Financial Diagnostics 12pages

GIFFNOCK CONSULTINGInteractive Finance

GIFFNOCK CONSULTINGInteractive Finance

Interactive Finance

Dr Richard [email protected] 699 992

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Interactive FinanceA business methodology to optimise financial value & profitability

mailto:[email protected]

Interactive Finance provides a business approach to financial management.

It can be tailored to each organisation’s requirements and to specific functions and executives.

There are commercial, contractual and financial methods of pricing

A business can

MANAGE OR ENGINEER REVENUES & COSTS

ANY TIME

ANY PATTERN

ANY CURRENCY

USING

FINANCIAL INSTRUMENTS

CONTRACTS

COMMERCIAL MARKETS

AND MOVE SEAMLESSLY BETWEEN

P&L ACCOUNT

BALANCE SHEET

OFF-BALANCE SHEET

IN ORDER TO MAXIMISE GLOBAL VALUE

INTERACTIVE FINANCEProfit optimisation

OVERVIEW OF VIRTUAL TREASURY: THE SEVEN DIAGNOSTICS

ENTERPRISE DIAGNOSTICIAN

VALUE MATRIX

Market or

Today Single Volaatility positive Tailore

d

Contract Real Repricing clauses Step up/dow Covenan G warrants

Currency nil Forward Futures

Deferred Accelerated

Structured

Swaps nil global Accreti ecreti Roller coaster

Synthetics

Options DeepITM

Engineered KI KO Swaptio

n Hybrids

Structures Secrit/n SPV PF Sinking

Funds Venture

GOALSEEKER

BENCHMARK MONITOR

&MANAGEMENT

INTERACTIVE FINANCEBusiness methodoogy

INITIAL EXPOSURE IN THE ENTERPRISE STRATEGISTOPENING EXPOSURE

BOARD CORE DIRECTIVES

Stage 1Board

Diagnostics

Stage 5Treasury

Operations

Stage 4Operations:

Tactics

Stage 2Strategies

Targets

Values

Goals

Stage 3Value

optimisation

0.6

0.7

0.8

0.9

1

1.1-10%-5%0%5%10%15%20%25%30%35%40%

Triggers 2013 - 2014

Diagnostics & Pricing Dealing & Valuations

Funding

Treasury

Manager Operator Monitor

Enterprise Diagnostics

Prior to the Executive Directors overseeing the key strategies, the Board of Directors needs to resolve the enterprise’s operational ‘footprint’ in three areas:

Core targets or objectives: The goals of the enterprise – as diverse as mining & extraction, mission work, government services or share market investments

Operational parameters: Stakeholder expectations, which will include issues of values and ethics.

Risk Tolerances: The Board sets the acceptable levels of risk, which drives the determination of benchmarks. These may include Share price (a board-level goal), or at the operations level profit & output targets, services provided, portfolio value protection and other enterprise-specific drivers.

Commodity Currency Capital & cash flow Assets Shares & shareholdings

Measure of value Time horizon Existing price clauses Existing financing

covenants

Risk tolerances Return on Equity (ROE) Margins Profit Cash

INITIAL POSITION ADJUSTED FOR EXISTING OFFSETS

APPLIED INTERACTIVE FINANCEVirtual Treasury

ENTERPRISE STRATEGIST – AN INITIAL DIAGNOSTIC

The business can tailor any initial position to any final position.

Enterprise Strategies

Targets for value management Key parameters Drivers & Benchmarks

THE EIGHT MOST COMMON PREFERRED OUTCOMES ARE LISTED BELOW

CHOOSING A DESIRED GOAL

Best rate/ return Worst rate/ return Implications

1. High reward/high risk(No insurance)

Unlimited Unlimited Base Case

2. Known return

(Full Protection)

Current revenue + /- premium/cost

Current revenue +/- premium/cost

Take full forward cover

3. Protect a minimum target

Unlimited Limited to minimum target

“Crisis” protection

4. Cheaper minimum target protection

Lose some upside (CEO can nominate)

Adjust minimum level upwards

Adjust minimum level

5. Protect current level as minimum(Floor)

Unlimited (equal to (3) above, less a premium)

Current 12 month forward rate

Puts a floor on possible returns by using options.

