- Time value of money: the value of a dollar changes with time. When analyzing projects you need to take this into account.
- Net Present Value of a project: A way to compare projects to literally see which gives you the most bang for the buck.
- Project Payback: How long will it take for a project to pay for itself.
Thursday, November 6, 2008
Finance for IT people
Soon I will add a few posts to describe three financial concepts that all IT people should know:
Friday, October 10, 2008
Will it Work?
The other day I mentioned that I thought the bailout was a good thing if it works. I will be the first to say that I am about as accurate at predicting the future as most people: I have very limited success! So I decided to research the “if it works” theory by tapping some bigger and better brains than my own!
I spoke with my current Finance Professor, Dr. Christofi, and he is skeptical. He agrees the government had to do something, but feels the real culprit of the mess was FASB 157 – Fair Valuation. For those that have not taken accounting, this rule basically forced companies holding mortgage-backed securities to take a loss and write down their value because the price they could sell their securities for dropped (even though the hold till maturity value was still mostly there). This removed company’s liquidity and made them a higher credit risk. No loan for you, bond holders want more assets, and security holders sell. Ouch!
My old economics professor, Dr. Pressman, feels that the bailout does not provide enough money to really fix the problem. Sure it will add a little liquidity juice, but it will not be enough. Look at what AIG said: “We need to more money.” Of course if you throw $400,000 parties, you would probably need more money too!
So should we throw more money at the financial institutions? Dr. Pressman says no. That does not treat the root cause of the problem: Mortgages. Now my take on that is we unfortunately have to bail out the people who made really poor decisions and bought houses they could not afford.
Sorry if you are one of them, and this may sound harsh, but what were you thinking? I could have gotten a loan for more than twice what my mortgage is. I could have gotten a really low adjustable rate with low payments too. Did I? No. I knew rates were low and they would most likely go up. I also knew my budgetary constraints and the fact that if something sounds too good to be true, it probably is. But hey, housing prices always rise so there is no risk, right? No, wrong. Anyway, I truly hope you get your mortgage issues resolved.
Enough on that tangent, back to Dr. Pressman. He said if the ARMs adjust upward, you would have many more people just walking away from their homes and devaluing the hold to maturity value of the mortgage-backed Securities. Why?
First, they won’t be able to afford the new payments. Second, they will owe more than the house is worth. While he thinks the market will probably stop its death spiral around 7,000 to 7,400, if the ARMs adjust up, the market will go even lower.
I still want to get another economist’s view on the subject: Dr. Scott. He will add the dimension of gaming theory and oil pricing to the overall analysis. He is a really fun guy to talk to and knows his stuff. More to come…
I spoke with my current Finance Professor, Dr. Christofi, and he is skeptical. He agrees the government had to do something, but feels the real culprit of the mess was FASB 157 – Fair Valuation. For those that have not taken accounting, this rule basically forced companies holding mortgage-backed securities to take a loss and write down their value because the price they could sell their securities for dropped (even though the hold till maturity value was still mostly there). This removed company’s liquidity and made them a higher credit risk. No loan for you, bond holders want more assets, and security holders sell. Ouch!
My old economics professor, Dr. Pressman, feels that the bailout does not provide enough money to really fix the problem. Sure it will add a little liquidity juice, but it will not be enough. Look at what AIG said: “We need to more money.” Of course if you throw $400,000 parties, you would probably need more money too!
So should we throw more money at the financial institutions? Dr. Pressman says no. That does not treat the root cause of the problem: Mortgages. Now my take on that is we unfortunately have to bail out the people who made really poor decisions and bought houses they could not afford.
Sorry if you are one of them, and this may sound harsh, but what were you thinking? I could have gotten a loan for more than twice what my mortgage is. I could have gotten a really low adjustable rate with low payments too. Did I? No. I knew rates were low and they would most likely go up. I also knew my budgetary constraints and the fact that if something sounds too good to be true, it probably is. But hey, housing prices always rise so there is no risk, right? No, wrong. Anyway, I truly hope you get your mortgage issues resolved.
