its natural gas trading company to the North American branch of Australia's Macquarie Group. Constellation was one of the largest gas trading businesses and specialized in moving about 10 billion cubic feet of natural gas per day. This company was similar to the specialization of American Barrick in mining gold. One of our questions for the case study on American Barrick was whether the company should switch from a mining company to a trading company. I was reminded of this because Constellation was going to have to increase the amount of capital to stay in the trading business. Instead of changing their business or increasing their capital, Constellation sold the business.
For companies thinking to switch their business strategies, such as Delta, the oil company in our exam, and American Barrick, they must analyze and weigh the costs. For American Barrick we decided that they were very good at hedging their risk in mining and extraction. Maybe switching over to a trading company would hurt their business even though it would eliminate extraction costs. For Delta, the past essay question discussed eliminating their oil price risk. This would force Delta to be better managers. The oil company in our exam was the same as Delta. They could eliminate the oil extraction costs as well and simply sell it. Constellation could not or did not want to switch their business strategy like the possibility with American Barrick. So they sold their company.
http://www.247wallst.com/2009/02/constellation-e.html
For companies thinking to switch their business strategies, such as Delta, the oil company in our exam, and American Barrick, they must analyze and weigh the costs. For American Barrick we decided that they were very good at hedging their risk in mining and extraction. Maybe switching over to a trading company would hurt their business even though it would eliminate extraction costs. For Delta, the past essay question discussed eliminating their oil price risk. This would force Delta to be better managers. The oil company in our exam was the same as Delta. They could eliminate the oil extraction costs as well and simply sell it. Constellation could not or did not want to switch their business strategy like the possibility with American Barrick. So they sold their company.
http://www.247wallst.com/2009/02/constellation-e.html
Did Risk Management Cause the Crisis?
I would like to comment on the article posted on the class website: Did Risk Management Cause the Crisis? Yes and no. Improper risk management (accounting controls) does not take the place of enterprise risk management.
The failure was due to a failure in maintaining and enacting appropriate risk management behaviors. Risk Management did not fail and did not cause the crisis. The lack of RM was the cause. Therefore, the RM strategies and ideas do not need to be destroyed and started over from scratch because they work for companies that implement them properly. Risk Management is not a guarantee that bad things won't happen, but firms must experience some risk to create value.
The failure also came from blind reliance on models. In class we discussed that a company's risk does not always follow a normal distribution. This is how the economy is: disasters can occur and surprises can occur. The organizations that fail do not pay enough attention to the tails in the distributions just as we discussed. Tails can be fatter than expected or predicted, which means that points are farther from the mean. These investments are more risky.
I found this article very interesting. It helped me distinguish between enterprise risk management, risk management, and financial risk management. The article defines Enterprise RM as risk management that can identify situations in which risk may be a competitive advantage instead of only a threat. "ERM encompasses all aspects of an organization in managing risks and seizing opportunities related to the achievement of the organization’s objectives… not only for protection against losses, but for reducing uncertainties, thus enabling better performance against the organization’s objectives." Our RMI 4350 class is titled Enterprise Risk Management, and we have been discussing this process exactly: identify risks and then form a plan to minimize the costs of risk to maximize the firm's value.
http://community.rims.org/RIMS/Upload/f26b1c64-8123-4c96-9c59-83fc43bc99cb.pdf
The failure was due to a failure in maintaining and enacting appropriate risk management behaviors. Risk Management did not fail and did not cause the crisis. The lack of RM was the cause. Therefore, the RM strategies and ideas do not need to be destroyed and started over from scratch because they work for companies that implement them properly. Risk Management is not a guarantee that bad things won't happen, but firms must experience some risk to create value.
The failure also came from blind reliance on models. In class we discussed that a company's risk does not always follow a normal distribution. This is how the economy is: disasters can occur and surprises can occur. The organizations that fail do not pay enough attention to the tails in the distributions just as we discussed. Tails can be fatter than expected or predicted, which means that points are farther from the mean. These investments are more risky.
