How Euribor Affects Your Savings and Loans

Euribor (Euro Interbank Offered Rate) is a widely used benchmark for euro-denominated short term loans. Calculated and published every working day, it indicates the typical interest rate that European banks are asking for their lending on the interbank market for maturities ranging from 1 week to 1 year.

euribor

Here you can find more detailed explanation of what Euribor is and how it is determined.

Euribor effects on financial products

Although Euribor and the interbank market only concern transactions where both parties (the lender and the borrower) are banks, changes in Euribor have significant effects on a wide range of financial products and their interest rates, such as floating rate bond yields, fixed income derivatives and also interest rates on consumer products like savings accounts, consumer loans and mortgages.

Interest rates explicitly linked to Euribor

Many financial products, especially in the corporate banking world, have their interest rates directly linked to Euribor. For example, when a company (such as a carmaker or an airline) issues variable interest rate bonds to finance their business, the bond’s prospectus (a lengthy document governing its terms and conditions) can contain a rule like this: The yield (interest rate) will be adjusted every 6 months (typically after a coupon payment) so that it is 80 basis points (0.80 percentage points) above 6-month Euribor.

In practice it means that when 6-month Euribor is 1.35% on the reset day, it will make the new yield equal to 2.15%, which will remain for 6 months until the next reset. As a result, both the issuing company and the investors who buy the bonds will closely watch Euribor, as it will directly affect their financing cost (for the company) or return on their investment (for the investors).

How it works with consumer products

Many consumer products like loans or mortgages work in the same way as the corporate bonds described above.

For example, when you take a variable rate mortgage in euros, the interest rate can be expressed as 3-month Euribor + 1.20%. As a result, the interest on your mortgage goes hand in hand with Euribor and you are in the same position as the bond issuing company in the example above. If Euribor increases by 1 percentage point, so does the interest rate on your mortgage. This can be very dangerous in the current situation when Euribor is extremely low (all maturities below 0.30% at the time of writing this article). If it increases in the future, a variable rate mortgage that appears affordable now may become very expensive.

Many consumer products have their interest rates not linked to Euribor explicitly, but they are still affected by its changes due to the nature of the banking business, particularly the fact that a bank uses the interbank market for short-term financing and effectively Euribor is a measure of its short-term financing cost.

There are of course other factors (such as marketing and getting or retaining customers) which a bank takes into consideration when setting interest rates on savings accounts or loans, but in the long run it has to keep its rates in line with the overall interest rate level in the economy. For example, now with interest rates very low, it is hard to find a euro savings account earning more than 1-2%.

In short, if you have financial products denominated in euros, it is worth knowing what Euribor is doing.

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What is Euribor and how is it determined?

If you live in Europe or have savings, loans or a mortgage denominated in euros, Euribor most likely affects your life, or at least your personal finances. You have probably heard about it in the media, where experts often discuss its changes and implications of Euribor being too low or too high. Nevertheless, if you are like most people, you may not be entirely sure what exactly Euribor is and how it is calculated or determined.

euribor

Euro Interbank Offered Rate

The word Euribor is short for Euro Interbank Offered Rate. In general it is an interest rate on short-term euro-denominated loans.

The word “interbank” means that it only concerns transactions between banks – when one bank lends money to another bank; not when a bank lends money to a non-banking party, such as a business or a consumer.

Euribor and Euribid

The word “offered” means that it is a rate at which a bank is willing to lend money. This is typically a little bit (like 0.20 percentage points) higher than the rate at which the same bank is willing to borrow money, which is less widely known and called Euribid. The relationship between Euribor and Euribid is the same as the relationship between a stock’s offer price and its bid price.

Euribor maturities

In fact, Euribor is not a single number, but a set of several numbers, which represent interest rates on loans with different maturities. At present there are 8 Euribor maturities – 1 week, 2 weeks, 1 month, 2 months, 3 months, 6 months, 9 months and 12 months (until October 2013 there were 15 maturities). Therefore, when talking about Euribor and how much it is, you need to also state the maturity, for example you say that 6-month Euribor is 0.16%. Note that all Euribor rates are quoted in annualized form.