Enough on that tangent, back to Dr. Pressman. He said if the ARMs adjust upward, you would have many more people just walking away from their homes and devaluing the hold to maturity value of the mortgage-backed Securities. Why?
First, they won’t be able to afford the new payments. Second, they will owe more than the house is worth. While he thinks the market will probably stop its death spiral around 7,000 to 7,400, if the ARMs adjust up, the market will go even lower.
I still want to get another economist’s view on the subject: Dr. Scott. He will add the dimension of gaming theory and oil pricing to the overall analysis. He is a really fun guy to talk to and knows his stuff. More to come…
Monday, September 29, 2008
Why this blog has been innactive since December
I know I don't have many readers on this obscure blog, but the ones I do have are a dedicated bunch! Sorry, I was busy working on my MBA and writing VMware Infrastructure 3 for Dummies. That kept me pretty busy.
I am back now and will be updating this blog at the very least, monthly. Hopefully a lot more frequently.
If I decide to go through with a relaunch of this blog under a new domain and blog name, I will definitely update more frequently. I just need to make sure I have the time.
I am back now and will be updating this blog at the very least, monthly. Hopefully a lot more frequently.
If I decide to go through with a relaunch of this blog under a new domain and blog name, I will definitely update more frequently. I just need to make sure I have the time.
For Those Against the Bailout
How did we get here?
Companies held these mortgage-backed securities (Derivatives). The mortgages went down in value, so the securities went down in value. According to the matching principle in accounting, you need to adjust the value of your asset when this happens. This changed company’s current ratios. That made debt holders and equity holders nervous.
Meanwhile, some other companies used extreme leverage to buy these securities. If you have a million dollars and borrow another 19 million to buy securities, you are extremely leveraged. You know have 20 million in securities and only 1 million of your own principal was used. If the value of the securities drops 5%, you just lost your million and want to sell fast. The first time there were other leveraged buyers who thought it was a great deal. Then prices dropped 5% for them and they had to sell. This continued until no one wanted to buy. The securities were extremely devalued.
Now back to the original companies. They just lost a chunk of their asset value. The debt holders want them to raise cash to cover it (raise their current ratio), but don’t want to lend them money because they are now more risky. So how does the company get cash? Borrow from the banks? No, they are not lending due to increased risk and reserve requirements. Sell more stock? Well no, the company is now worth less and more risky. The shareholders are selling, not buying. This further devalues the company.
At this point, you either sell your company to another (more conservative) company that did not invest as heavily in mortgage-backed securities, or you go the way of Lehman Brothers.
Where are we going from here?
How does this affect our economy? Production is reduced because companies can’t borrow money. In conjunction, people are nervous so they aren’t buying anyway. Demand falls, the economy shrinks. Company’s lay people off. Demand shrinks more because less people have income to buy things. Companies need to produce less and lay more people off. This process continues until we are in a deep recession or worse.
Eventually this brings down prices and demand starts to tick up. Companies start hiring again so they can produce more. Oh wait; they can’t borrow money to ramp up production so they don’t hire people back. The deflationary cycle continues. There is mass unrest and extremely high unemployment. Cushy life as we know it comes to an end.
Should Wall Street be bailed out for making bad investments?
If you say no, ask yourself how long you can be unemployed. Did Wall Street make billions on bad investments? You bet. Do they deserve to be punished? Yes indeed. Should they be punished to the point where we all suffer severely? No.
This is why the bailout is a good thing if the plan works. Worst case, it stops the deflationary cycle. Best case, it kicks off a new growth cycle. Much as I hate the idea of it, we need it or life as we know (growing economy / increasing standard of living) will likely cease to exist. Also, if foreign governments lose faith in the dollar, they won’t lend us money. Although I have yet to take International Finance, my understanding is foreign governments finance our trade deficit. What happens if that line of credit dries up? Very bad things.
