My view on options

3 March, 2009

Currency options. Very popular word in Poland last time. I think one year ago only people related with finance knew what are currency derivatives and how they work, but nowadays this topic is raised almost every day by public media. I don’t want to explain here what is an option, if you are interested in finance markets you probably know the topic. I’d just like to express my own opinion about the issue.

First of all, it would be good to explain some historical background. In 2008, when PLN was increasing, many people thought soon EUR/PLN will be below 3. That’s why many companies (especially exporters), in order to secure their future income in PLN, have bought currency options offered by banks. That’s the normal procedure practiced by exporters for many years. And everything should be clear till that moment. But because the price of such instrument is quite high (what is understandable, because the bank takes the risk of currency price changes, so it expect premium for that risk), the companies decided to sell similar instrument to the bank (it is so called option strategy). This is already not security, but speculation. This is a very dangerous transaction and involves the risk of unlimited losses, in the case when the exchange rate increases. And guess what…

In August suddenly the trend has changed. Instead of receiving money from banks, companies had to pay them the difference between the agreed and market price of EUR. As a result, few companies went bankruptcy and many other (about 100 of them are traded on Warsaw Stock Exchange) suffered losses. There is also big discussion going on, whether the government should subsidize them from the budget or not.

One of the characteristics of free-market economy is that the entrepreneur makes a decision and takes the risk for the consequences of this thecision. If his decision was right, he enjoys the premium for his risk, but if he was wrong, he suffer losses. It is the right of the market, where only those are winning, who can adapt. But Polish populistic government blames banks for companies’ losses caused by options, trying to cancel their consequences. Moreover, Waldemar Pawlak wants to help those wrongly managed companies to survive, give bonuses for their’s CEOs and let them continue this maladministration. But it was a voluntary agreement, nobody has forced companies to cooperate with those banks. If the managers didn’t know about the risk connected with option strategies (maybe they didn’t even know how do they work), they shouldn’t sign contracts with banks (which should, by the way, protect the companies against the exchange rate risk, instead of exposing them for losses). Assuming they knew about the risk, they should go to caisno instead of managing the companies.

There is the other side of the coin. Big financial institutions can manipulate the currency exchange rate, by selling it or buying in the market. Probably international investment banks are responsible for strengthening PLN in the middle of 2008, and maybe those are the same banks which offered the currency options for the companies. Maybe they even did it knowingly, and they might even know that PLN will depreciate soon. However, the managers should expect that if somebody offers them the strategy which let them avoid the risk, adn doesn’t want anything (or almost anything) in return, he doesn’t have good intentions. My conclusion is that the managers are fully responsible for those bankruptcies, not banks!

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Things you can do with your credit card, part 1

2 March, 2009

Everybody can tell you that credit cards are bad. They were invented to addict the customer to the bank. Once you use your debt limit, you wait for the salary to pay it back. After that you have the money only to pay your bills but… you still have your limit on the credit card, which you can spend for consumption. ‘Credit card saved my life’, you think. But really, you’ve just became a credit-card-addict. You are in vicious circle. Unless you pay all your debt, you are your bank’s prisoner.

However, there are some advantages of credit cards. In this article I’d like to acquaintance you to one of them.

Do you know how to invest the money you don’t have? Sounds impossible, doesn’t it?

But it’s possible! The only thing you need is a credit card (with the access via Internet and free transfers) and savings account. The way to do it is very simple – you just have to transfer the money from the credit card to your savings account in the beginning of clearing period. In the end of the period you transfer the money back on your credit card account, so that you don’t pay interest. Another option is to transfer the money to your checking account and open a 1-month deposit. In hardcore version you can transfer your salary every month directly to your savings account, and use credit card for everyday shopping (remember, withdrawing the cash from your credit card in ATMs is usually interest-bearing!).

The profit you make depends on the interest rate of your savings account and your card’s credit limit. For example, if you have a limit of 1500€ and your savings’ interest is 5%, you make (1500€ * 5%)/12 = 6,25€ every month. You think it’s little money? I know, but who gives you 6,25€ for free?

It is important to have a credit card account which allows you to make free of charge transfers to your savings account! Otherwise, your transaction may be unprofitable. You also have to watch when your clearing period ends, to not be late.