Loans are by nature sources of change
Partnerships are by nature a source of change, so you’ll want to identify what might cause you stress in a partnership as soon as possible. The checklist in Exercise 4 will help you determine which of the most common stress points in a partnership affect you most. The statements you mark “yes” indicate areas that are likely to cause you some anxiety when it comes to change. If you dislike giving up control when performing a task, for example, you probably feel stress in a partnership when you have to do a task together. The anxiety you feel is the aftermath of the change you’re experiencing. You may try to avoid or even deny the change to prevent the anxiety—this is the normal “fight or flight” response we all experience during periods of stress.
If we can’t control the change that’s occurring around us, at least we can recognize the stressors and develop a plan to deal with them. Knowing your stressors and how you react to change is important in helping you cope with change.When two people or two organizations come together, things are bound to be different.
Assessments of an issuer’s credit quality
The rating agencies have been criticized for being too slow to react to changes in the credit quality of an issuer, leading to serially correlated rating patterns and limiting the value of ratings as a risk management tool. As a reaction, Moody’s decided to put its rating process under review, and acquired KMV to be able to provide investors with additional, marketbased assessments of an issuer’s credit quality. The feedback from market participants was surprising. Since investors themselves tend to use spreads and spread volatility as indicators for credit risk, the vast majority does not want Moody’s or the other rating agencies to switch to a more marketbased approach when assessing the credit quality of an issuer. There is really a need for, according to the feedback, more transparency with regard to the rating process. This would allow investors to use rating agency information in their risk management most efficiently.
Downgrading your loan is a good solution
The addition of the individual contributions to expected excess return in Experience yields an expected 1-year excess return of 88.2 bp for A-rated corporate bonds with a maturity of 5-years. This is significantly below the initial spread of 100 bps. The difference reflects the fact that a downgrade is more probable for A-rated corporate bonds than an upgrade, and that the associated spread changes are not symmetric. The magnitude of spread widenings due to downgrades is usually much higher than the spread tightening after rating upgrades. It is interesting to note that among investment grade bonds the ratio of upgrades to downgrades is most favorable for Baa-rated bonds. However, in the case of a downgrade these bonds often suffer massive price declines, because they fall below investment
grade levels.
The impact of credit on operating income
The paper sector is only mildly exposed, since in general companies generate no more than 20 percent of their revenues in the United States. The more internationally oriented technology and chemical companies like Siemens, Philips and Akzo generate about 30 percent of sales in the United States, and have substantial further sales outside the Euro area. Yet, the impact on operating income is reduced by the fact that a significant part of costs accrues in US operations. Additionally, most industrial companies engage in hedging activities. Among the companies with a high exposure to currency risk are UK companies FKI and Pearson that both generate more than 60 percent of sales in the United States. When the US dollar depreciates significantly, these companies are hit hardest.
With respect to their vulnerability against currency movements, companies from the consumer sector benefit from their broad geographic diversification.
It appears to be common policy to match assets and liabilities in the various regions to minimize overall currency risk. However, while transaction risk is accounted for, companies tend to leave translation risk unhedged. But many of the well-known European consumer companies like Nestle and Unilever have been able to raise funds in US dollars. Thus US dollar denominated debt exceeds assets and earnings. During the US dollar weakness those companies have seen their debt and interest burden diminish faster than their earnings. UK tobacco companies tend to finance a significant part of their business with Euro denominated debt, leaving them exposed to a strengthening of the Euro versus Sterling.
Loans are particularly exposed to currency movements
Being one of the most global sectors, the automotive sector is particularly exposed to currency movements. Significant changes of major exchange rates therefore may have a material impact on earnings. Yet, some manufacturers are better positioned than others due to a number of factors that do not only relate to natural or derivatives hedging. Awell-filled model pipeline, restructuring plans, cost reduction issues and a high degree of flexibility in the use and sourcing of raw materials and intermediate goods may outweigh negative effects due to currency fluctuations. With regard to transaction risk, those companies that have no foreign exchange exposure or are hedged, either naturally or through derivatives, clearly have the lowest risk. In terms of translation risk, companies whose assets and liabilities are well matched have the lowest risk and will have the lowest volatility of operating profits.
During the 2002/03 US dollar weakness, revenues and to a lesser extent operating profits of most European industrial issuers suffered significantly due to substantial US operations. However, exposure to US markets varies across industries.