Comments on: Leverage and Interest Rate Risk http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/ Helping you invest and prosper Sun, 12 Feb 2012 00:54:40 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Jonas Björkman » Fixed income attribution http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-191283 Jonas Björkman » Fixed income attribution Tue, 12 May 2009 21:49:19 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-191283 [...] Leverage and Interest Rate Risk | Canadian Capitalist [...] [...] Leverage and Interest Rate Risk | Canadian Capitalist [...]

]]> By: The Financial Blogger » The Opportunity Cost of Paying Interest over an Investment Loan http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-43230 The Financial Blogger » The Opportunity Cost of Paying Interest over an Investment Loan Fri, 08 Jun 2007 10:32:14 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-43230 [...] interest can compensate of the risk of interest. Canadian Capitalist wrote another post related to Leverage and Interest Rate Risk. He was explaining that we must consider the opportunity cost of paying interest when we contract [...] [...] interest can compensate of the risk of interest. Canadian Capitalist wrote another post related to Leverage and Interest Rate Risk. He was explaining that we must consider the opportunity cost of paying interest when we contract [...]

]]> By: FinancialJungle.com http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42830 FinancialJungle.com Thu, 07 Jun 2007 01:34:47 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42830 FourPillars - I've written a piece on leveraging to buy BMO: financialjungle.com/2007/05/13/investing/bmo-a-poster-child-for-cash-flow-leverging/ I agree that the dividends should be considered as opportunity costs, but whatever. :D Reality is, leveraging to buy BMO is still much safer than buying stocks that don't pay dividends, because dividends are more reliable than capital gains. Additionally, when you strip away the dividends and measure share prices alone, I'm not convinced that the average dividend-less stock can still outperform BMO. Having said that, I'm not comfortable with over-leveraging. 15% is the most I can tolerate. I'm currently sitting on 17% cash. FourPillars – I’ve written a piece on leveraging to buy BMO:

financialjungle.com/2007/05/13/investing/bmo-a-poster-child-for-cash-flow-leverging/

I agree that the dividends should be considered as opportunity costs, but whatever. :D Reality is, leveraging to buy BMO is still much safer than buying stocks that don’t pay dividends, because dividends are more reliable than capital gains. Additionally, when you strip away the dividends and measure share prices alone, I’m not convinced that the average dividend-less stock can still outperform BMO.

Having said that, I’m not comfortable with over-leveraging. 15% is the most I can tolerate. I’m currently sitting on 17% cash.

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42794 Canadian Capitalist Thu, 07 Jun 2007 00:05:48 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42794 FB: You are right. Both investment returns and interest payments are being reduced by the inflation rate as well. You can compare nominal dollars in the same year (in fact, in the post all the 10th year calculations are in nominal dollars) but to compare 1st and 10th year dollars, you have to account for inflation. FB: You are right. Both investment returns and interest payments are being reduced by the inflation rate as well. You can compare nominal dollars in the same year (in fact, in the post all the 10th year calculations are in nominal dollars) but to compare 1st and 10th year dollars, you have to account for inflation.

]]> By: The Financial Blogger http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42784 The Financial Blogger Wed, 06 Jun 2007 23:02:47 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42784 Correct me if I'm wrong (sometimes I think maths were created to increase Tylenol's sale) both your monthly payment and your investment return is being reduced by the same 3% inflation rate, nominal dollar value comparaison approach should be as good as actual dollar value. In the end, the gap between the interest rate paid and the investment return will be represented for both situations. Thx. FB. Correct me if I’m wrong (sometimes I think maths were created to increase Tylenol’s sale) both your monthly payment and your investment return is being reduced by the same 3% inflation rate, nominal dollar value comparaison approach should be as good as actual dollar value. In the end, the gap between the interest rate paid and the investment return will be represented for both situations.
Thx.
FB.

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42760 Canadian Capitalist Wed, 06 Jun 2007 21:53:13 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42760 FB: Not sure I understand your question. The only way to compare money in the first year with the tenth year is to take inflation into account. Inflation affects loan payments positively (in real terms it is decreasing) and opportunity cost negatively (part of the 7.2% return is inflation). FB: Not sure I understand your question. The only way to compare money in the first year with the tenth year is to take inflation into account. Inflation affects loan payments positively (in real terms it is decreasing) and opportunity cost negatively (part of the 7.2% return is inflation).

]]> By: The Financial Blogger http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42756 The Financial Blogger Wed, 06 Jun 2007 21:33:26 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42756 CC, I was thinking about your example today and I would like to know why are you considering inflation as your loan payment will be affected by it anyway right ? Cheers, FB. CC,
I was thinking about your example today and I would like to know why are you considering inflation as your loan payment will be affected by it anyway right ?
Cheers,
FB.

