Effect on interest rates due to the investment in REITs - Essay Example

Introduction: The earnings by oil groups and record returns in services businesses revived the fortunes in manufacturing sector in Britain in 2006. The capital invested by UK companies in manufacturing sector rose to 15.5 percent in the final quarter. The increase of profitability for the corporate companies in Britain came in spite of squeezing margins and rising energy costs. This is due to the boosted sales that enabled companies exploit the increased pricing power. The driving force behind record fourth quarter returns was sharp gains on gross trading profits. The Bank of England has concern about the companies' attempts to boost the prices. According to the experts' opinion, the rising pricing power of the companies may trigger the rise in interest rates as the demand for credit increases. The oil companies gained in fourth quarter after average performance in third quarter. Compared to 2005, the profitability in the manufacturing sector climbed back into double figures. The rate of return has increased to 10 percent in fourth quarter. In third quarter it is just 6.9. The increase in pricing power of the companies has shown its effect on real estate sector also and the industry benefited from low interest rates existed last year and the pricing power enjoyed by them. According to the opinion of the analysis, the UK corporate sector remained to enjoy the continued strong profitability during this year as energy prices have been reduced. Though there are high energy costs, the companies have gained from the high pricing power. The decrease of energy costs and a retained pricing power will increase the profitability of the companies further. As the firms are pushing up their prices, the profitability is set to be increased. The utility prices can increase the cost effectiveness of the companies by reducing the manufacturing costs. This will further aid in increasing the profitability. 1 Interest Rates Effect on interest rates due to the investment in REITs: In the year 2007, the real estate industry in UK is about to give the chance to investors to invest in real estate investment trusts. These are public listed vehicles that can satisfy the record demand experienced for investment in real estate. This can increase the capital acquiring capacity of the real estate firms and it can decrease its dependence on the bank credit. This in turn may decrease the interest rates or at least remain at what they at the end of last quarter of 2006. These investments not only impact the interest rates but also, these provide the required liquidity to an asset class that is considered as inflexible. The historically inflexible asset turning into a flexible asset and the provision of the liquidity for it can decrease the demand for the bank loans. One of the factors that impact the interest rates is the liquidity of the assets. The increased liquidity of the assets of a company or the people can decrease the demand for the bank credit up to some extent. This will certainly show a negative effect on interest rates and is capable of decreasing them or can stop them from increasing. Generally the international transactions involve the risk regarding exchange rate. The interest rates also effect the forwards yet times. For example a UK company is looking to buy a property in another country. A contract is signed and for completion within 3 months. Generally any one thinks about the exchange rate of GBP with the currency of that country. If the interest rates are considered and if the UK rates are higher, there will be a higher cost for the forward contract. In this case one can sign forward contract with a firm in the country that is having higher interest than in UK. This will reduce the burden on the buyer if there is any delay in execution of contract. Effect of the investments These investments will result in limited partnerships that have institutions as investors. There is a chance of emergence of onshore and offshore property unit trusts that contain institutional high net worth investors. The increase of investors will decrease the necessity of credit in the industry. These onshore and offshore property unit trusts are opening ended and have a large percentage in securities. There will be some entities in cash that depend on the allocation. The provision of liquidity and dilute the firms. To avoid the dilution and decrease the necessity to approach the bank for credit, the liquidity should be in its limits. The liquidity will be in its limits, if the asset management is in a productive manner. The REIT like ING has a variety of investors, but the presence of double taxation for the investment may limit the investing to a certain extent. The removal of the double taxation if possible, can further enhance the tax gathering capacity of the firm. The arrival of UK REIT has provided another opportunity for the domestic market. The listed real estate investment trusts can be considered as a rare commodity in the UK market. The changing REITs could over time which can expand the market that is currently GBP 100 billion. 