Real Return Methodology (RRM)
A Financial Engineering Solution for the
Capital Formation Markets
There are few times in the market when an opportunity for a new application technology can be incorporated into the practice of capital formation. One that offers benefits to all parties in an industry is more rare.
RRM is one such application technology. It is applicable for all financial structures and transactions.
The developers of this method began with the premise that finance should be simple, transparent, and flexible. It must produce output that is lower in variability and volatility and eliminate the weakness in current forms of nominal and inflation adjusted methods of capital formation.
What is RRM?
RRM is a system for defining all of the terms of a financial transaction in purchasing power (real, inflation adjusted) terms and precisely calculating out the equivalent nominal amounts to be utilized and to be compliant for all payments/receipts, accounting, clearing and regulatory requirements. It also provides a complete methodology for record keeping and servicing of these transactions.
RRM is a revolutionary ‘Alpha’ adding strategy / method for both borrowers and lenders. It is a cutting edge concept that offers a design for financial engineering of new instruments that support stability, opportunity and transparency. RRM finds the lowest common ground of finance for a simpler, more robust capital formation and investment application.
What do Borrowers, Lenders, Market Makers, Hedgers, Servicers and Regulators gain from RRM?
Lowers cost and reduces risk it:
· Eliminates the inflation risk premium in interest rates.
· Funds user’s real assets with real liabilities and funds providers fund future real outlays with real financial assets.
· Reduces default risk is reduced by matching real debt service to expected real income – full amortization with constant real payments.
· Reduces interest rate risk because real interest rates vary less than nominal interest rates.
RRM creates value for funds users by lowering the cost of capital.
· The real cost of capital is determined by the real cost of new financing – not the realized real cost of existing financing.
· The fixed real cost of new financing is always less than the expected real cost of new nominal financing (elimination of the inflation risk premium) – therefore, the real cost of capital is always lower with RRM.
· By matching of the known real cost of financing to the expected real income of the project higher levels of symmetry are captured.
Although rising inflation may cause the realized real cost of nominal financing to be lower than the fixed real cost of RRM financing:
· The rise in inflation shifts future real cash flows from holders of nominal bonds to shareholders (or taxpayers in the case of municipal financing).
· The value gain to shareholders is less than the value loss to bondholders because: 1) shareholders discount future cash at a higher discount rate than do bondholders due to greater risk; and, 2) corporate income taxes apply to the shifted cash flows.
A shift in the efficient frontier for investors—higher returns with less risk (free alpha).
· New asset class with real returns that have low correlations with the returns on other real assets.
· Inflation risk is eliminated, interest rate risk and default risk are reduced.
· Exchanges can add a product line focused on REAL rates or currencies.
· Hedgers can add a fixed real rate asset class and have additional opportunities for risk management.
· Because RRM is a patented methodology, early adopters will gain market share.
· Regulators and Servicing firms can use existing infrastructures.
For Spreadsheets comparing RRM vs Traditional debt financing, please contact me at information listed below.