FINANCIAL NOTEBOOK

Q&A with CMMB Securities

Q. I have several outstanding loans I am paying off and I’m also putting aside about $250 a month. I was wondering if it would be better for me to forget the savings for a year or so and just deal with paying off my debts, especially the credit cards.
Nirissa, Point Fortin

A. The interest rates on loans, especially credit card facilities, are extremely high when compared to the rates of return earned on savings instruments. Therefore the rate earned on the extra $250 you set aside to savings every month is much lower than the interest cost paid on the $250 in debt you keep on your credit card per month. Your current arrangement does not make economic sense as you are in effect eating away at the value of your wealth. It is tantamount to your borrowing $250 every month from your credit card to fund your $250 in savings per month. The growth of your money is determined by your net worth, that is, the difference between your assets and your liabilities. If you have loans that are costing you about 12 percent per year, paying them off is like finding an investment with a guaranteed return of 12 percent. Let us work out the dollar value effect of the two options on each $250 set aside and prove that paying down debt would be better. Assume that you pay 24% per annum on you credit card debt while you earn 6% on your savings in a Money Market account. Annually, you pay an interest cost of $60 while you earn $15 on your savings. Therefore by saving rather than paying down debt you save yourself $15 per year on every $250. However, if you pay down debt every month then you remove the $60 interest cost altogether. Therefore from an economic point of view it is better to pay down debt rather than putting aside for savings. If you need funds on short notice for an emergency you can always drawback down on your overdraft or credit card.

Q. I’ve been hearing a lot about the futures market. What is it?
Stanley, Tunapuna

A. The futures market is conceptually a place where an investor can arrange to buy or sell something at a specified date in the future and at a price agreed upon today. There are futures markets for commodities as well as financial instruments. There are many different types of commodities that can be traded including wheat, oil, soyabeans, corn, silver, etc. Similarly futures contracts on financial instruments such as equities, Eurodollar deposits, and indices are available. Futures contracts can be extremely useful. For example, if a producer of wheat is going to have a certain quantity of production to sell in three months time but thinks that the price may fall over that time, he can get into a contract to sell at the futures price agreed upon today. In this way the producer hedges the risk of the price he gets for his produce. On the other hand, the purchaser of wheat may think that the price of wheat may rise and in order to avoid paying a higher cost can also hedge this risk by arranging to purchase wheat at a specified future date and price. The financial markets also have such hedging facilities. For example, if a mutual fund manager has to pay a distribution in six months, but feels over this time the prices of shares in his portfolio may fall, he can hedge the prices of the shares falling by arranging to sell these in the future at prices agreed upon today. This sounds all well and good, but remember nothing comes for free. The opportunity cost in a futures contract is if the price of the commodity or financial instrument moves in the opposite direction to what was anticipated. Let’s say the wheat producer arranges to sell at the futures price, but the spot price at the time of settlement is higher than what was expected, then the producer loses the opportunity to sell at the higher price. The producer may prefer incurring this opportunity cost rather than selling at a lower price.

Q. I read in the press that Trinidad and Tobago recently got an upgrade by Standard & Poor’s. What does this mean?
Kay, Scarborough

A. Standard & Poor’s is a recognised credit rating agency whose job is to assess the risk of investing in different countries and companies. They have developed a hierarchy of ratings — the higher the rating assigned the lower is the risk of investing. Recently Trinidad and Tobago’s long-term foreign currency rating (the ability to pay back long term foreign debt) was upgraded one notch from BBB minus to BBB. This means that Trinidad is now in a higher rating class than before. This improvement in its risk rating means that international investors would now be even more comfortable about investing in this country as the risk is now perceived as lower. The reason for this upgrade is the fact that the country’s economic indicators have been consistently improving. The international reserve position is high and the foreign debt load and debt servicing levels have been falling. A direct consequence of this is that Government (if it wants to) would be able to borrow on the international market at a lower interest rate than before the upgrade, since the risk of investing is now lower. Questions can be sent to: PO Box 1830, Wrightson Road, Port-of-Spain.
Email: cmmbsecurities@mycmmb.com