2 Exchange Rate In January 2007, the Gannet co., inc., reported increase of 1.7 percent in the first period when compared to that of in 2006. The strengthening exchange rate of the British Pound also affected results for the company's UK operations. Provided, the exchange rate is constant, the revenues of the firm in UK operations will be 0.3 percent higher. The pro from a news paper advertising revenues were increases by 0.3 percent. In this case also if the exchange rate remains constant year over year the total advertising revenues in the news paper will be 1.3 percent higher. The classified revenues have increased by 2.5 percent and the absence of constant currency could have done the revenues flat. The constant currency exchange rate of pound with dollar and euro enhanced the real estate revenues of the company up to 10.3 percent. The automotive and employment revenues are increased by 13.5 percent. Not only Gannet all the export oriented and MNCs will enhance their rate of growth due to the existing exchange rate of GBP with international currency. The performance in UK is better for the company than in US. This is due to the fluctuating exchange rate of the dollar when compared to GBP. News papers, real estate, automotive, employment revenues were less in US than in UK. When UK revenues are considered the revenues of News quest are up to 19.4 percent. Real estate, automotive and employment revenues were increased by 36.5 percent. Based on the current exchange rate the television revenues for first quarter of 2007 will increase to a double digit growth when compared to a single digit growth recorded last year. Other revenues advanced to 19.4 percent in the first period and this growth will be consistent if there is a constant exchange rate or there is an increase in exchange rate of GBP. As the company operates through internet and is reachable to a number of places across the globe, the exchange rate affects the company's revenues. The fixed term forward contract can be selected for the ability for budget the costs more effectively. This is due to the facility to fix an exchange rate at the current market exchange rate. The return can be guaranteed irrespective of the fluctuations in the currency markets. In forwards a fixed term forward contract or forward can be an effective budget for the foreign payments of any company. This helps in hedging the fluctuations in the currency markets. If the company is able to take a small risk, forward time option contract can be done. This gives more flexibility than the fixed forward contract. A fixed term is decided to follow a fixed exchange rate. In that fixed term the company has to decide the future option of selling or buying the currency. In case of GBP it is more stable than USD. This situation can be favor the forward time option contract as sit gives fixed exchange rate for a fluctuating currency. The news daily like News quest is a regional news paper that receives advertisements from abroad. As a result the effect of the exchange rate will be on their advertisement revenue. The advertisement revenue of the news paper also depends on the exchange rate of the currency as there are advertisements from Global companies. Though there are advertising linage statistics for non daily products and health care group are not included above as changing strategies of the company can minimize the effect of exchange rate on the company's revenues. Property derivatives The derivative is considered as a generic term that covers financial deal types. These deals derive the value from the underlying market. The financial transaction involves the meeting of a buyer and seller. They approach through a broker. Bench marking of the residential property has been happened in UK and determined the deals' financial settlement. This type of derivatives that are known as swaps are arranged for various time frames and all of them resulted in increasing the value of them in the market. The index data needed to be gathered and compiled by the organization for informational purposes regarding property derivatives. The index data will help the organization to provide information about the derivatives and the options. 3 The following are the results up to third quarter about the property derivatives in UK. The above statistics are adopted from http://www.ipdindex.co.uk/derivatives/trading_volume.asp The above details are useful in estimating the real estate and property investments in the coming chapters of this paper. The real estate companies opened doors on the property derivative business in October 2005. The global property derivative brokers are involved in risk management consultancy. The real estate derivatives brokered live at the beginning of Q2-Q6 and have been successfully transacted. The property derivative prices of some property consultancies are recognized and comprehensive sourcing of pricing entered into the market. Out of these consultants TFS can be considered as leading organization. The initiation of broker arrangements with number of banks facilitated the opening of futures accounts and clearing CME housing futures contracts. When prices are considered the derivative prices are principally distributed daily by telephone and this resulted in increasing of the demand for the derivatives. The bench marks are important elements of the market. In real estate market these happened in the recent past rapidly. Generally the bench marks are considered to lie at the middle of the market. In January 2005, the first over the counter UK property derivate has been traded. 