Euribor rate vs. interest rates used in practice

Euribor rates are updated every working day. While there is only one Euribor rate for each maturity on any given day, in practice this does not mean that all lending on the interbank market (on that day for that maturity) is agreed at the same rate. Banks are private enterprises and, although highly regulated, they are free to borrow and lend among themselves at whatever rate they agree on.

As a result, when 6-month Euribor is 0.20% on a given day, some banks may be willing to lend at 0.17%, others at 0.22% and others at different rates. The published Euribor figure is an average that represents a rate that is typical for that kind of transactions on that day.

Euribor panel banks and EMMI

To find out the typical interest rate and calculate Euribor every day, there is a panel of large banks, which report their quotes to the organization that calculates and maintains Euribor – the European Money Markets Institute (EMMI), formerly known as Euribor-EBF (European Banking Federation).

The banks represented in the Euribor panel are selected based on volume of their relevant transactions and with respect to the “diversity of the euro money market”. At present the panel consists of 25 banks: 21 banks from 10 different Eurozone countries and 4 non-Eurozone banks (Barclays, Danske Bank, JP Morgan Chase and Bank of Tokyo Mitsubishi). The composition of the panel is regularly updated.

More information

For more information on Euribor, Libor, ECB rates and Eonia; follow our previous blog post here.

 

 

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Euribor vs. Libor, ECB rates and Eonia

For people who don’t work in banks, Euribor can easily be confused with some other financial terms and rates. This article looks at the most common ones.

First let’s define Euribor. Short for Euro Interbank Offered Rate, it is the average interest rate at which European banks are willing to lend money to each other (hence “interbank”). Actually, it is not a single rate, but a set of several (currently eight) interest rates for different maturities ranging from 1 week to 1 year.

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Euribor vs. Libor

Libor is probably more familiar than Euribor to most people. The reason is that it has been around much longer. While Euribor only started when the European Monetary Union was established in 1999, the history of Libor goes back to mid 1980’s.

Libor (London Interbank Offered Rate) is generally the same thing as Euribor – a set of reference interest rates based on the interbank lending market – but with two very important differences.

Firstly, there is a difference in geography, or in composition of the panel of banks which report their interest rate quotes for the reference rate calculation. For Euribor they are banks trading in the Eurozone, while for Libor they are banks trading in London. Of course, given the globalization and concentration of the financial industry, many large banks have offices and trading desks in multiple countries and they are represented in both Libor and Euribor panels (for example Deutsche Bank, Societe Generale, Barclays or Citibank, to name just a few).

Secondly, while Euribor only applies to Euro-denominated lending, there are different Libor rates for different (currently ten) currencies, including British pound (GBP), US dollar (USD), Japanese yen (JPY) and even Euro itself. It is therefore common to also specify the currency when talking about Libor rates – for example you say GBP Libor or USD Libor.

Euribor vs. Euro Libor

EUR Libor rates (Libor rates for the Euro currency) are not exactly the same thing as Euribor, although their values are usually very similar. The first of the above mentioned differences (composition of the panel of banks) still holds. EUR Libor is based on rates reported by London banks, while Euribor is based on rates reported by banks trading in Frankfurt, Paris, Milan and other places in the Eurozone.

Euribor vs. ECB interest rates

Euribor is also often confused with the interest rates decided and published by the European Central Bank (ECB). There is a strong economic relationship between them, as the very essence of ECB’s monetary policy is to influence liquidity on the interbank market (and therefore the Euribor rates) through its various operations and tools (one of them being the ECB interest rates).

However, the ECB does not have any direct power over Euribor. While ECB interest rates apply to borrowing and lending between individual commercial banks and the ECB, Euribor rates apply to transactions among commercial banks themselves and are determined by supply and demand, without any direct involvement of the ECB.

