£1 million for two weeks work? Not bad, but what about exchange rates and discrimination?

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One of the highlights of the summer as far as I’m concerned is the Wimbledon tennis tournament that takes place in London in June.  The atmosphere, the skills of the players and the event itself are fantastic.

Whilst tennis clearly gets priority, running the Wimbledon event is very much a business.

Earlier this week the All England Club (the organisation that runs Wimbledon) announced increases in the prize money for the 2010 championship.

The total prize money for the event will be £13.725 million. Both the men’s and ladies’ champions will each receive £1m, an increase of £150,000 over last year.

The increases over recent years emphasise that tennis is now big business. Roger Federer, the 2009 men’s champion, for example, was born in 1981. In 1981 the prize money was nowhere near £1million being only £21,600.

Tim Phillips, Chairman of the All England Club was quoted as saying “Wimbledon exists in a highly competitive global marketplace ….  it is important that we offer a level of prize money which is both appropriate to the prestige of the event and which gives the players full and fair reward.”

It certainly is a global marketplace with players and spectators coming from all over the world and TV rights being sold to many countries.

It was also reported that there were pressures to increase the value of the prize in sterling terms due to sterling weakening against the dollar and euro over the last year. It remains to be seen though if they would decrease the value of the prize in future years if sterling strengthens!

As well as currency issues there’s also an interesting debate to be had concerning discrimination between the men’s and ladies’ championship. Up until 2007 the men’s champion was paid more than the ladies’ champion. This was then changed to avoid discrimination but as every tennis fan knows the men’s game is played over 5 sets whilst the ladies’ is over 3. Does this mean that the men are being paid proportionately less?

An interesting debate but I’m sure that when it comes to the finals this year the players will be more concerned with winning the championship than discussing discrimination issues!

Ready to go to the movies? Don’t forget your drink, your popcorn and your derivatives…

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Students are probably aware of what currency futures are. To quote our ExPress notes:

“These are contracts, transacted over an exchange, representing a standard amount of currency which can be bought or sold with a specified future settlement (delivery) date, at a rate expressed in another currency. Settlement is guaranteed by the exchange, which acts as counterparty.”

Currency futures, interest rate futures and even relatively obscure items such as soya bean futures are all currently traded.

Last week however an application was made to the US futures regulator to create a contracts market for film futures. If the application is successful this will mean that there will be a “movie derivatives” exchange.

In simple terms this will enable people to “bet” on whether a movie makes money or is a financial failure. Traders will be able to buy and sell contracts speculating on how much money a movie will make at the box office.

As an example of how movie futures could work, a futures contract could be bought by a trader valued at say $1 for every $1m in expected ticket sales during the first month. Therefore, if the market believes a movie would make $100m, traders would be able to buy a futures contract for $100.

If box office estimates were to rise to say $150m because of positive movie critic reviews in the run up to the movie launch, holders of existing contracts would be able to resell them for $150. This would result in a profit of $50.

Of course, if the reviews aren’t very good then the box office estimates would decrease and the value of the contracts would go the other way and there would be a loss!

There are two opposing views to this.

Some people say that this offers a new, novel way for movie producers to manage their financial risk.

Last week however, the Motion Picture Association of America (MPAA) joined forces with producers and cinema owners to oppose the move on the basis that it would encourage speculation, financial irresponsibility and could be harmful to film releases.

To be honest though as an ACCA P4 tutor I find all this so interesting that I personally think they should make a film out of it – surely it would be a box office hit?

Despite the recession, one food product is now 35% more expensive than last year. You’d be bananas not to know the reason.

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I had dinner with a group of friends earlier in the week and there was a nice mix around the table between finance people and marketeers.

When the dessert menu was brought out and one of the group decided to go for the “banana split” dessert an interesting discussion started.

According to the marketeers around the table, bananas are considered to be “known value items” by the large supermarkets. These items are considered by the supermarkets to be products where the average customer has a reasonable knowledge of how much they should cost. These include items such as bread and milk (and bananas!).

They are therefore always priced competitively by the supermarkets as it is the price of these products that customers most commonly compare between the supermarkets. If the supermarkets can attract customers to their shops with attractive pricing of these “known goods” then they can maybe be more relaxed with the pricing of other goods!

According to a recent report in the trade magazine, the Grocer, banana prices are heading towards the critical point of £1 per kilo. This is approximately 35% higher than the price one year ago. This is a huge increase in percentage terms and customers are noticing.

And the reason for the increase in prices?

Well, this was where the finance people around the table suddenly came into their own.   Apparently, there are two main reasons for the increase in prices.

Firstly, the increase in oil prices. Shipping companies that transport the fruit over to Europe have been hit by the increase in their shipping fuel costs as a result of the increase in oil prices.

Secondly, banana importers have been hit by the weakness of sterling. As a dinner companion put it succinctly, “the bananas are more expensive as it’s simply costing the importers more pounds to buy the same amount of bananas they were buying for less pounds last year”.