I found this article very interesting. It helped me distinguish between enterprise risk management, risk management, and financial risk management. The article defines Enterprise RM as risk management that can identify situations in which risk may be a competitive advantage instead of only a threat. "ERM encompasses all aspects of an organization in managing risks and seizing opportunities related to the achievement of the organization’s objectives… not only for protection against losses, but for reducing uncertainties, thus enabling better performance against the organization’s objectives." Our RMI 4350 class is titled Enterprise Risk Management, and we have been discussing this process exactly: identify risks and then form a plan to minimize the costs of risk to maximize the firm's value.
http://community.rims.org/RIMS/Upload/f26b1c64-8123-4c96-9c59-83fc43bc99cb.pdf
Friday, January 30, 2009
Government Buys Bonds to hedge credit risk
The idea of this article is for the government to issue bonds at points where their credit default swaps are trading. Some companies, such as John Deere, are doing this, and the government bank, or state-owned bank, could do the same but even at lower rates. They could fully hedge the associated credit risk in the CDS market. Companies who need the money would then receive it, instead of banks keeping the money and doing nothing with it. Arbitrage exists in the current CDS market, so this new CDS exchange to include the government could possibly change the amount of arbitrage, or inefficiencies in the market.
The risk that the CDS market is facing is an illiquidity premium, which would not be a problem for the government. The government has limitless liquidity. This will also encourage spending becaus ehte government can hold cash bonds and loan out money to companies that need it without the compnaies having to pay a large premium or loading, as we discussed in class.
Many comments were posted about this article, some agreeing and some disagreeing. I think it is a good idea to help the current financial crisis, but the government can only help so much. The government spends so much more money than it has. We have increased the deficit more and more, and this hedging would only increase it more. The government is already bailing out companies. One comment addresses my complaint: this proposal does not justify spending government money wastefully and unwisely.
http://www.portfolio.com/views/blogs/market-movers/2009/01/29/let-the-government-buy-corporate-bonds
The risk that the CDS market is facing is an illiquidity premium, which would not be a problem for the government. The government has limitless liquidity. This will also encourage spending becaus ehte government can hold cash bonds and loan out money to companies that need it without the compnaies having to pay a large premium or loading, as we discussed in class.
Many comments were posted about this article, some agreeing and some disagreeing. I think it is a good idea to help the current financial crisis, but the government can only help so much. The government spends so much more money than it has. We have increased the deficit more and more, and this hedging would only increase it more. The government is already bailing out companies. One comment addresses my complaint: this proposal does not justify spending government money wastefully and unwisely.
http://www.portfolio.com/views/blogs/market-movers/2009/01/29/let-the-government-buy-corporate-bonds
Risk management strategies beyond insurance
The risk management profession is growing. This is what we want to see coming out of the current financial crisis. I found this article from Business Insurance about France's emerging market for risk management. They conducted a study with Deloitte and found that only 17% of respondents said their job was restricted to managing insurance risk and management. 30% pilot a global approach to risk management within their companies. Half have responsibility for strategic risks and insurable risks. This creates a broad spectrum of risks being monitored, which is the best strategy. Through our daily business examples in class, we have found that the hardest part of risk management is to identify all of your risks. With many people studying all types of risk, they are bound to find more and cover more for the company to reduce costs.
Results were also taken on communication within and throughout the companies. Most risk managers do not report directly to the CEO. Some report to financial departments, some to the top management, and some to the legal department. Only 6% have a specific risk management directorship. My first article posted on January 30 was about communication and improving it to improve risk management strategies. Communication is key to see who is covering what risks, how it can be improved, etc. If communication is lacking, companies go bankrupt.
