Q&A with CMMB Securities

Q.  I recently got a small salary increase and want to be sensible with the extra cash. I have 10 years left on my home mortgage. Would it be wise to increase my monthly mortgage payments in order to finish it early, or would it make more sense to invest the extra $300 in a high interest savings account?

Douglas, Caroni

A : It is better to use the extra cash to clear your debt. The reason is that the rate on the highest interest bearing account would be lower than that of the interest rate charged on your mortgage. Therefore the extra interest earned on the additional $300 per month would be less than that of the interest due on the unpaid $300 of your mortgage per month. You would thus be making what is described as a negative spread if you use that extra $300 per month as savings. Nevertheless some people would tend to keep these additional funds and count it as savings. This is merely mental accounting, as these funds should only be considered as part of your net worth after subtracting outstanding liabilities and debt. So from a purely financial point of view the funds should be used to increase your monthly mortgage installment. However, there are other practical considerations. Depending on your situation, an additional $300 per month may be valuable in case of  emergencies. You may thus want to keep it, as the value of having funds to be used when it is really needed cannot be quantified economically. It is always prudent to have money to be used in case of contingencies. So you would have to judge for yourself, considering your overall financial position, which option is more suitable for your particular needs and circumstances.

Q.  You answered a question recently about alternatives to using an overdraft, but can you explain the difference between a banker’s acceptance and a repurchase agreement?

Gary,  St  Madeleine

A banker’s acceptance is a product used by a bank to match borrowers and lenders, giving a bank guarantee to the lender on the funds advanced. For example, if an exporter needs funds to manufacture products the bank can undertake to raise funds directly from an investor who has excess cash flow instead of raising it from depositors’ funds. The investor is given a certificate or Paper with the name of the borrower as the obligor (the one who has pay) of the investment, but the principal invested is secured by a bank guarantee. Hence the name banker’s acceptance. The bank has agreed to accept liability and so the investor has recourse to the bank in case of a default by the borrower. A repurchase agreement is a sale and buy back agreement on existing paper. For example, if a client wants to raise funds on a bond which he has purchased but does not want to sell the bond outright, he can arrange to sell the bond and simultaneously agree to buy it back at some point in the future. The seller/repurchaser pays the buyer a rate of return referred to as the repo rate. However, the interest rate on the bond is still paid to the seller/repurchaser. The difference is that the investor takes the risk of the underlying bond and does not have a bank guarantee as in the case of a banker’s acceptance.

Q.  If I want my money to keep pace with inflation, what sort of interest rates should I be looking to get on my investments?

Anjanie, Diego Martin

A: There are certain instruments, which hedge the effects of inflation while others do not. For example, a fixed deposit with a commercial bank, which has a fixed rate of interest for a fixed term, is not very sensitive to changes in the rate of inflation. However, a Treasury Bill (T-Bills were explained in a previous column) is a good instrument for achieving an inflation-adjusted return, as it is very sensitive to changes in price levels and the money supply. Similarly a money market account is also extremely sensitive to inflationary pressures as the rate floats up or down ever so often depending on the state of market liquidity. However, the rates on T Bills are extremely low right now and so it may be better to invest in a money market account, which pays a higher yield as well as adjusts for inflation. Real Estate is also an investment, which closely tracks the rate of inflation, and so it is a good vehicle for preserving the value of wealth over the long term. If it can be structured where a rental income can also be earned, then you would have a dual benefit.

Questions can be sent to PO Box, Wrightson Road, Port-of-Spain.
E-mail: cmmbsecurities @mycmmb.com