Like Euribor, Eonia (Euro Overnight Index Average) is also an interbank reference interest rate and also applies to the Eurozone money market and Euro-denominated transactions. It is calculated in a way very similar to Euribor, using quotes by the same panel of banks.

The only difference is in the tenor (maturity or time horizon). While Euribor is a set of several rates for maturities ranging from 1 week to 1 year, Eonia is only a single rate which applies to overnight transactions (lending money only until the next day). With some simplification you can say that Eonia is like 1-day Euribor.

 

 

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Hedge Fund: The Advantages and Disadvantages of Investing. Part 2: Disadvantages

Hedge funds have significant benefits, such as higher returns, low correlation to traditional investment products and access to a wide range of assets and unusual trading strategies. At the same time, there are several limitations and disadvantages which you should keep in mind when considering hedge funds as an investment.

hedge funds

High minimum amount

Although hedge funds are generally less tightly regulated compared to mutual funds, their relative freedom comes at a cost. In order to avoid some of the regulatory requirements, hedge funds can only accept so called “qualified investors”, which simply said means rich investors who are able to withstand losses from the often risky trading strategies.

In practice this translates into higher minimum investment amount that a typical hedge fund would accept. While it is possible to invest as little as a hundred dollars in a mutual fund, for hedge funds the minimum is usually tens or hundreds of thousands and often much more. Furthermore, investing all your capital in one hedge fund is rarely a good idea and if you want to diversify and invest in at least 5 or 10 different funds, you need to multiply the minimum amount by that.

Low liquidity

Mutual funds typically offer daily or weekly liquidity. You decide one day that you want to withdraw money from the fund and a few days later the cash is in your bank account. It is less simple with hedge funds. Their trading strategies often involve thinly traded assets and therefore liquidating a position quickly (to get cash for investor withdrawals) can cut into profits. In order to avoid that, hedge funds place various restrictions on redemptions:

  • With many funds you can’t withdraw money during the first few months (and sometimes years) after your investment. This is called lock-up period.
  • You often have to notify the fund manager well in advance (several weeks or months) when you wish to withdraw money, in order to allow sufficient time for liquidating positions. This is called notice period.
  • Many funds only allow redemptions on specific dates or with a particular frequency, such as at the end of each quarter.

High fees

The cost of hedge fund investing is much higher than with mutual funds. Typically a hedge fund management firm makes money from two sources.

Firstly, like with mutual funds there is management fee, charged as a fixed percentage of the invested amount.

Secondly, there is performance fee (also called incentive fee), charged as a percentage of profits. Its calculation often follows additional rules, for example the fee only applies to returns over a minimum rate (called hurdle rate), which is either fixed (e.g. 5%) or linked to a benchmark (e.g. a stock index).

For illustration, let’s say the management fee is 2% per year and the performance fee is 20% (this is a very popular fee structure in the hedge fund industry, referred to as “two and twenty”), with a fixed hurdle rate of 10%. Let’s say you have invested one million dollars in the fund and it returns 30% in the first year, which is 20% or 200,000 dollars above the hurdle rate. Out of that the fund management company gets 20,000 (2% of 1,000,000) in management fee and 40,000 (20% of 200,000) in performance fee.

Limited transparency and costly due diligence

Compared to mutual funds, it is more difficult to collect and analyse information on hedge funds. The reasons are fewer reporting requirements and the secretive nature of hedge fund managers, who want to keep their trading methods and positions hidden from the competition.

Furthermore, it is not easy to find investment professionals who really understand hedge funds and provide unbiased advice at the same time. The process of hedge fund investing, when done right with proper due diligence, requires substantial amount of time and money.

We take a look at the advantages of investing in hedge funds in our previous post.