France has seen the risk management profession growing. The majority of risk managers came from other jobs within the company. A small percentage have fewer years of experience and so are new to the profession. This percentage can be seen as a sign that the field is growing. More people recognize that risk management is necessary.
http://www.businessinsurance.com/cgi-bin/news.pl?post_date=2009-01-30&id=15217
Results were also taken on communication within and throughout the companies. Most risk managers do not report directly to the CEO. Some report to financial departments, some to the top management, and some to the legal department. Only 6% have a specific risk management directorship. My first article posted on January 30 was about communication and improving it to improve risk management strategies. Communication is key to see who is covering what risks, how it can be improved, etc. If communication is lacking, companies go bankrupt.
France has seen the risk management profession growing. The majority of risk managers came from other jobs within the company. A small percentage have fewer years of experience and so are new to the profession. This percentage can be seen as a sign that the field is growing. More people recognize that risk management is necessary.
http://www.businessinsurance.com/cgi-bin/news.pl?post_date=2009-01-30&id=15217
How will the financial crisis affect insurance and risks?
In class we discussed that one way to hedge against risk is to purchase insurance. An expert Dr. Robert Hartwig, answers questions about insurance weaknesses and issues with the current financial crisis. He predicted that we will see a lot of financial legislation and regulation from President Obama's administration, which has been seen to be true. We have mortgage legislation to help limit the foreclosures. We have also seen financial bailout legislation for struggling companies. Dr. Hartwig predicts that the insurance and entire financial services industry will be more conservative after the eventual improvement in the market. I think that this conservatism is what disasters help put into place. We need bad times to recognize the good times and to prevent future disasters. This crisis ccould help encourage more risk management.
People are worried that more and more companies will have committed the same risk mistakes as AIG and will also go bankrupt. We have seen companies fail, and we have seen more and more asking for bailout money. But, insurance companies operations are different from those of AIG and will not likely suffer the same fate. Banks and other companies separated the bearing of risk from the underwriting of risk. With this method, comes a huge moral hazard. Insurance companies do not operate this way and are not subject to acting in ways that cause more risk. As in our class discussion, you cannot simply take large risks with large returns to quickly turn your company around. If you have been losing money with small risks, you will most likely fail with large risks as well. This is how companies have been putting themseleves down, by taking last minute huge risks at the chance of making large returns to make up for loss. These companies just end up bankrupt and costing themselves large amounts of money, which could have been prevented through risk management.
http://www.rmmag.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=332&AID=3838&Volume=56&ShowArticle=1
People are worried that more and more companies will have committed the same risk mistakes as AIG and will also go bankrupt. We have seen companies fail, and we have seen more and more asking for bailout money. But, insurance companies operations are different from those of AIG and will not likely suffer the same fate. Banks and other companies separated the bearing of risk from the underwriting of risk. With this method, comes a huge moral hazard. Insurance companies do not operate this way and are not subject to acting in ways that cause more risk. As in our class discussion, you cannot simply take large risks with large returns to quickly turn your company around. If you have been losing money with small risks, you will most likely fail with large risks as well. This is how companies have been putting themseleves down, by taking last minute huge risks at the chance of making large returns to make up for loss. These companies just end up bankrupt and costing themselves large amounts of money, which could have been prevented through risk management.
http://www.rmmag.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=332&AID=3838&Volume=56&ShowArticle=1
Risk: The Unseen Predator
Risk Management:
I found an article in the Risk Management Magazine which defines risk. It discusses companies which have failed recently and analyzes their risk management strategies. What went wrong? The article makes the case for using effective risk management strategies to hedge your risk.
AIG was a global giant company that specialized in underwriting risk, providing risk management services and training risk professionals. Yet, the company still failed. The confidence in risk managers and the like has been shaken and questioned. The article also discusses that failures and defaults have occurred in companies who investment grade ratings are AAA or AA. AAA and AA ratings are the safest, so is the system of notifying people about risk not working? The AAA and AA ratings were obviously not true if the company defaulted. The ratings should be modified to prevent misleading information. Maybe the rating system could be changed to reflect financial stability and the effectiveness of the risk management practices of the company at the time.
