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UGA MBUS 3000 - Interest Rate
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VII. 2 elements of recording deal:VIII. Greece vs. FranceIX. FactsX. Artist recording advanceXI. Grunge ActXII. Record CompaniesXIII. Not risk freeXIV. Properly function marking for recording artistsXV. Some famous financial bubblesXVI. The bubble popsXVII. The 3 “I”sXVIII. Different eras of the grunge bubbleCurrent lectureA) Interest rate1. Present value formula: PV=FV/(1+i)^nWhen interest rate goes up present value goes downWhen n changes it makes the present value go down2. Interest rate represents the market expectation of inflation + risk3. Hypothetical situation:If we assume this amount is risk free the only thing the interest rate represents is expectations of inflationIn this case use the interest rate for US treasuries for that period of timeMoney borrowed from US treasuries is risk freeWe always calculate interest annually when we are calculating a lump sum4. Example:Absolutely risk free $100,000 due 30 years from now and treasury 30 year yield is 3.22% (per year)PV=100000(1+.0322)^30=38644.20Absolutely risk free $100,000 due 30 years from now and treasury 30 year yield is 3.22% (per year)PV=100000(1+.0322)^30=38644.20Example: Calculate PV of 5000 dollars (risk free) payable 10 years from now. 10 year treasury is 2.26%PV=50005. What is the present value of a lump sum of money in the future?6. What is the present value of a stream of monthly payments (example pension, royalties etc) in the future?7. You need to know this because of:DivorceBuying out a partner in a businessBuying out a member of the bandValue of a life insurance policyGetting an advance against royalties owed in the future?Calculating a recording advanceB) 2 elements of recording deal:1. artist royalty: reflects the risk2. recording advance also reflects the riskC) Greece vs. France1) More risk results in those countries paying a lot higher interest rate than the expected rate based on inflation. There is more risk.2) $10,000 from the government of Greece due 10 years from now, compare that to is worth $923.38 nowGreece 10 year yield = 26.9% interest rate3) $10,000 from the government of France due 10 years from now and $7319 now because the French government is less riskyFrench 10 year yield =3.017% interest rateD) Facts1) Present value:As the interest rate increases PV decreasesAs the interest rate decreases PV increasesAs the risk increases PV decreasesAs the risk decreases PV increases2) Future value:As the interest rate increases FV increasesAs the interest rate decreases FV decreases3) But what happens when present value does not reflect risk properly?4) Example: housing market in 2008 there was a bubble and the bubble was because the risk in subprime borrower for houses was not properly pricedE) Artist Recording Advance1) Established Artist $700,000 advance2) Advance New Artist $150,000 advance3) Not just artist royalty/ implied interest rate that reflects risk Advance reflects risk4) Advance reflects how risky that artist isF) Grunge Act1. Advance for unknown Grunge Act Seattle 1989 $125,000 Niche genre, bubbling under, no one cared about Grunge but 4 years later everyone loved them2. Not just risky but market is limited3. Advance for unknown Grunge Act Seattle 1993 $500,000The price went up because there was no longer a niche market mainstream market and also less risky proposition to put out a grunge artist so these advances reflect the lowering of the riskits still risky but not as risky as it used to beRisk is decreasing so the present value went overG) Record companies1. Record Companies/Publishers often make enormous profit when (by luck) an underground sound moves mainstream2. This is why record labels continually look for the next big sound and this is when record companies make the most moneyH) Not Risk free1. Market does not exist to price risk or set interest rates so someone somewhere guesses. It could be a highly educated guess. It could be a wild guess.2. Example: David Barbe reliable debtor. Known to pay debts. PV of $100,000 3 years from now. Your supervisor tells you to use and interest rate of 7%PV=100,000/(1+.07)^3=81.6293. David Lowery is not a reliable debtor. Known to sometimes not pay his debts. PV of $100,000 3 years from now. Your supervisor tells you to use an interest rate of 23%PV=100,000/1+.23)^3=53.738As risk increases the PV decreasesI) Properly function marking for recording artists:1. New artists advance $70,0002. Established artists advance $250,000If thoese advances come too close you make get a bubble3. The mid 1990’s early 2000’sEstablished act, less risk, Artist Royalty 18% and Advance $750,000New artist, more risk, Artist Royalty 20% and Advance $750,000These advances are too close to each otherJ) Some famous financial bubbles1. Tulips Holland 1634-382. The French Mississippi Company 1719-1720 The South Sea Company 17203. Railway Mania UK 1840s Florida Land Boom 19264. Roaring ‘20s Stock market bubble 1929 Japanese Stock/Real Estate5. Bubble 1980’s Dot Com Bubble 1995-20006. US Housing Bubble 1999-20067. The Grunge Bubble 1992-19998. Many economists say that you cannot predict or identify bubbles and others say you can subjectively even objectively identify one.K) The bubble pops:1. Minsky argued that you can predict when a bubble was going to occurHe said that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts.He noted that when the “hedge borrowers, speculative borrowers and ponzi borrowers” begin accumulating a lot of debt you have a bubble underway.Hedge borrower: can make debt payments (covering interest and principal) from current cash flows from investmentsSpeculative borrower: the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal.Ponzi borrower: borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloatMinsky proved his theory with the


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