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Hedge Fund: The Advantages and Disadvantages of Investing. Part 1: Advantages

Hedge funds have become increasingly popular in the last one or two decades, as investors have discovered the benefits of adding them to their portfolios. This article explains the most significant ones – diversification potential, higher returns and access to new investment opportunities.

hedge funds

Diversification

Diversification potential is widely accepted as the greatest benefit of hedge funds (and alternative investments in general). By adding hedge funds to a typical portfolio of stock and bond investments you can achieve higher risk-adjusted return (higher return and/or lower volatility, other things being equal).

The reason is that most (although not all) hedge fund strategies have consistently shown low correlations to the performance of global stock and bond markets. In other words, hedge funds often make profits even when stock prices are falling and traditional investments are losing money.

Strategies which tend to perform particularly well during periods of high volatility and decreasing stock prices include short selling, global macro and managed futures. On the contrary, the performance of strategies with net long market exposure, such as long/short equity or distressed securities, tends to be more highly correlated to market returns.

Higher returns and alpha

Investment theory differentiates between two components of returns – alpha and beta.

Beta results from systematic exposure to the market. For example, when you buy an index fund which tracks the S&P500 index, such as the SPY ETF, it is highly likely that your return will be the same as the performance of that index. Your entire return will come from beta. The downside is that you will only make money when the stock market as a whole goes up.

On the other hand, if you invest with a skilled manager who is able to pick stocks which outperform the market, your return will be higher than the overall market’s performance. The difference is alpha – the part of return which comes from skill, rather than from taking systematic risk.

Naturally, alpha is very highly valued in the investment world, because very few people (including professional fund managers) are able to consistently outperform the market and generate positive alpha in the long run. Many of these highly skilled managers work for hedge funds and therefore hedge funds are known for being able to generate alpha.

This does not mean that all hedge funds always perform better than traditional funds. While most people hear about hedge funds when media report stories about star managers who have just made 100% or more in a single year, it is extremely rare for a fund or a manager to deliver such performance year after year. Many hedge funds can consistently beat the market, but triple digit returns are outliers.

In general, some hedge fund styles, such as global macro, have (as a group) shown higher long term returns than others, such as short selling. However, even greater differences exist among individual funds within each style group.

New opportunities

Besides higher returns and diversification potential, hedge funds also represent a possibility to invest in assets and trading strategies which would be inaccessible with traditional funds. Examples include highly illiquid securities or derivatives. This is due to the fact that, compared to mutual funds, hedge funds are more loosely regulated and their managers enjoy greater freedom in terms of what and how they can trade.

When investing in hedge funds, you should also be aware of their limitations, disadvantages and risks, which often arise from the same factors as the above listed advantages – greater freedom in trading strategies, access to illiquid or exotic assets and greater importance of the fund manager’s skill (which the manager wants to be handsomely compensated for).

We take a look at the disadvantages of investing in hedge funds in our next post.

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Introduction to Hedge Fund Trading Styles

To many people hedge funds are a mysterious part of the financial industry. Even many financial professionals don’t understand what exactly hedge funds do.

In fact, hedge funds work much like traditional mutual funds. Most of them trade and invest in the same securities, like stocks, bonds or currencies. The difference is in the way they trade these securities, i.e. leverage, direction, time horizon or decision making tools and procedures.

Not only do hedge funds as a group differ from traditional funds – most importantly, there are big differences in trading styles within the hedge fund universe. Understanding the styles, particularly their risk exposures and performance drivers, is essential to successful hedge fund investing.

Four big groups are:

  • Equity market directional.
  • Corporate restructuring.
  • Relative value.
  • Macro and opportunistic.

Holborn_Assets_Money_Tree

Equity market directional hedge funds

As the name suggests, equity market directional funds trade equities (stocks). Unlike stock mutual funds, they often take short positions, apply leverage or trade more frequently. Sub-styles include long only funds, short selling funds and the very common and popular long/short equity style, where both long and short positions are open at the same time, typically with net long exposure to the overall market.

