International and domestic payments

We shall return later to the vital distinction between international and domestic payments which is created by the existence of currency frontiers. Meantime it may be helpful to observe that balances of payments of a sort may be traced between localities or regions within the same currency area. To be sure, they lose significance because credit or debit balances pass almost unnoticed where there is no fluctuating foreign exchange rate and no gold movements to call attention to them. Yet structurally these intranational payments balances have much in common with international payments balances.

The Analogy of the Individual

One might even begin the analysis with the individual human being in economic society. Mr. Micawber rather dramatically called young Copperfield's attention to the fact that the balance between income and outgo in the affairs of a person could spell either prosperity or disaster. From analogies of this sort, as we shall see, the mercantilists were led to conclusions concerning the international balances of payments of a country which are from our viewpoint untenable. It can properly be observed, however, that the power of the individual to buy goods, services, securities, and so on, is limited by his income from sales of such things to others or from savings (investments) and by his capacity to borrow. If the individual's purchases exceed his income plus his borrowings, some of his creditors are very obviously going to have bad debts on their hands. Similarly, there is an intimate relationship between the international income and the international outgo of a country-its ability to buy from abroad is conditioned by the amount of its exports (of all sorts, including gold) and its foreign borrowings. We shall be at pains in this and subsequent chapters to demonstrate the nature and validity of this idea of balance or reciprocity. It is here needful only to observe that it has its roots in the ordinary relationship of man to man in an exchange economy. Fundamentally (ignoring all refinement of analysis) people cannot buy unless they can sell; neither can nations.

Measuring the Interest Rate Risk Exposure of Savings and Loans

Casual observers of the savings and loan industry identify the basic cause of current industry problems as the fact that interest rates have risen substantially in the last few years. This statement is true but somewhat of an over simplification. There are benefits which accrue to savings and loans when interest rates rise. Unfortunately, the disadvantages from the rise far outweigh the advantages.

For these reasons, an examination of the consequences of interest rate changes for savings and loans is in order. One of the best tools for this examination is a statistic referred to as duration. The emphasis of the discussion is on the intuitive concept, so any reader unfamiliar with the mathematics of the various formulas should nonetheless be able to grasp their significance. Once the meaning, significance, and limitations of duration have been clarified, we proceed to the concept of "immunization," which refers to the process of reducing or eliminating the effects of interest rate changes on the net worth of SLAs.

One of the most important features about duration is that no value is unique to a single bond. In other words, there is an infinite number of combinations of yield-to-maturity, term-to-maturity, and coupon rate that will produce the same duration number. Hence a bond with some particular yield-to-maturity, termto-maturity, and coupon rate can be described as having price risk equal to that of another bond whose yield-to-maturity, term-to-maturity, and coupon rate are all different from those of the first bond.

For every combination of bonds which have the same duration, there is always one easily identifiable bond. It is the one referred to as a zero-coupon bond. A zero-coupon bond is one which provides no interest payments but has a redemption value, and it is sometimes referred to as a pure discount bond.

The duration of a zero-coupon bond is equal to its term-to-maturity. The validity of this last statement is easily demonstrated algebraically.