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42707 Canadian Capitalist Wed, 06 Jun 2007 17:03:17 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42707 Confused: The background to the post is another post by FB in which he showed that interest rate risk diminishes over time when you leverage and invest in equities. What I am trying to show (I don't blame you, the math makes my head hurt too) is that the advantage is not as large as you might think and to make a valid comparison you should account for the interest payments made on the leveraged loan. I am not denying for a minute that leveraged investing probably will give you a better return. But you get the extra return by taking extra risk. To borrow a metaphor from the book "When Genius Failed", leveraging is a bit like picking up quarters in front of a steam roller. You should be extremely careful or you'll get flattened. Confused: The background to the post is another post by FB in which he showed that interest rate risk diminishes over time when you leverage and invest in equities.

What I am trying to show (I don’t blame you, the math makes my head hurt too) is that the advantage is not as large as you might think and to make a valid comparison you should account for the interest payments made on the leveraged loan.

I am not denying for a minute that leveraged investing probably will give you a better return. But you get the extra return by taking extra risk. To borrow a metaphor from the book “When Genius Failed”, leveraging is a bit like picking up quarters in front of a steam roller. You should be extremely careful or you’ll get flattened.

]]> By: Confused http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42685 Confused Wed, 06 Jun 2007 16:26:25 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42685 CC, I’m pretty new to investing so please bear my ignorance. We are comparing leveraged investing to non-leveraged normal investing. Isn’t it the case that if I had the money to invest I wouldn’t need leveraged investing? If it is a choice between not investing at all and leveraged investing wouldn’t it be better to leverage invest? Perhaps what we are discussing is whether to invest more using leveraged investing or less using tradition investing. However, if it is the case that we know leveraged investing is better than not investing we can extrapolate that investing more using leveraging is better than investing less? BTW: great blog and excellent topic, especially now that interest rates may be on the rise CC, I’m pretty new to investing so please bear my ignorance.

We are comparing leveraged investing to non-leveraged normal investing. Isn’t it the case that if I had the money to invest I wouldn’t need leveraged investing? If it is a choice between not investing at all and leveraged investing wouldn’t it be better to leverage invest?

Perhaps what we are discussing is whether to invest more using leveraged investing or less using tradition investing. However, if it is the case that we know leveraged investing is better than not investing we can extrapolate that investing more using leveraging is better than investing less?

BTW: great blog and excellent topic, especially now that interest rates may be on the rise

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/leverage-and-interest-rate-risk/#comment-42662 Canadian Capitalist Wed, 06 Jun 2007 14:45:03 +0000 http://www.canadiancapitalist.com/2007/06/05/leverage-and-interest-rate-risk#comment-42662 4P: Dividends are part of the total return of 7.2%. If you use dividends to cover the interest payments, you have to subtract the dividend yield from the return assumption. I'll grant you that banks have been yielding 3% and posting total return in the double digits for the past 15 years, but I don't think it is sustainable. So, you can either consider dividends as being reinvested (which would imply accounting for an opportunity cost) or you can consider dividends as reducing your current interest obligations (which would reduce future total return assumptions). oxCC: I agree with you that whether or not dividends are paid and to what purposes those dividends are used are immaterial to the analysis. The 7.2% assumption is total returns including dividends. Phil: I follow the same strategy whenever I think there is a huge bargain in the market. But then I pay down the investment loan out of future savings. This allows me to invest regularly and not try to time the market and take advantage of any good opportunities when they arise. But this happens very occasionally (like during the income trust massacre). Enough Wealth: I agree totally with your analysis. However, the post I referred to assumed that the investment is made for 10 years, not one. You clearly understand that leveraging is no free lunch: you take more risk to earn a higher reward. Others seem to want to show that it is not so. 4P: Dividends are part of the total return of 7.2%. If you use dividends to cover the interest payments, you have to subtract the dividend yield from the return assumption. I’ll grant you that banks have been yielding 3% and posting total return in the double digits for the past 15 years, but I don’t think it is sustainable. So, you can either consider dividends as being reinvested (which would imply accounting for an opportunity cost) or you can consider dividends as reducing your current interest obligations (which would reduce future total return assumptions).

oxCC: I agree with you that whether or not dividends are paid and to what purposes those dividends are used are immaterial to the analysis. The 7.2% assumption is total returns including dividends.

Phil: I follow the same strategy whenever I think there is a huge bargain in the market. But then I pay down the investment loan out of future savings. This allows me to invest regularly and not try to time the market and take advantage of any good opportunities when they arise. But this happens very occasionally (like during the income trust massacre).

Enough Wealth: I agree totally with your analysis. However, the post I referred to assumed that the investment is made for 10 years, not one. You clearly understand that leveraging is no free lunch: you take more risk to earn a higher reward. Others seem to want to show that it is not so.

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