Economy & Credit Chest

To compare both asset classes and tranches one needs to construct a corporatebond fund invested in 100 equally weighted BBB corporate bonds (assuming that the bond fund pays a Libor _ 100 bp and runs a maturity of 5 years). The risk/return tradeoff between a corporate bond fund and a BBB–CDO note looks as shown previously.

The BBB note sustains a higher cumulative default rate before suffering any losses, as the equity absorbs the initial losses. But the corporate bond fund may outperform in severe default scenarios. This is largely because of the leverage in the CDO note. At one stage the mezzanine notes become the equity of the structure. The huge difference in IRR is explained by the extra risk between the cash bonds and the BBB-tranche as a total.

The success or failure of a decision frequently depends on the delegation process. Empowerment, which is discussed below, goes beyond the delegation of specific tasks. It involves granting a defined level of authority and responsibility within which someone makes their own decisions and implements them.

There are several stages in the delegation process.

Preparing to delegate. Some preparation and planning are always needed, perhaps limited to gaining the approval of others or simply informing people. Priorities may also need to be considered. Most of all, you should be clear about the reasons for delegation and what it is meant to achieve. This requires a focus on results and having clear, precise objectives.

Matching person and task. The person who is required to do the job must understand it and have the personal skills and competence to have a realistic chance of doing it successfully.

Discussing and agreeing objectives. Targets, resources, review times and deadlines should be discussed with the delegatee and agreed. It may be necessary to formalise the process in writing in order to avoid, or at least minimise, any misunderstanding.

Providing resources and the appropriate level of authority. When delegating work, it is imperative to provide the delegatee with the necessary resources as well as the authority to complete the task, and then to provide support when needed.

One way of appraising competing options is to look at the desired outcome and then see which option will achieve it. This simple approach is often complicated by the need to prioritise goals, reduce costs or minimise risk, and in selecting the best option usually involves trade-offs and compromise. Another approach is to establish criteria for the final decision – for example, it needs to work quickly, not be expensive, take a reasonable amount of time to organise and so forth – and then score each option against these components on a scale of 1–10. The highest-scoring option wins. With both approaches, you need to fully understand what each option requires, how it works and what it achieves.

A lack of sufficiently thorough analysis is common in decision-making. The natural tendency is for people to gravitate towards a particular option, often because of prejudice, fear (especially fear of change), a desire to avoid risk, laziness, or an over-reliance on instinct. We highlighted the importance of carefully assessing the situation, defining critical issues and specifying the decision. These are the first three stages of the rational decision-making process. Combining “hard” factors such as data, technology and information with “soft” factors of intuition, experience and creativity can test potential decisions. It is important to question assumptions and see things from another perspective (such as that of the customer or person most affected by the decision).