Structure should be more important to the risk management system. Each officer in each department should report to each other about their strategies and progress. For Enron, risk management programs were in place; however, communication about the practices was lacking. Also, risk management should be encouraged and not viewed as a strain on profits. Risk management is supposed to minimize the costs of risk to the company. If the programs are reducing profit too much or making it negative, maybe the programs need adjusting because they are too extensive. You can't eliminate all risk, but you should try effectively and efficiently to minimize the costs of uncertainty in areas where it is possible and still make profits.
http://www.rmmag.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=332&AID=3831&Volume=56&ShowArticle=1
I found an article in the Risk Management Magazine which defines risk. It discusses companies which have failed recently and analyzes their risk management strategies. What went wrong? The article makes the case for using effective risk management strategies to hedge your risk.
AIG was a global giant company that specialized in underwriting risk, providing risk management services and training risk professionals. Yet, the company still failed. The confidence in risk managers and the like has been shaken and questioned. The article also discusses that failures and defaults have occurred in companies who investment grade ratings are AAA or AA. AAA and AA ratings are the safest, so is the system of notifying people about risk not working? The AAA and AA ratings were obviously not true if the company defaulted. The ratings should be modified to prevent misleading information. Maybe the rating system could be changed to reflect financial stability and the effectiveness of the risk management practices of the company at the time.
Structure should be more important to the risk management system. Each officer in each department should report to each other about their strategies and progress. For Enron, risk management programs were in place; however, communication about the practices was lacking. Also, risk management should be encouraged and not viewed as a strain on profits. Risk management is supposed to minimize the costs of risk to the company. If the programs are reducing profit too much or making it negative, maybe the programs need adjusting because they are too extensive. You can't eliminate all risk, but you should try effectively and efficiently to minimize the costs of uncertainty in areas where it is possible and still make profits.
http://www.rmmag.com/MGTemplate.cfm?Section=RMMagazine&NavMenuID=128&template=/Magazine/DisplayMagazines.cfm&IssueID=332&AID=3831&Volume=56&ShowArticle=1
Friday, January 23, 2009
Behavioral finance, actuarial science and you
Another article I found while researching the Society of Actuaries, discusses how to make risk management more attractive to people. The article states that there are certain behaviors to focus on when presenting risk management to customers. Many lessons about managing risk before a crisis arises can be taken from the current financial crisis. We need to balance and manage our risks and stay open to opportunities.
The article presents an interesting valuation of money and risk problem which I have seen previously in my finance and RMI classes. Q: If people are given the option of choosing $7000 or taking the opportunity to have an 80% chance of receiving $10,000 and a 20% chance of receiving nothing, the majority of people will choose the certain outcome of $7000. The expected value of the risky outcome is higher, but people are afraid of the loss. People focus on a loss frame of mind instead of a gain frame of mind. The article states risk managers should help switch the focus so companies can have an investment goal and higher future gains. Expected value is key to changing people's minds.
People also assume the more risky option is what you hear about more. For instance, an airplane crash is less likely to happen than a car crash, but people are more afraid of a plane crash because they end up on the news. Airplane crashes, however, are less likely and more unexpected than a car crash. The unexpected always catches our mind more and tends to become our focus. Therefore, if this recession was unexpected to some people and companies, those are the ones who risk managers should be seeking out to offer safe options. This is the ideal time to catch the business of those who were caught off-guard. They need the risk management the most.
Some people also don't focus enough on the future and focus more on what is happening to them at this moment. For example, most people will take $1000 today rather than $1500 in two years. I have taken finance classes and AS classes enough to know the present value of the future payment is more than the present value of $1000. It is just the uncertainty of the future payment that turns people away. Risk managers and actuaries can help people calculate these values to improve their investments. Actuaries and risk managers need to help people in this time of need to develop plans and educate them on minimizing the costs of their risk. People need to have financial plans to encourage security.
http://www.producersweb.com/r/SOA/d/contentFocus/?tk=2,f,23991,home&adcID=e6cca8ddd22a2ca79d25c6a845e9ff75&apID=0&aTp=3
The article presents an interesting valuation of money and risk problem which I have seen previously in my finance and RMI classes. Q: If people are given the option of choosing $7000 or taking the opportunity to have an 80% chance of receiving $10,000 and a 20% chance of receiving nothing, the majority of people will choose the certain outcome of $7000. The expected value of the risky outcome is higher, but people are afraid of the loss. People focus on a loss frame of mind instead of a gain frame of mind. The article states risk managers should help switch the focus so companies can have an investment goal and higher future gains. Expected value is key to changing people's minds.