6. Take out insurance if nominated level reached(Knock-in)

Unlimited, less smaller premium than (5)

Limited to pre-specified level

7. Protection, but with no cash outlay

Upper level automatically set when minimum specified

CEO pre-selects minimum level.

Methodology is to match premium paid for

8. Leverage Can leverage potential returns

Varies from low to extreme

HIGH RISK, HIGH RETURN

APPLIED INTERACTIVE FINANCEVirtual Treasury

ENTERPRISE STRATEGIST OUTPUT: BUILDING STRATEGIES

Below is an example of how the Enterprise Strategist model builds and prices a strategy for a company

INTERACTIVE FINANCE

STRATEGIC PLANS FOR GLOBAL MARKETS

TWO OTHER STRATEGY PLANS: EXPORTER AND IMPORTER

PART A: EXPORT INCOME PROTECTION SCHEME

ENTERPRISE STRATEGIST FOR AN IMPORTER

PART B: ALTERNATIVE SCENARIOS FOR IMPORTERS

0.8000 0.8500 0.9000 0.9500 1.0000 1.0500 1.1000 90

95

100

105

110

115

120

125

130

Unhedged100% CoverFloorCollar

AUD/USD rate in 12 months time

Reve

nue

AUD

m

INTERACTIVE FINANCEValue optimisation

OPTIMISING VALUE: UTILISING THE MATRIX OF FINANCIAL CONTRACTUAL & COMMERCIAL ALTERNATIVES

The Matrix is a complete financial & commercial engineering and pricing model.It can be used to which commercial, contract or financial method best achieves the enterprise’s goals.

These may centre on objectives to increase revenue, reduce procurement costs, minimise the cost of capital and achieve other financial and commercial objectives.(The Matrix is also utilised to ensure pricing anomalies are exploited and business opportunities identified – and to identify hidden margins or mis-pricing.)

By using The Matrix for pricing and financial engineering, an enterprise can

manage or engineer returns any time any pattern any currency any tax regime

using any instrument any contract any market

and move seamlessly between P&L Account Balance Sheet Off-Balance Sheet Funds Flow

in order to maximise global value

EVERYTHING CAN BE BROUGHT BACK TO A SINGLE TIME AND EQUIVALENT PRICE

Table 3 Present Value at time 0 of Cashflows in Table 2End of Zero Cpn Discount Negative Inter-Year Interest Factor Initial Single Single Uniform Increasing Decreasing & Positive mittent

t Rate DF0t Cashflows Amount Amount Amounts Amounts Amounts Amounts Amounts%pa ($) ($) ($) ($) ($) ($) ($) ($)

0 10% 1.000000 10,000.00 10,000.00 1 10% 0.909091 2,398.16 909.09 4,045.45 (909.09) 2,727.27 2 10% 0.826446 2,180.15 1,652.89 2,851.24 (826.45)3 10% 0.751315 1,981.95 2,253.95 1,840.72 3,291.01 3,547.20 4 10% 0.683013 1,801.77 2,732.05 990.37 4,098.08 5 10% 0.620921 10,000.00 1,637.97 2,452.02 272.22 4,346.45 3,725.53