Like stock mutual funds, hedge funds often specialize in a particular industry, geographical area or market capitalization. Decision making is based on in depth fundamental analysis, quantitative models, or a combination of these.

Corporate restructuring hedge funds

Corporate restructuring funds take advantage of special situations such as mergers, acquisitions or cases when a company is in severe difficulties or even bankruptcy. The securities (mostly stocks, bonds and options) traded by corporate restructuring funds are often very illiquid or even not exchange traded. Sometimes the hedge fund manager is trying to actively influence the company’s management, which is known as activist investing or activist hedge funds.

Profit is made when an event (e.g. a merger) happens as the manager has expected or when the company is turned around and survives its distress situation. Popular sub-styles include event driven funds, distressed securities funds and merger arbitrage funds.

Relative value hedge funds

Key characteristic of relative value funds is that their net exposure to the stock or bond market as a whole is zero or very small. This is achieved by taking long and short positions in similar securities (for example two different mining stocks or two bonds with different maturities) in equal size at the same time. A trading opportunity arises when relative prices of a pair of securities diverge from their long term average pattern and the hedge fund manager bets on them coming back (it is called mean reversion). Because relative price changes tend to be very small, these funds often apply high leverage, which can be very risky if something unexpected happens.

In theory, the performance of relative value funds should be uncorrelated to the direction of the overall market, making them suitable for portfolio diversification. Common sub-styles include equity market neutral (stocks), fixed income arbitrage (bonds), volatility arbitrage (options) and convertible arbitrage (convertible bonds and stocks).

Macro trading and opportunistic hedge funds

The last group contains particularly global macro or macro funds, which trade assets driven mostly by macroeconomic trends, such as currencies, interest rates, commodities and stock indices. Some of these funds are managed by experienced economists, relying mostly on fundamental analysis and predicting global macroeconomic and political trends, while other funds are quantitative and trade based on complex computer models.

Other common styles within this group are commodity trading advisors (CTAs) or managed futures funds, which trade mainly futures contracts on commodities and other assets.

Different hedge fund style classifications

Numerous classifications of hedge fund trading styles have evolved over time. Some of them use different names or aggregate the individual sub-styles in different groups, but more or less all approaches recognize the common trading styles explained above.

Hedge funds with no single style

To make things even more complicated, some hedge funds trade in very unique ways and don’t quite fit in any of these groups. There are also funds which combine multiple styles (multi-strategy funds) and funds which invest in other hedge funds (funds of funds).

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Choosing an Offshore Company Location

There is no perfect offshore company location.  Different jurisdictions have different advantages and disadvantages. When selecting one, there are a number of factors that should be considered.

Offshore_Company_Formation_Location

Taxes

Reducing or eliminating taxes is probably the most common motivation for offshore company formation. Unfortunately, you can’t simply choose a country with zero corporation tax without considering your particular situation. The following are some questions you should ask yourself:

  • What is your country of residence?
  • Are there any double taxation treaties between your country of residence and the offshore country?
  • Is the offshore country included in any black lists or considered a tax haven by your country’s laws? There are often exceptions in tax laws of developed countries, effectively treating companies from some tax haven jurisdictions as domestic companies for tax purposes.
  • How will you extract profits from the offshore company? The typical ways are salary and dividends, but sometimes there are other alternatives, such as getting paid for services which you provide to your offshore company.

Anonymity and company directors

Privacy is another common motivation. Names, addresses and other personal details of company directors and shareholders are publicly accessible in most developed countries. Many offshore jurisdictions don’t have this requirement.

Some countries allow companies to have non-resident directors, while others will require you to hire a nominee director, which may or may not be convenient for your business requirements.

Cost and ease of incorporation

Incorporating a company in some offshore countries can be done remotely, take only a few days and cost just a few hundred dollars. In other locations the cost goes into thousands, you will have to provide lots of documents and in some cases even physically travel there. Required initial capital also varies – from zero to tens of thousands.