The good thing about all this turmoil is, in the long run, the securities will increase in value when the housing market turns around. And it will turn around. Economics is a self-sustaining pendulum. The bailout is just trying to accelerate the swing without years of pain.
The bailout could actually make money as long as the securities are bought below the current value of the hold to maturity annuities that back them. If you disagree with the bailout, read the Macro Economics section in the very well written book Economics for Dummies. I am not picking the title out of sarcasm. This book was extremely helpful in my MBA economics class.
The politicians know we need this, but many of their constituents are against it. Therefore, it got voted down today (9/29/08). After the constituents lose their jobs and the economy is in an even worse death spiral, it may be to late for the bailout plan to help. If you are against the plan, please do some research on macro economics and re-evaluate your position.
Companies held these mortgage-backed securities (Derivatives). The mortgages went down in value, so the securities went down in value. According to the matching principle in accounting, you need to adjust the value of your asset when this happens. This changed company’s current ratios. That made debt holders and equity holders nervous.
Meanwhile, some other companies used extreme leverage to buy these securities. If you have a million dollars and borrow another 19 million to buy securities, you are extremely leveraged. You know have 20 million in securities and only 1 million of your own principal was used. If the value of the securities drops 5%, you just lost your million and want to sell fast. The first time there were other leveraged buyers who thought it was a great deal. Then prices dropped 5% for them and they had to sell. This continued until no one wanted to buy. The securities were extremely devalued.
Now back to the original companies. They just lost a chunk of their asset value. The debt holders want them to raise cash to cover it (raise their current ratio), but don’t want to lend them money because they are now more risky. So how does the company get cash? Borrow from the banks? No, they are not lending due to increased risk and reserve requirements. Sell more stock? Well no, the company is now worth less and more risky. The shareholders are selling, not buying. This further devalues the company.
At this point, you either sell your company to another (more conservative) company that did not invest as heavily in mortgage-backed securities, or you go the way of Lehman Brothers.
Where are we going from here?
How does this affect our economy? Production is reduced because companies can’t borrow money. In conjunction, people are nervous so they aren’t buying anyway. Demand falls, the economy shrinks. Company’s lay people off. Demand shrinks more because less people have income to buy things. Companies need to produce less and lay more people off. This process continues until we are in a deep recession or worse.
Eventually this brings down prices and demand starts to tick up. Companies start hiring again so they can produce more. Oh wait; they can’t borrow money to ramp up production so they don’t hire people back. The deflationary cycle continues. There is mass unrest and extremely high unemployment. Cushy life as we know it comes to an end.
Should Wall Street be bailed out for making bad investments?
If you say no, ask yourself how long you can be unemployed. Did Wall Street make billions on bad investments? You bet. Do they deserve to be punished? Yes indeed. Should they be punished to the point where we all suffer severely? No.
This is why the bailout is a good thing if the plan works. Worst case, it stops the deflationary cycle. Best case, it kicks off a new growth cycle. Much as I hate the idea of it, we need it or life as we know (growing economy / increasing standard of living) will likely cease to exist. Also, if foreign governments lose faith in the dollar, they won’t lend us money. Although I have yet to take International Finance, my understanding is foreign governments finance our trade deficit. What happens if that line of credit dries up? Very bad things.
The good thing about all this turmoil is, in the long run, the securities will increase in value when the housing market turns around. And it will turn around. Economics is a self-sustaining pendulum. The bailout is just trying to accelerate the swing without years of pain.
The bailout could actually make money as long as the securities are bought below the current value of the hold to maturity annuities that back them. If you disagree with the bailout, read the Macro Economics section in the very well written book Economics for Dummies. I am not picking the title out of sarcasm. This book was extremely helpful in my MBA economics class.
The politicians know we need this, but many of their constituents are against it. Therefore, it got voted down today (9/29/08). After the constituents lose their jobs and the economy is in an even worse death spiral, it may be to late for the bailout plan to help. If you are against the plan, please do some research on macro economics and re-evaluate your position.
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