Total Present Value: 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00

Value Matrix

INTERACTIVE FINANCEValue Matix

VALUE MATRIX: IDENTICAL & INTERCHANGEABLE VALUES

THE MATRIX BASIC ALTERNATIVES

Market or Instrument

Today Single future time

Uniform amounts

Increasing & decreasing amounts

Negative & positive amounts

Tailored

Contractual Real options

Repricing clauses

Factoring Leasing

Step-up step down clauses

CovenantsWarranties

Guarantee

Forwards nil Forward Futures

FRA

Flat or average rate

forward

Stepped Deferred or accelerated

Structured forward

Swaps nil Fixed floating currency

commodity

Vanilla Accreting/ decreting

Roller coaster Structured; Synthetics

Options Deep in-the –

money

Put-call parity structures

Caplets strips

Knock-ins or outs

Swaption;Barrier

Hybrids

Bonds Zero Coupon Annuity Warrants Foreign; Eurobond

Bills Bill of ExchangeP/Note

Commercial Bill lines US CP

Equity Issues IPOs

Placement Warrant Calls Buy backs Equity engineering

Debt Factoring Loan/ overdraft

Bill line Facility Line of Credit Debt portfolio

Structures & vehicles

Securitisation

SPV Amortisation

Project Financing

Sinking Funds Venture capital Joint Venture

EXAMPLE: Your Home Loan

Director’s Loans (zero

interest)

Amortising (standard

Home Loan)

Low-start loan;Rapid

Repay***

Line of Credit ***(“Save 7 years & $100K”)

INTERACTIVE FINANCEValue optimisation

VALUE OPTIMISATION

THE THREE KEY PRICING & VALUATION PATHWAYS

There always at least two ways of pricing or valuing a position or proposal and one will virtually always be superior (Law of Two Prices):

Contractual Contract pricing clauses and repricing & value variation clauses. Virtually all financial contracts can be replicated through commercial contracts

Financial Standard financial instruments plus derived or synthetic financial engineering

Commercial Real (economic) options. Common often overlooked and potentially highly valuable

The value optimisation stage either adds value or confirms best value: it cannot reduce value.

Once the initial positions for each key variable have been quantified, the valuation stage provides three key services that are at the heart of optimising value:

Price verification Determines which of the three parallel sectors of financial, contractual and commercial provides the best value.

Arbitrage Takes any available pricing advantage from ‘mismatches’ between the three parallel markets - financial, contractual and commercial.

Control This stage is also called ‘stage-gating’. It ensures there is no price gouging or any hidden charges or fees.

Treasury diagnostics

Pricing analytics Portfolio offsets Expert Reports Currency diagnostics Matrix engineering

Contract & legal diagnostics

Contracts strategy Embedded options Financial offsets Economic options Benchmarking

Pre-contract diagnostics

Real Options Funding contracts Global pricing Asset Pricing Project Finance

Value OptimisationThe Matrix

Financial Pricing & engineering

ContractualPricing & conditions

CommercialIncluding real options

INTERACTIVE FINANCEOperations

TACTICS - AND TRIGGERS

Goalseeker is a proactive management system that anticipates events but does not attempt to forecast specific times or directions.

It ensures upside movements are re-enforced and negative trends identified and managed.

Triggers: Reactive management plans

Tolerances: Proactive management plans

Techniques: Utilises a diagnostics toolbox and a library of analytics from contract management check lists and foreign exchange matrices through to project financing schematics and liquidity management contingency plans.

Enterprise TacticsTreasury functions

TechniquesAnalytics & controls

Pricing analytics Portfolio offsets Advisory

Tolerances Reactive management

Covenant breaches External shocks Financial offsets

Triggers Proactive management

Global price triggers

Capital market covenants

Global pricing

0.6

0.7

0.8

0.9

1

1.1-10%-5%0%5%10%15%20%25%30%35%40%

Triggers 2016 - 18

Goalseeker


TREASURY OPERATIONS

An enterprise’s Financial Services operations - delegated to financial executives or retained by businesses - are designed to assist executives and businesses to identify & value opportunities and exposures as well as providing:

Independent valuations & advice on external funding or market proposals.

Business and financial contract valuations, especially repricing clauses

Dealing & cash management and financial services

BUSINESS FINANCIAL MANAGEMENT:10% ‘BANK’, 90% NON-BANK FINANCIAL DIAGNOSTICS & MANAGEMENT

Treasury ManagerTreasury Operations Centre

Liquidity management Pricing & dealing Investments Currency operations Financing & funding

Virtual Treasury OperatorCore Executive strategic

services Global Opportunities Financial engineering Project Financing

Treasury MonitorDiagnostics & financial

advisory Marketing Procurement Valuations Diagnostics BU Advisory

OperationsTreasury

Diagnostic & business ne-

gotiationsContract and financial val-

uations

Interacting with financial insti-

tutions

Business Interactive Finance

Treasury Management


SUMMARY

A business can


ANY TIME

ANY PATTERN

ANY CURRENCY

USING


CONTRACTS

COMMERCIAL MARKETS


P&L ACCOUNT

BALANCE SHEET

OFF-BALANCE SHEET


DealingMarketing

Financial Advice

Bank Treasury

APPENDIX 1SCENARIO PLANNING

SCENARIO PLANNING: THE DECISION MATRIX

“What if?”