Maintenance cost and accounting requirements

The cost and administrative workload in subsequent years can be as little as paying a small fixed annual fee in some locations, but it can involve complex accounting and auditing requirements in others.

Reputation

In many industries, for example finance or consulting, being based in London or Switzerland will earn you extra points in reputation, while an address in a remote Caribbean island may cost you business. In such cases, choosing a more traditional location with higher taxes and higher cost of doing business may be worth it.

On the contrary, if you are merely operating a website or have a business model where reputation does not play a significant role, it would make sense to choose a cheap and low-tax jurisdiction.

Industry specific regulations

Different countries have different rules and regulations in some industries. Many kinds of services, for example in finance, health care or gambling, are only accessible to domestic companies or subject to extensive licensing and reporting requirements. In such case, moving your business offshore could make it much harder, more expensive and sometimes impossible to comply and continue to provide your services legally. Before setting up an offshore company, make sure that it is legal for companies from the particular offshore country to do business in your industry in all countries where your customers live. Make sure you understand all regulatory requirements.

Combining all factors

Unfortunately, there is no offshore company location that would score high on all the above listed factors. Some of the criteria are clearly in conflict with each other. For example, it is hard to have the reputation of a big global corporation, remain completely anonymous and enjoy low maintenance cost all at the same time. Therefore, it is essential to honestly evaluate your particular needs and set priorities before you select a suitable offshore company jurisdiction. It is best to think about this and roughly know what you want before you approach a lawyer or formation professional.

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What Is the Best Offshore Company Location?

This is probably the most frequently asked question when it comes to offshore companies. The selection of possible jurisdictions seems endless – from well-known countries like Switzerland, Singapore or the Netherlands to small islands and places that most people have never heard of, like Grenada, Samoa or Marshall Islands.

The answer to this question is very simple, but not what most people want to hear: There is no perfect, one-size-fits-all offshore company location. There are several reasons for that.

Why there is no perfect offshore company location

  • Different people have different goals and motivations for going offshore. Your best offshore location will depend on your particular needs.
  • It will also depend on your country of residence, your industry, applicable laws and treaties between countries.
  • Everything in the world of offshore companies and taxes constantly changes. A country that seems best now may get blacklisted or change its laws next year.

International Finance

Specific needs and objectives

People have different needs and objectives when setting up an offshore company. The first thing that comes to mind is reducing or eliminating taxes, but there are many other motivations:

  • Privacy
  • Lower cost of doing business
  • Fewer accounting and administrative duties
  • Addressing particular industry regulations and restrictions

You must know which of these motivations matter to you and what you want to achieve before selecting an offshore company location.

Your country of residence and other circumstances

Furthermore, the selection of an offshore company location must be made with respect to your existing personal and business affairs, such as:

  • Your country of residence
  • Your industry
  • Your business model
  • Your target markets (where your customers live)
  • Your financing and banking needs

Make sure you understand any double taxation treaties and other bilateral agreements between your country of residence and the particular offshore country. Also make sure that your country of residence allows foreign companies to do business in your industry.

Changes in onshore and offshore laws and regulations

Offshore company rules and regulations change very quickly, as big developed nations have become more desperate to collect taxes and balance their public budgets in the recent years. Many offshore countries change their laws to comply with new requirements, they are being added to and removed from various black lists and new double taxation agreements are being signed.

As a result, an offshore location that was perfect (for your needs) last year may not be suitable now and, on the contrary, a country which you had never thought of can now become perfect for your needs.

Choosing the best offshore company location

In light of the above, asking the question “What is the best offshore company location” is not very useful, unless you add “for me” and “now” to the end. Before selecting a jurisdiction, make sure you have considered your needs and unique circumstances across all the key areas, such as taxes, anonymity, reputation effects, incorporation cost, accounting requirements and industry specific regulations.

 

 

 

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