The majority of price movements that is caused by a rating action is explained by new information which is revealed at the time of the rating action. Typically companies reserve the right to hold back certain information from investors, clients, business partners and competitors. This can be long-term projections, business plans or internal analyses. Usually rating agencies have access to internal documents during their rating process. Therefore, the rating of a company reflects more information than available to the public and to institutional investors such as mutual funds or insurance companies. A rating change itself is therefore an information about a change of a company’s credit quality because it incorporates nonpublic information.
January 2, 2010
What information about a credit you should gather
December 19, 2009
What factors affect your credit value
Significant price changes are not only observed after changes of the rating, but also after changes of the rating outlook. In many cases technical factors represent a major reason for bond price changes after a negative rating action. In particular, large price movements can be observed when investment restrictions of institutional investors are triggered by a rating action.
A good example is the downgrade of Fiat in June 2002. The downgrade from Baa2 to Baa3 induced a large sell-off because investors anticipated
a further downgrade to high yield. But Figure 9.1 also shows that bond prices already fell significantly when Moody’s put Fiat on review for downgrade.
Empirical studies by Weinstein (1977), Hand et al. (1992) and Kliger and Sarig (2000) highlight the following relationships between rating changes
and a corporate issuer’s bond and stock prices:
- Bond prices adjust to a new rating.
- Equity prices also react on rating changes, usually opposite to the bond price movements.
- Surprise upgrades tend to result in a reduced implied equity volatility.
There is no indication that new rating information has an impact on firm value. According to the Asset Substitution Theory equity and bond prices react in opposite directions to rating changes, which ultimately leads to changes in the ratio of the market value of equity to debt.
November 21, 2009
Credit worthiness is a stable concept
In order to arrive at a rating, one crucial assumption is made: credit worthiness is a stable concept. This means that historical data may be used to transform the information obtained from a company into estimates for default probability and loss severity. Since fundamentals change gradually over time, multinotch rating changes are unlikely. Rating agencies therefore use Outlooks and Watch Lists as leading indicators for potential rating changes. They signal in which direction the next rating step will probably occur. If, for example, a negative outlook is assigned, the rating agency usually defines certain criteria that have to be met by the issuer over a certain period of time, otherwise a rating downgrade can be expected. An example would be that a company must achieve positive free cash flows within a predetermined time-horizon. The failure to do so will result in the loss of the current rating.
October 20, 2009
How credit is perceived by customers
The concept of positioning relates to how a product is perceived by customers relative to its competitors. It originated in the advertising industry as a way of identifying those attributes of a product that should be placed in the buyer’s consciousness. For example, a product may be positioned as inexpensive, innovative, old fashioned, prestigious, high quality or any of a multitude of other attributes. Positioning influences attitudes to and perceptions of a product or company brand, rather than changing the product itself. The value of positioning decisions is that they increase awareness of a company’s or product’s capabilities. Positioning can refresh or reinforce an existing brand or explain a specific concept. It links closely with such things as brand management, competitive strategy, pricing, segmentation and market entry strategies.
July 17, 2009
The problem of Overconfidence
A lesser form of ego inflation is overconfidence. Overconfidence is your mind telling you that you know what you are doing and that things will work out even though you have little experience and have done little research or investigation. Overconfidence can lead you to trust your own decisions, as well as your advisors, based on flimsy or nonexistent evidence. Overconfident investors fail to scrutinize investment advisors, money managers, mutual fund managers, realtors, journalists, and other supposed experts.
Many people with money to invest suffer from overconfidence. The fact that you have money to invest tells your ego that you have a superior intellect than those who have no money to invest. The mere fact of having money to invest leads you to believe that you will invest it well.
However, overconfidence is not always the result of any prior success or experience. Many investments are sold as simple, easy paths to riches. This triggers overconfidence in inexperienced investors. The notion that stocks are the best investment for the long-term led to overconfidence in stocks for millions of investors. Without challenging this notion, investors shifted money out of bonds and money market funds and into stocks. Overconfident investors failed to ask how long the long-term is. If stocks are a bad investment while you are saving for retirement and a worse investment during your retirement, is it helpful if they are the best investment for the next hundred years after your death?