1. Where are interest/exchange rates expected to go?

unchanged

up

down

don’t know / don't care

2. What is going to happen to risk (volatility)?

high (specify extent)

low

moderate

don’t know / don't care

3. Should losses be limited?

yes (specify level and over which ranges)

no

4. Should profits be limited?

yes (specify level and over which ranges)

no

Goalseeker

INTERACTIVE FINANCEScenario planning

THE STRATEGY MATRIX

USING OPTION COMBINATIONS (SAME EXPIRY DATE)

1 Market View Volatility View Loss Potential Profit Potential

Financial Strategy (may use contractual or

commercial solutions)

1 Up High Limited Unlimited Bought Call

2 Down Low Unlimited Limited Sold Call

3 Down High Limited Unlimited Bought Put

4 Up Low Unlimited Limited Sold Put

5 Up Moderate Limited Limited Bull Spread

6 Down Moderate Limited Limited Bear Spread

7 Neutral High Limited Unlimited Bought Straddle

8 Neutral Low Unlimited Limited Sold Straddle

9 Neutral High Limited Unlimited Bought Strangle

10 Neutral Low Unlimited Limited Sold Strangle

11 Neutral High Limited Limited Sold Butterfly

12 Neutral Low Limited Limited Bought Butterfly

13 Neutral High Limited Limited Bought Condor

14 Neutral Low Limited Limited Sold Condor

15 Up High Limited Unlimited Call Ratio Backspread

16 Down High Limited Unlimited Put Ratio Backspread

17 Down Low Unlimited Limited Ratio Call Spread

18 Up Low Unlimited Limited Ratio Put Spread, Up

INTERACTIVE FINANCETechniques

TRADER’S AID

ANY COMBINATION OF RISK AND RETURN BASED ON VIEW

Option Combinations - Financial Instruments, © CMBF 1997Market View

Loss Potential

Profit Potential

Volatility View Strategy (click to show) Combination = -1C(35) +2C(40)

1 Up Limited Unlimited Increase 0 0 1 0 0 0 0 0 0 02 Dow n Unlimited Limited Decrease 0 0 -1 0 0 0 0 0 0 03 Dow n Limited Unlimited Increase 0 0 0 0 0 0 0 1 0 04 Up Unlimited Limited Decrease 0 0 0 0 0 0 0 -1 0 05 Up Limited Limited Limited 0 1 0 -1 0 0 0 0 0 06 Dow n Limited Limited Limited 0 -1 0 1 0 0 0 0 0 07 Neutral Limited Unlimited Increase 0 0 1 0 0 0 0 1 0 08 Neutral Unlimited Limited Decrease 0 0 -1 0 0 0 0 -1 0 09 Neutral Limited Unlimited Increase 0 0 0 1 0 0 1 0 0 0

10 Neutral Unlimited Limited Decrease 0 0 0 -1 0 0 -1 0 0 011 Neutral Limited Limited Increase 0 -1 2 -1 0 0 0 0 0 012 Neutral Limited Limited Decrease 0 0 0 0 0 0 1 -2 1 013 Neutral Limited Limited Increase -1 1 0 1 -1 0 0 0 0 014 Neutral Limited Limited Decrease 1 -1 0 -1 1 0 0 0 0 015 Up Limited Unlimited Increase 0 -1 2 0 0 0 0 0 0 016 Dow n Limited Unlimited Increase 0 0 0 0 0 0 0 2 -1 017 Dow n Unlimited Limited Decrease 0 1 -2 0 0 0 0 0 0 018 Up Unlimited Limited Decrease 0 0 0 0 0 0 0 -2 1 0