Luckily for my dinner companions though, just as I was about to start talking about exchange rate risk and hedging facilities the desserts arrived and we suddenly forgot all about the price of bananas!

You’d think that an airline with grounded planes would have a falling share price? Think again.

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At the time of writing this, British Airways’ cabin crews are on strike, claiming that management has attempted to impose harder working conditions on them.  Both the airline and the labour union acknowledge that BA must make very substantial cost savings in order to survive, so the dispute is about where those cost savings can come from.

BA have contingency plans which they claim will get 65% of passengers to their destination, including “wet leasing” aircraft from other airlines. It’s one of the biggest news stories in European business at the moment.

Against a backdrop of record trading losses, costs of a strike (lost revenue, lost goodwill, extra standby costs), you might well expect the share price to fall.

In fact, since the start of 2010, British Airways’ share price has steadily risen by 20%.  The actual announcement of the strikes had no significant effect on the share price at all.  How can this be?

The answer is simply that the share price in an efficient market reflects expectations about long-term future profitability.  BA is seen by many analysts as a company with a great core business, but with simmering problems with unrealistic labour unions and inflated staff costs.  This has long produced a discount on the company’s share price, with low P/E ratio.  The fact that this has erupted into a strike has long been anticipated, so its actual occurrence hasn’t surprised anybody.  Indeed, the market’s confidence in the long-term future of the company appears to be rising, as Willie Walsh, the airline’s CEO, is seen as tackling some of the company’s deepest long-term problems instead of skirting around them.

Regardless of the alleged rights and wrongs of the dispute itself, it’s an interesting illustration of how share price valuation actually happens and how markets for some very deeply traded shares do appear to be rational.

$25 billion – was the gate strong enough?

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Our blog post last Wednesday concerning leveraged buy outs (LBO) and Manchester United received some emails from students with a number of them asking how popular LBOs are today.

The big picture answer is that they are not particularly popular nowadays for a number of reasons, not least of which is that debt funding at the moment isn’t easy to come by. Given all the turmoil in the financial system over the last couple of years banks are much more risk averse than they used to be.

The 1980s was the heyday in terms of LBOs and a good book to read is “Barbarians at the Gate: The Fall of RJR Nabisco”. It’s a well written book which tells the story of the $25 billion battle for RJR Nabisco. Although the event took place over 20 years ago it’s a great read which explains in a very reader friendly way the issues behind LBOs.

The book is one of the best read business books of all time and if I’m honest, when I read it it felt more like a thriller than a real life account of corporate America in the 1980s. All in all, a book that I would highly recommend.

Of course, if you’re studying for your exams then you may not have a lot of spare time for reading but you can always read it after you qualify!

Manchester Utd and Leveraged Buy Outs. What’s all the interest about?

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There was a meeting yesterday attended by various financial heavy hitters including renowned deal maker Keith Harris and Goldman Sachs chief economist Jim O’Neill.

What were they meeting for? Well, if press reports are anything to go by they were meeting to discuss proposals to buy one of the most famous football clubs in the world, Manchester United.

Back in 2005 Manchester United was a public company. The Glazer family then used a Leveraged Buy Out (LBO) to take the football club private (i.e. move it from a public company which was quoted on the stock exchange to become a private company).

There has been a lot of bad feeling amongst the Manchester United fans who feel that following the LBO the clubs finances are now causing real problems. Before the LBO the finances were healthy whereas now there is a huge debt obligation to fund which some feel is preventing them from buying players on the transfer market. The meeting yesterday was in connection with acquiring the club from the Glazers and restructuring the finances.

An LBO is something which some students find hard to grasp as it involves a company changing ownership with the funding mainly being secured on the assets of the company being acquired.

In simple terms it involves the acquiring company using significant amounts of borrowed money to fund the acquisition. In most cases the assets of the company being acquired are used as guarantees for the loans. This enables acquiring companies to fund the acquisition by way of debt as opposed to equity. The real problem though lies in the fact that interest has to be paid on these loans and on a number of occasions the interest payments on these loans have been so large that the company could not meet the payment obligations.

Whilst the workings of LBOs are interesting to students studying for their professional exams, I’m sure that the focus of most Manchester United supporters is getting ownership of their club back into the hands of what they consider to be real supporters of the club.

The figures though are quite staggering. For example, in the last three years Manchester United have paid £130 million in interest payments which to put it in perspective is more than five times what they sold David Beckham to Real Madrid for.

T-shirts and IPOs. Fashion or finance?

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I was impressed with two of my students last week. One of them was wearing a Superdry T-shirt and instead of talking about the fashion side of things they were discussing the concept of initial public offerings (IPOs).

If you’re not aware of the Superdry brand they are part of the Supergroup  company which was launched 6 years ago and has fast become an iconic fashion brand with celebrities such as David Beckham seen wearing their clothes.

