Q&A with CMMB Securities

Q. We have huge credit card debits (on which we pay the minimum every month) and I would like to focus on reducing these. But my husband believes it’s more important to have money saved for emergencies. So we put aside something every month in a mutual fund. I can’t help feeling this is mixed up logic.

Clive, Montrose

A: The interest expenses on outstanding credit card balances is relatively high and can go up to as much as 24%, if not more. If you place your savings in a low yielding instrument, such as a money market mutual fund, which earns around 6% - 7%, your borrowing costs are outweighing your returns on the mutual fund significantly. If you are not reducing your credit balance, you are losing 18% - 19% every month. This is money you could have been saving. Although it is important to have savings in case of emergency, reducing the credit card balance seems more logical. As such, once you reduce this balance, you would have more to save.

Q. Looking at various money market investments in the Caribbean, I notice different terms are used for interest rates such as current yield, discount rate, etc. What do they mean?

Neela, Marabella

A: These different terms represent different types of rates. On a fixed income instrument, such as a bond, you can come across the terms “current yield”, “coupon rate” or “discount rate”, all three of which vary. The current yield is a rate of return from an investment and measures the income generated by a bond. It is calculated as the amount of interest paid on a bond divided by the current price of the bond. When a current yield is quoted for a money market investment, it reflects the income as a percentage of the current prices of all the short-term instruments the funds would have invested in.

The “coupon rate” is the interest rate stated on a bond when it is issued. It is calculated as the coupon payment divided by the face value of the bond. For instance, if a bond has a face value of $1,000 and pays annual coupon payments of $100, then the coupon rate on the bond is 10%. The coupon rate differs from the current yield, as the yield is calculated on the present value (or current price) of the bond, whereas the coupon rate is calculated on the face value of the bond. The “discount rate” is a little more complex and is used in quoting the price of a security in the Treasury Bill market.

Q. Watching a business programme on cable recently, one analyst said there was a lot of “noise” in the markets. Surely he’s not referring to the talking on the trading floor, so what did he mean?

Pamela, Port-of-Spain

A: The noise the analyst was referring to is termed “noise trading” in financial literature. Noise trading refers to trading strategies that are not rationally based on the availability of new information about stocks. In an efficient market all new information affecting stock prices becomes readily available on the market and market participants factor this new information into prices and trade accordingly. With the presence of noise trading, no new information becomes available, however, there may be a lot of speculation, rumours or technical trading which serve to move the price of stocks. Technical traders are traders who forecast future stock price and volume movements based on historical price and volume patterns. So although new information has not become available, technical traders tend to trade during particular periods of time when they perceive (based on historical movements) that the stocks would move in their favour.

Investors must remain mindful of the presence of noise trading and be aware that these acts of noise trading can be irrational and therefore not necessarily reflect the true value of a stock. However, by detecting noise trading (which is difficult to do), an investor can determine a trading strategy which can result in gains. For instance, if market participants are bidding up prices which are irrational and seemingly unsustainable, an investor who currently holds the stock could realise gains by selling his/her stocks.

“All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the Author’s judgment as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever. CMMB and/or its employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.”