People also assume the more risky option is what you hear about more. For instance, an airplane crash is less likely to happen than a car crash, but people are more afraid of a plane crash because they end up on the news. Airplane crashes, however, are less likely and more unexpected than a car crash. The unexpected always catches our mind more and tends to become our focus. Therefore, if this recession was unexpected to some people and companies, those are the ones who risk managers should be seeking out to offer safe options. This is the ideal time to catch the business of those who were caught off-guard. They need the risk management the most.
Some people also don't focus enough on the future and focus more on what is happening to them at this moment. For example, most people will take $1000 today rather than $1500 in two years. I have taken finance classes and AS classes enough to know the present value of the future payment is more than the present value of $1000. It is just the uncertainty of the future payment that turns people away. Risk managers and actuaries can help people calculate these values to improve their investments. Actuaries and risk managers need to help people in this time of need to develop plans and educate them on minimizing the costs of their risk. People need to have financial plans to encourage security.
http://www.producersweb.com/r/SOA/d/contentFocus/?tk=2,f,23991,home&adcID=e6cca8ddd22a2ca79d25c6a845e9ff75&apID=0&aTp=3
"Using Risk Management to Beat the Downturn"
I received an email from the Society of Actuaries and found this article interesting. It is always fun to see how your future career is working in the real world today. You get to see what kinds of things you will be working with during your developing career.
The article is formatted as a Q and A to help you learn how to manage risk and how actuaries contribute to risk management. On the first day of class, Professor Grace asked who was a RMI major and who was an AS major. Most of the class was AS, but he went on to say that the school as well as the working world are trying to relate AS and RMI and tie the programs together. We need to realize how we work together and how our jobs can be similar. In marketing I learned that companies have threats and opportunities. Threats can be detrimental to business, and opportunities are ways to expand business. You would think risk would fall into a threat, but the article discusses that the risks our economy is facing in this recession should be considered opportunities. Risk Management can help the companies suffering today.
Through risk management, actuaries can help the companies identify what their risks are. Through exercises in class, we have seen how difficult it can be to identify all sources of risk, since there are so many. In class we decided the goal of risk management is not to minimize risk but is to maximize the value of the firm. Risk management should reduce the costs of risk to the firm to maximize the value of the firm. This article talks about ways to minimize risk by diversifying the firm's bank accounts. In a perfect ideal world all companies would have diversified portfolios because it is the best way to minimize the costs of risk. We also learned, however, that most people do not diversify enough. This reason is why risk should be reassessed often to discover new problems, or opportunities as the article states.
Some companies may think they can take on large risky projects to save their company in the end. The larger the risk the larger the return. However, this rarely works, and the company fails. For this reason, risk management should not be implemented just at the last minute. The article calls the recession (risk) an opportunity because without the bad times, companies simply see risk management as an unnecessary cost. The bad times help companies realize they need to manage their risk, which when done properly will maximize their value.
http://www.businessweek.com/smallbiz/content/jan2009/sb2009018_717265.htm?campaign_id=rss_topEmailedStories
The article is formatted as a Q and A to help you learn how to manage risk and how actuaries contribute to risk management. On the first day of class, Professor Grace asked who was a RMI major and who was an AS major. Most of the class was AS, but he went on to say that the school as well as the working world are trying to relate AS and RMI and tie the programs together. We need to realize how we work together and how our jobs can be similar. In marketing I learned that companies have threats and opportunities. Threats can be detrimental to business, and opportunities are ways to expand business. You would think risk would fall into a threat, but the article discusses that the risks our economy is facing in this recession should be considered opportunities. Risk Management can help the companies suffering today.