Supergroup is planning on raising £125 million to fund future growth plans and reward shareholders. Methods of raising funds for companies are often examined in the professional exams and as well as understanding the methods having an appreciation of the topical issues will help the good students stand out in the eyes of the examiner.

Supergroup has gone against the recent IPO trend though as they are still planning on going ahead with the offering!  Given the volatility of the equity markets so far this year, fellow retailers New Look and Matalan recently announced plans to postpone their proposed IPOs. Blackstone, the operator of Madame Tussauds in London also recently announced that it would shelve plans to float.

The Supergroup IPO will be an interesting one to follow as if it is successful then it could well encourage other companies to look for similar fund raising.

Whatever happens though given the topic of discussion was on IPOs rather than fashion then I’m sure that the two students will have a future career ahead of them in finance rather than fashion…

Perpetual bonds, the mexican restaurant and two crazy people?

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I had a lovely dinner last night at a nice Mexican restaurant with a good friend who is also an accountant. We’ve known each other for years and unfortunately always have a habit of talking about finance and business together. This is fine when we are by ourselves but if our “other halves” are with us then it can get a bit boring for them.

Last night we were determined not to keep on talking about finance and all was going well until some nice tortillas arrived. Within a couple of minutes the talk had switched to perpetual bonds.

Were we crazy or was it a logical step to go from tortillas arriving to perpetual bonds?

Well, in our defense the logic behind the switch was that Gruma, Mexico’s leading tortilla maker issued some perpetual bonds a few years ago. Some students have to think hard about whether a bond without a maturity (redemption) date has a (market) value. To remove any doubt, Gruma issued USD 300 million worth of perpetual bonds.

The appetite for perpetuals is starting to spread to Asia, especially among investors in search of high-yield investments.  Last year for example, the Union Bank of India (UBI) announced an issuance of such an instrument.

Back to my point of whether we were crazy or it was a logical step to go from tortillas to perpetual bonds. At the table last night two of us thought it was logical whilst the other two thought we were crazy…

So what have football players’ contracts got to do with the exams?

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Over the years contracts for professional football players have developed significantly but what’s the link to the exam syllabus?

Agency theory (included in papers such as ACCA F9) occurs when one party (the principal), employs another party (the agent), to perform a task or tasks on their behalf. Within this theory there is always a danger that the objectives of the two parties may not coincide and there may be problems with what is known as goal congruence.

Typically agency theory would apply to the relationship between shareholders and management. However, there is an argument that a form of agency theory could apply between management as the principal and an employee as the agent.

I’m a keen follower of football (soccer) and the contracts of professional players are becoming ever more complicated. In the “old days” the contracts would be very simple affairs with a monthly salary, a time limit to the contracts and maybe a team bonus if the team won a competition.

Nowadays football is big business. For example, Cristiano Ronaldo’s move last year from Manchester United to Real Madrid was for a new world record in terms of transfer fees (£80m) and his annual remuneration from Real Madrid alone will be in the region of £11m per year.

I’ve no idea what Ronaldo’s contract is like but my guess is that most professional football contracts have various measures built in to ensure that there is goal congruence.

Ideas for items that could be included within football contracts to help goal congruence include:

– Bonuses based on number of games played (i.e. the player will only get these if he is performing well and is in the team),

– Bonuses based on international appearances (this is independent confirmation that he is performing well)

– Penalty provisions for undertaking activities that could cause injuries (e.g. bungee jumping or extreme sports).

All of the above would help in ensuring goal congruence.

Always keep an eye open in real life for any situations where goal congruence is present. If you can link real life situations you come across with the exam syllabus it will help you retain the knowledge needed for exam success.

Monte Carlo or bust.

I bumped into an old friend of mine that I haven’t seen for nearly a year the other day. He’s a really good guy and I’ve known him a long time. We were chatting over a coffee and the subject of Grand Prix motor racing came up. He’s a keen follower of the sport and was excited by the prospect of Jenson Button joining Lewis Hamilton on the McLaren team. He was even more excited in that he was planning a trip to the Monaco Grand Prix this coming May with a group of friends. It was a lifelong ambition of his to make the trip to Monaco to see the Grand Prix and he’s been lucky enough to secure some tickets for the Grand Prix in May.

I was excited for him and, if I’m honest, slightly jealous! Having said that, May is always a busy month for us tutors so I’m not sure I’d be able to get the time off to join him. In fact, the closest I’ll get to Monaco in May is the Monte Carlo simulation model which as every good P4 student knows is a model that uses probability distribution analysis to analyze the possible outcomes of a project. It is built on the simultaneous changes of many variables, the relationships between these variables being defined in advance, e.g. if price is reduced, how much demand may go up. (Monte Carlo is also a district within Monaco!).

Now, I love teaching P4 and explaining the mechanics of the Monte Carlo simulation is good fun but I must admit that if a spare ticket does comes up then the joys of teaching the Monte Carlo model may have to take a back seat to the joys of watching the Grand Prix!