Q’s and A’s To Enlighten Portfolio Management BY JIM REBER, PRESIDENT AND CEO, ICBA SECURITIES Time Out For Trivia If you’re a sports fan (and I know you are) and you’re also of a vintage that can recall back several decades, you may have heard of Todd Donaho. Donaho was the self-proclaimed “Commissioner of Sports Trivia” as the host of Time Out For Trivia (TOFT), a popular live call-in show that ran on the USA Network on weekday evenings from 1985 to 1990. The Commish would fire off questions in rapid-fire succession to phone-in contestants who hoped to win prizes ranging from telephones to grills. Players would compete at their own peril, as Donaho would often ask “boneheads” who guessed incorrectly to “take a hike.” Nonetheless, it was a winning formula, and by cable TV standards, TOFT had high ratings. What does this have to do with community banking? Hang with me as I pose a series of my own questions relating to community banks, which I hope you will view as more helpful than trivial. Even better, your author supplies the answers, so there’s no risk of nationally broadcast humiliation. As Donaho himself would exhort, “Who’s playing Time Out For Trivia?” Question: If you buy a callable bond, are you long or short a call option? Answer: You are short. Mechanically, you have simultaneously bought a bond and sold an option. The issuer has done the opposite and owns the right to take the bond away from you at designated dates in the future. Most callables have periodic call features (e.g., quarterly), but some are callable one time only. The aggregate value of the series of options translates into the additional yield over and above a noncallable “bullet.” Question: Why is Average Life always longer than Effective Duration for a given bond? Answer: Average Life is the weighted average period of time to receive your principal, whereas Effective Duration is the weighted average period of time to receive principal and interest. Average Life is more relevant for amortizing securities such as mortgage-backed securities (MBS). Since interest is received periodically (as well as early and late) in the life of a bond, the weighted average time period is less than for the principal alone. Average Life is more useful for calculating portfolio cash flows and liquidity; Effective Duration is a standard for measuring price volatility. Question: If you sell the guaranteed portion of an SBA 7(a) loan, what are the total proceeds? Answer: There are two sources and a third element that bears mentioning. First, the proceeds include the principal plus the premium paid by the buyer. If the guaranteed portion is $250,000 and the bid is 108.00 (which isn’t unusual), the total is $270,000, of which $20,000 is gain, and booked on the sale date (not settlement date). Additionally, SBA mandates that the seller retains 1% of the interest flow from future payments as servicing income. Finally, the entire amount of the unguaranteed portion, principal and interest, is retained by the original lender. Question: Why does the inflation gauge consumer price index (CPI) usually come in higher than the Fed’s preferred measuring stick, personal consumption expenditures (PCE)? Answer: It’s a two-pronged answer. First, the basket of goods for both indices (which is very deep — more than 80,000 items) changes over time as new products enter the market, some 12 | CURRENCY
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