Sunday, April 26, 2015

Arjunan Mahendran and Central Bank Loss Costs LKR 12.5 Billion

The whole Arjuna Mahendran Central Bank Fiasco explained very simply.
At end some explanation of the Greek Bond "losses" that Harsha de Silva was talking about.

Bottom line one is a minimum of LKR 12.5 billion lost to the country.
Bottom Line two, no law has been broken. The beauty of high finance white collar crime.

Update: Apparently the losses are on  many bond and T-Bill issues (see note below).   The estimate is a whopping LKR 42.5 billion loss by T-Bills and T-Bonds over 5 weeks.   This post looked at just one deal.

The Numbers:
  1. 1 billion was needed to roll over expiring bonds.
  2. Expected Interest Rate was 9.5%
  3. Instead 10 billion was accepted at Interest Rate of 11.75% for 30 years.
  4. Expected Interest Rate in 5 years 6.75%
    (As of 2015/4/26 Bond Yields Thai 2.5% and Vietnam 6.37% and Greek 12.7% )
In a country where economy is growing or is stable, it is expected that interest rates for borrowing will keep dropping. Specially in a world where negative interest rates are in play.

Any one with basic financial knowledge then does not borrow on long term. You issue short term bonds say for 5 years and then roll over. i.e Do a new issue of Bonds/Treasuries at a lower interest rate.

So what are the problems.
  • LKR 10 billion Bonds/Treasuries issued when only LKR 1 billion needed.
  • High Rate of Interest (11.75% when it could have been 6.75% (or less) in 5 years 
    Note, Thai (2.5%) and Vietnam (6.37) Bond yields are far lower as of
  • 30 year issue, when a 5 year issue should have been made.
  • We are paying close to Greek Bond yields of 12.7% , which Harsha de Silva called Greek Junk Bonds.
That means Sri Lanka will be over paying LKR 12.5 billion over the next 25 years.  (10 billion * 5% * 25 = 12.5)   

Greek Bond Losses

I wish Harsha De Silva would explain the above numbers of the Bond Issue and compare them his quote on LKR 2 billion (USD 15 billion) loss on purchase of Greek Bonds.

Basically the Central Bank bought Greek Bonds, probably because they are paying high interest rates.  Its basically a hedge, risky though. i.e. Use some of the money that we have borrowed and invest in higher interest paying bonds. The CB gets to keep the difference.

Because there are issues of whether the EU will bailout Greece, the Effective Interest Rate (Yield) has Increased on Greek Sovereign Debt (Treasuries/Bonds).  i.e the Value of the Bonds has decreased.

Unless the Greek Bonds/Treasuries are sold or used as collateral it is just a book value loss. 
That is until if and when the Greek Govt defaults on its interest payments.   Only one other country has done that so far, Argentina but does not mean Greece would not do it too. 

So as yet we have not had tangible loss on the Greek Bonds.

Note: If book Value of Bonds/Treasuries was a big deal, then Goldman Sachs, JP Morgan etc would be bankrupt.  Thats because their Tier 3 capital, mainly Mortgage Backed Securities (MBS) and Asset  Backed Securities (ABS) are probably worth less than 50 cents on the Dollar.  However after 2008 Financial Collapse have relaxed accounting rules/requirements (FASB and Basel) and allowed Tier 3 capital to be valued at Par, i.e. original purchase price.

Note:  Treasurys are less than one year, sold at discount. The interest is effectively the difference between the full value you get at at end and the discount price. Notes are 2-10 year maturity issues. Bonds are over 10 years.  Both Notes and Bonds pay interest semi annually.

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