Sunday 30th December, 2007

 

Santa saga

 
 
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Someone propositioned Santa that since he was over weight, he should walk more and drive less. So Santa parked the sleigh and bought a state of the art gym pack. Conditioned by his globetrotter habits, he got the best price in Jamaica, and paid in US dollars.

Money buys goods and services; the real worth of money is what it can buy at any point in time. Since the value of money was un-pegged from the value of gold decades ago, the dollar bill can buy more in some places or it can be virtually useless.

If you exchanged US$100, for Jamaican currency, you’d get enough JA dollar bills to stuff your wallet AND your pockets with them. The same would happen in Guyana. If you changed it into TT dollars you’d get only $630, and in Barbados you’d get just about BdS$300.

Obviously, this affects the trade between countries, when currency has to be bought and sold. Also trade in goods takes place in order for individuals to provision the household. There is virtually nothing you can do to alter that imbalance.

When we travel we tend to mentally convert everything back to TT dollars and then attempt to rationalise the comparative costs. Sometimes we wonder if we are paying more for better quality, or less for inferior quality.

But everybody loves a bargain. And everyone takes a risk. But what about those interested in investing?

Currency risk refers to how the returns will vary as the value of the currency fluctuates, when the returns are converted from a foreign currency into the local currency. It is also better known as exchange rate risk.

Currency risk is important in international mutual funds, foreign stocks, and foreign bond issues.

On top of currency risk, one must also understand the concept of country risk.

Country risk is also called political risk. This weighs the country’s economic and monetary policy profile against social and civil stability. Some countries are high on the political risk scale, like Pakistan and Venezuela and some others are low eg the US.

In general, risk can be pervasive, meaning it affects the entire market, such as inflation risk. This is called systematic risk. Non-systematic risk is different from market risk, since this type of risk is specific to the issuer. An example would be shares issued by a private company—it is commonly understood to be: issuer risk and the risks are unique to the security or asset.

Total risk is made up of both components: market risk plus issuer risk.

It is important to also differentiate financial risk. This is an often-misunderstood terminology. It does not really refer to broad risk in financial affairs. Instead financial risk is properly the risk involved in leverage.

Financial risk is the risk involved when people borrow money to finance their business. It weighs against what they actually own or the amount of equity held in the portfolio.

So Santa, faced with a health risk, financed his gym pack with a loan from the bank. He has faced country risk year after year going in to carry his toys, but will Santa survive his health crisis?

The saga of Santa continues.