BOUGHT CALLSOLD CALL

BOUGHT PUTSOLD PUT

BULL SPREADBEAR SPREAD

BOUGHT STRADDLESOLD STRADDLE

BOUGHT STRANGLESOLD STRANGLESOLD BUTTERFLY

BOUGHT BUTTERFLYBOUGHT CONDORSOLD CONDOR

CALL RATIO BACKSPREADPUT RATIO BACKSPREAD

RATIO CALL SPREADRATIO PUT SPREAD, UP

-10

-5

0

5

10

25 35 45 55

Prof

it/Lo

ss

Stock Price

Profit/Loss

MORE DETAILED MATRICES INCLUDE LEVERAGE AND HYBRIDS

INTERACTIVE FINANCEOptional strategies

TRADER’S AID

1. Buy call 2. Sell call 3. Buy put

4. Sell put 5. Bull spread 6. Bear spread

7. Buy straddle 8. Sell straddle 9. Buy strangle

10. Sell strangle 11. Sell butterfly 12. Buy butterfly

13. Buy condor 14. Sell condor 15. Call ratio b'spread

16. Put ratio b'spread 17. Ratio call spread 18. Ratio put spread

APPENDIX 2

INTERACTIVE FINANCECase studies

THREE CASE STUDIES

Enterprise Tactician and The Matrix can engineer & price any requirement at any time in any currency

1. Currency

Importer strongly believes A$ will collapse & damage margins - BUTwants cash in hand today and to benefit from a collapse of the A$/US$ rate

Enterprise TacticianAchieved using three financial instruments (forward + 2 options)Result: cash up front Importer gains if A$ falls Can leverage if needed

2. Project Finance

Builder owns land & needs $20M borrowing to construct building. However, extra borrowing would violate financial covenants on other loans.

ContractCreates synthetic borrowing using simultaneous sale of land plus two contract clauses (embedded options) synthetic fixed term

1 year fixed term secured mortgage loan

3. Offshore Dual currency bearer bond with warrants

Borrower in a war situation with commodities but uncertain ability to deliver. If wins the war can afford generous bonuses – so needs to issue a Junk Bond

BondUS Confederacy 1863 Dual Currency 20 year Bearer Bond with Commodity warrants + knock-in [when war ends] + embedded repay option coupon redemption lottery + bonus @maturity

= 150 year-old Junk Bond (replicated in Libya 2011)

Bottom line:Every enterprise has specific requirements that can normally be met by standard products from

commercial & financial markets

Requirement Solution

Interactive Finance


TREASURY OPERATIONS

An enterprise’s Financial Services operations - delegated to financial executives or retained by businesses - are designed to assist executives and businesses to identify & value opportunities and exposures as well as providing:

Independent valuations & advice on external funding or market proposals.

Business and financial contract valuations, especially repricing clauses

Dealing & cash management and financial services

BUSINESS FINANCIAL MANAGEMENT:10% ‘BANK’, 90% NON-BANK FINANCIAL DIAGNOSTICS & MANAGEMENT

Treasury ManagerTreasury Operations Centre

Liquidity management Pricing & dealing Investments Currency operations Financing & funding

Virtual Treasury OperatorCore Executive strategic

services Global Opportunities Financial engineering Project Financing

Treasury MonitorDiagnostics & financial

advisory Marketing Procurement Valuations Diagnostics BU Advisory

OperationsTreasury

Diagnostic & business ne-

gotiationsContract and financial val-

uations

Interacting with financial insti-

tutions

Business Interactive Finance

Treasury Management


SUMMARY

A business can


ANY TIME

ANY PATTERN

ANY CURRENCY

USING


CONTRACTS

COMMERCIAL MARKETS


P&L ACCOUNT

BALANCE SHEET

OFF-BALANCE SHEET


DealingMarketing

Financial Advice

Bank Treasury

Financial Diagnostics 12pages

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Transcript of Financial Diagnostics 12pages