Through risk management, actuaries can help the companies identify what their risks are. Through exercises in class, we have seen how difficult it can be to identify all sources of risk, since there are so many. In class we decided the goal of risk management is not to minimize risk but is to maximize the value of the firm. Risk management should reduce the costs of risk to the firm to maximize the value of the firm. This article talks about ways to minimize risk by diversifying the firm's bank accounts. In a perfect ideal world all companies would have diversified portfolios because it is the best way to minimize the costs of risk. We also learned, however, that most people do not diversify enough. This reason is why risk should be reassessed often to discover new problems, or opportunities as the article states.
Some companies may think they can take on large risky projects to save their company in the end. The larger the risk the larger the return. However, this rarely works, and the company fails. For this reason, risk management should not be implemented just at the last minute. The article calls the recession (risk) an opportunity because without the bad times, companies simply see risk management as an unnecessary cost. The bad times help companies realize they need to manage their risk, which when done properly will maximize their value.
http://www.businessweek.com/smallbiz/content/jan2009/sb2009018_717265.htm?campaign_id=rss_topEmailedStories
How does the risk premium reflect Beta? (JQ)
Beta tells you what your company would have to pay to attract investors. You would have to pay more if you are a risky company and less if you are less risky. Beta tells you how senisitive your company is to the market. When Beta=1, then your company moves with the market rate. When Beta is less than 1, the rate of your company stock is less sensitive to the changes in the market rate, making the investment in your company less risky. When Beta is greater than 1, the rate of your company stock is more sensitive to changes in the market rate, which makes your company a riskier investment depending on how high the Beta.
Risk premium tells you exactly the same things. From calculating the risk premium you should be able to estimate the beta. Risk premium also tell you how much more your company needs to pay to attract money to your company, which are also known as investments. The risk premium reflects the risk of your cash flows; therefore, the riskier your cash flows, the higher the risk premium. A higher risk premium means a riskier investment just as a higher Beta above 1 means a riskier investment. If you see you have a high risk premium (risky investment) you can assume you have a Beta greater than 1.
Beta tells you what your company would have to pay to attract investors. You would have to pay more if you are a risky company and less if you are less risky. Beta tells you how senisitive your company is to the market. When Beta=1, then your company moves with the market rate. When Beta is less than 1, the rate of your company stock is less sensitive to the changes in the market rate, making the investment in your company less risky. When Beta is greater than 1, the rate of your company stock is more sensitive to changes in the market rate, which makes your company a riskier investment depending on how high the Beta.
Risk premium tells you exactly the same things. From calculating the risk premium you should be able to estimate the beta. Risk premium also tell you how much more your company needs to pay to attract money to your company, which are also known as investments. The risk premium reflects the risk of your cash flows; therefore, the riskier your cash flows, the higher the risk premium. A higher risk premium means a riskier investment just as a higher Beta above 1 means a riskier investment. If you see you have a high risk premium (risky investment) you can assume you have a Beta greater than 1.
Wednesday, January 21, 2009
The capital asset pricing model was created because the assumptions in the Modigliani-Miller Theorem created an ideal world or a pure theory. The CAPM was adjusted with a beta which describes how the company relates to the market. CAPM works with all the M and M assumptions but uses beta to tell you if the company is more or less sensitive to the market. CAPM turns out to have some assumptions as well. The first assumption is that we have perfect information about our risks, investments, revenues, costs, etc. Second, there are no transaction costs to reducing risk. Third, there are many well diversified shareholders. Forth, there are no taxes, and fifth, there are no agency costs. We know these assumptions are not true. Most common shareholders do not have well diversified portfolios to hedge against risk. There are taxes, and managers are not always acting in the best interest of the shareholders causing agency costs.
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