Professional Guide to PayDay Loans

If the issuer does not default, which is, measured by historical standards, extremely unlikely for an A-rated company, an investor earns an incremental coupon income of 100 bp over a 1-year horizon. Conditional on the fact that the bond receives a downgrade to Baa during the course of the year, a price depreciation of 50 bp times the duration of the bond at the end of the year, that is approximately 3.5, would have to be expected. Since Baa-rated US corporate bonds on average traded at 150 bp over treasuries, 50 bp represents the spread widening that has to be expected as a consequence of the downgrade. Consequently the investor expects a negative excess return of 100 – 3.5x 50= -75 bp, if the rating is downgraded from A to Baa. Table 9.4 details the same computation for the other potential rating changes.

Evidence shows that a spread level of merely 25 bp was never achieved between 1989 and 2003 for Baa rated US corporate bonds. One reason is that from an economic perspective the default probabilities and recovery rates that were assumed to calculate the required spreads were too optimistic for this period. Especially between 1997 and 2002 the fundamental environment for corporate bonds was unfavorable. New technologies, company takeovers and equity buyback programs were primarily financed by the issuance of corporate bonds, resulting in an increased level of leverage in the corporate sector. Investors consequently required higher risk premia to invest in corporate bonds. One way to obtain more adequate estimates of required spreads is to use default probabilities and recovery rates that are typical for the current stage of the business cycle. Modern models for credit risk management and the pricing of credit derivatives account for the current economic environment. In particular, they differentiate between periods of expansion and contraction, because historically default rates increased and recovery rates fell during economic downturns, thus leading to a higher risk for credit investors. Additionally, a worst-case-scenario can be constructed assuming a zero per cent recovery value. A fair spread of 0.46 percent will be computed for Baa rated corporate bonds with a maturity of 5 years which is again a lot lower than the actually observed spreads.

Air France, in common with other established carriers in Europe and North America, found its traditional markets threatened by the downturn in the airline industry and the increase in low-cost carriers. To remain competitive, the company paid special attention to four techniques:

Reacting rapidly. All Air France’s main decisions following the crisis of September 11th 2001 were taken on September 18th. They were later adjusted and developed, but the new strategy was formed and implemented quickly.

Acting collectively. The board meets to react quickly, considering how best to respond to events and how to co-ordinate their response.

Constantly looking at all competitors. This keeps the business lean and focused on what matters. In France, there has been an established lower-cost competitor to Air France since 1981: the TGV high-speed train. This has meant that many of the disciplines needed for competing with low-cost operators have been developed over many years.

Using all available resources. Competing has meant employing all the assets and advantages that a big industrial carrier has in order to counter low-cost operators, including its brand, market position and operational strengths. Often a competitor’s strategy is to build market share with temporary low prices and then to raise them. An active and patient approach can help to reduce or remove the threat of competitors.

A strategy may be well conceived and executed, and it may even succeed in achieving its aims, but it may still be vulnerable to a competitor’s actions. To be robust, decisions need to take account of potential competitive threats, and so it is useful to consider worst-case scenarios to make decisions.

Consider the example of a small sandwich bar with a regular, local clientele. Suddenly, a film crew comes to town and, because of its exclusive patronage, business booms. Is this good for the sandwich bar? In the short-term, definitely. In the longer term, possibly not. Regular customers may go elsewhere, tired of waiting longer than usual to be served, and when the film crew leaves, the sandwich bar will be in a weaker position than it was before they came, if its original customers have discovered better or cheaper competitors. One solution may be to deliver orders (or at least the film crew’s), and have more pre-prepared sandwiches to minimise delays. A more desperate and less satisfactory measure might be (after the film crew has left town) to reduce prices or increase marketing with the extra cash made during the boom. In any event, market awareness is vital to competitiveness.