July 13, 2009
Decreasing Variable Expenses
Variable expenses are simultaneously the easiest to cut and the hardest to control. If you fail to pay attention to your variable expenses, your debt-reduction plan will feel like it’s going nowhere. If you get creative, you’ll reach your goals faster than planned. Here are some ideas:
1. Use grocery coupons. No one decision may decrease your variable expenses like using grocery coupons. Consistent use may cut your monthly grocery expenses anywhere from 35% to 60%. In fact, my wife consistently purchases about $1,000 worth of groceries for about $400 each month. Be sure to check out websites like TheGroceryGame.com and CouponMom.com to maximize your savings.
2. Always use a 2-for-1 coupon. Whether you are going out to dinner or going to a theme park, don’t go anywhere without using a discount voucher or coupon. Order an Entertainment Discount Book (approximately $40) for your area at www.Entertainment.com.
3. Always go “off-peak.” While you should be trying to cut back on your expenses, you and your loved ones may still need that occasional escape. When that time comes, always try to go “there” when no one else can or wants to. Most bed and breakfast inns are 50% off if you go Monday through Thursday.
4. Set gift limits. A lot of people with credit card problems can trace it back to holidays, birthdays, and anniversaries. Consider setting an agreed-upon dollar limit with the people you’re exchanging gifts with. Consider giving gift cards or
writing a letter to tell someone how much they truly matter to you.
5. Trim clothing costs. One person can easily spend over $1,000 per year on clothing. To help lower your costs, consider shopping at the end of the season when clothes are on sale. Also look around your local second-hand store—there are great bargains to be found, especially on kids’ clothing.
6. Download the song, not the album. One of the great blessings of the technological age is websites like iTunes. Instead of buying a $15 album just to get that one song, you can download the one you want for 99?.
July 10, 2009
How to decrease fixed expenses
1. Go green. A few years ago, our son, who was in kindergarten, started giving us a hard time about all the energy we waste. To humor him, we started working really hard to shut off the lights when we walked out of a room, bought more
energy-efficient appliances, and got rid of that second, inefficient fridge in the garage. Our monthly utility savings were $50 to $100 per month.
2. Get rid of cable. Cable TV, while a fun luxury, can easily cost $50 or more per month just for the basic service. When you add in digital cable, HDTV, and those digital video recorders, it can easily cost you $100 or more per month. That’s $1,200 per year. That’s a lot of debt you could pay off!
3. Get rid of a phone. In this day and age, it feels like a little bit of overkill to have a house phone and a cell phone. Consider getting rid of your house phone and using the $20 to $40 per month to pay off your debts.
4. Quit smoking. Don’t get me wrong, I enjoy the occasional fine cigar. But heavy smokers are costing themselves a ton of money. A pack a day will cost you over $1,000 per year, plus the increased insurance and out-of-pocket medical costs. It may help lower your stress, but so will being debt-free!
5. Use regular gas instead of premium. For most light drivers, the difference in quality will be negligible. Most car experts would also agree that it doesn’t make any difference in how long your engine lasts. Saving 20? per gallon, with one weekly fill-up, could easily save you $150 to $200 per year.
6. Send your kids to public school. Private school tuition can run anywhere from a couple hundred dollars per month, into the thousands. Consider putting all your kids in public school at a certain age, and using the thousands of dollars in savings to pay off debt and save for college.
7. Buy from the source. I have many friends, both in the city and suburban neighborhoods, who buy fresh produce straight from the farm. In fact, for $30 per month, one friend gets two huge baskets of fresh produce delivered straight
to her door. It’s fresh, healthy, and about 50% less than buying from the local supermarket. Other companies do this for meat, poultry, and fish, offering similar savings. A good place to start is your local farmers’ market.