The Quest: Pursuit of Prosperity

The “X” in every financial equation should be a result in Real (inflation adjusted) purchasing power currency.

The real purchasing power of the return is the lifeblood of a lender. The ability to use what is borrowed effectively at the lowest feasible interest rate is the focus of a borrower. Default is the enemy of all. A loan made using the nominal interest rate attempts to address the business risk and the inflation risk with a rate comprised of an assessment of their combined effects. Business risk is determined by prudent evaluation. Inflation risk is determined by learned guess. The result will tend to be imprecise and proportionally risky. The resulting inefficiency takes funds away from the intended purpose.

In the case where the lender over-insures against inflation the rate is too high and inefficient if not uncompetitive. Paradoxically, default risk may increase through the borrower not being able to meet the implied inflation insurance charged by the lender for inflation that never happens. When too low, the lender will suffer. Our method balances the sometimes competing but ultimately common requirement of a financial transaction that supports successful outcomes for both.

Current efforts are numerous, many impressive and proven. However, for those governments, enterprises and individuals most damaged by the effects of inflation, the available tools are too complex, expensive, tax-inefficient and imprecise to serve the need. Some of these tools/products fail the most basic tests of Asset Liability Management.

We propose a transparent, simple and effective method: Financial instruments that ensure returns in Real purchasing power, not nominal currency. Real Return Methodologies (“RRM”) utilizes a straightforward amortized loan structure that can be readily superimposed on complex debt structures. By effective and efficient handling of inflation risk it permits the lender the ability to focus upon the business risk per se while providing use of funds to the borrower more effectively. Default risk is lessened.

In our method, the parties agree to a rate that is appropriate to the business risks. Inflation premia are not added. The loan results in more of the funds being applied to the business purpose from the onset. Inflation effects are addressed by the timely and mutually agreed addition of the actually experienced inflation based upon an agreed index at agreed intervals.  The loan is repaid using our fully amortizing method. Inflation is managed by facts, not guesses. Lower overall costs are the result.

The net is that the funds are put fully to use with the effect of inflation addressed by using the actual rate experienced during the term. The additional cost implied by any inflation will come later in the project cycle when the borrower has enjoyed the use of a greater portion of the funds long enough to have material benefit, thereby lessening default risk. The lender improves their management of inflation risk without driving the borrower to default or pricing themselves out of the loan at the onset.

The use of derivatives to hedge potential inflation risk may provide additional advantages in some circumstances. But the majority of transactions will not require added complexity. If derivatives are used, they can be structured using loans made in RRM format as a leg of the structure. RRM increases the number of available products and swaps for governmental, currency, business inflation and asset/liability management.

We believe that we represent a novel and efficient risk management tool with global trade competitive advantage to early implementors, and overall simplicity and efficiency with respect to the cost of inflation/currency risk management for all stakeholders over time.