4 Topics Other Than Interest Rate and Exchange Rate When the company is not able to call on the share holders, the growth will be financed by long term debt. If the dividend is increasing more than 5 percent regardless of the results, the shareholders also do not contact the administration. In case of daily mail and general trust Plc, the compound dividend growth over the last ten years is 10 percent. Having a look at the DMGT's business to business divisions, some divisions have grown strongly. The growth of DMGI and euro money is due to strategy of reducing the dependence on UK market. This not only makes the paper independent on interest rates but also makes it dependent on exchange rates. This is the general case with any company. When a company concentrates in the local market the change of rates of interests will effect the growth and other aspects of the business. If the company expands its business and act internationally, the exchange rate of the currency of the country the industry belongs to will show its effect on the growth of the industry. This can be proved by the advertising markets experience by the DMGT's local news paper's advertisement revenues. The news papers that attract international revenue are free of the interest rates as they attract more investment that can avoid credit and the currency in the required from international players as ad revenues. Not only the news papers, any company that attracts more investment and acts internationally, will have a chance to grow at more speed. The growth also will be at international level as the marketing strategies are web and internet based. Any UK company that can adopt a strategy on the dependence on domestic market and expands its presence overseas can look forward for a speedy progress as the UBP is constant and even showing the signs of growth. Classification and investment objectives The funds of the companies that grow globally need to be diversified. The fund should use the securities, instruments, policies and strategies further identified in seeking an objective. The investments on certain profit making fields from time to time will make the fund successful in achieving its objective avoids loosing money. The information about the securities, instruments, policies and strategies used by fund in seeking the objective, need to be furnished to the shareholders. Words counter 1897 Reference: 1. Gary Duncan, 2007, Profitability of UK plc's non-finance groups hits record high, available at http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article1610263.ece 2. Elliot Caldwell & Christopher Tabor, 2007, UK REITS, ING real estate, available at http://www.londonstockexchange.com/NR/rdonlyres/6E9B0BC6-4404-42F3-A6CB-A05E92F31B85/0/UKRealEstateInvestmentTrusts2_BPF.pdf 3. PD, 2007, indicies for derivatives disclaimer, IPD, available at http://www.ipdindex.co.uk/derivatives/disclaimer.aspcp=/derivatives/trading_volume.asp 4. TFS, 2007, property derivatives, TFS, available at, http://www.tfsbrokers.com/property_derivatives.html 5. The above statistics are adopted from http://phx.corporate-ir.net/phoenix.zhtmlc=84662&p=irol-newsArticle_print&ID=965026&highlight 6. The above statistics are adopted from http://www.ipdindex.co.uk/derivatives/trading_volume.asp Appendix: Example of an Interest-Rate Swap Assume A wants a floating rate loan. Usually the floating rate loan is pegged at LIBOR of a particular term (+ spread). The LIBOR term is set equal to the settlement date periodicity. For example, if settlement is every six months, the floating rate is six-month spot LIBOR (prevailing over the next six months). Assume B wants a fixed rate loan. Usually the fixed rate loan is pegged at the yield-to-maturity of the Treasury security of the swap tenor (+ spread). The (non-swap) borrowing structure for Parties A and B is as follows: S&P Credit Rating Party Fixed (%) Floating (%) AA A 10 LIBOR+0.3 BBB B 11.2 LIBOR + 1.0 Gain: BA 1.2 0.7 We say B has a comparative advantage in floating rate loans. Hence, it can "offer" a floating rate loan to A. Similarly, A can "offer" a fixed rate loan to B. These "offer", using an interest rate swap, beat the rates at which they can borrow by going to the market for loans directly. Comparative advantage gain = (1.2 -0.7) % = 0.5 % (50 b. p.). Note: 100 basis points (b. p.) = 1% Parties A and B can agree to split the gain B-Afloating -BA each party can improve its borrowing by 0.25% (25 b. p.). Recall: B wants fixed, A wants floating. They can enter into a direct interest rate swap agreement as follows: Assuming the face values of Party A's and B's liabilities are $100M each, the notional principal value of the swap can be set at $100M, too. This notional principal never changes hands. Net Result: - B borrows at: (LIBOR + 1%) -LIBOR + fixed = 10.95% Fixed leg of swap = 9.95% (Note: 10.95% was obtained by subtracting Party B's swap gain of 25 b. p. from its fixed rate (non-swap) loan of 11.2%) - Therefore, A borrows at: 10% + LIBOR -9.95% = LIBOR + 0.05% The floating leg of the swap was picked to be LIBOR exactly. It could have been picked to be LIBOR + spread; we would have to increase the fixed leg of the swap by the spread amount, too, in order to achieve parity. Example of Forward: Consider a six-month long forward contract on a non-dividend-paying stock. The risk-free rate of interest (with continuous compounding) is 10% per annum, the stock price is $25, and the delivery price is $24. F0 = 25 e0.1*0.5 = $26.28 The value of the forward contract is: f = (26.28 24) e 0.10.5= $2.17 Example of option: "Sell-a-call" Assume that the share price is 70 and the exercise price is 60. Knowing that exercise is imminent, the option seller buys shares in the open market at 70, because he is obligated to sell at 60. Because he is obligated to sell at 60, he loses 10 (60-70) per share. "Sell-a-put" Assume that the share price is 60 and the exercise price is 70. In this case, the holder of the put will exercise. So he will sell the underlying shares at the exercise price 70. This means that the sellers of the put must buy the underlying shares at strike price of 60. Because the share is only worth 60, the loss here is 10 (60- 70) per share under option. Read More