In a CDS transaction, the borrower seeks to obtain a loan from the protection buyer in a CDS. For protection, the protection buyer avails of the CDS by paying a default protection fee from a protection seller based on tradable CDS Index. The borrower can be a private entity or a government (for sovereign debts). The borrower pays interest to the protection buyer for his loan using the LIBOR (London Interbank Offered Rate). The borrower should repay the loan to the protection buyer upon maturity date. In case of default of the borrower, the protection buyer will seek recovery from the protection seller. There are two kinds of settlement to be done by the protection seller depending on the agreement: Physical settlement and Cash Settlement. If a physically-settled CDS is triggered, the protection seller pays the face value of the debt (or another pre-specified amount) to the protection buyer in exchange for the debt itself, which would be worth less than face value given the recent credit event. Triggering a cash-settled CDS would require the protection seller to make a payment to the protection buyer of the difference between the original value of the debt (typically the face value) and the current value of the debt based on a specified valuation method.
Innovation and Current Trends of the CDS
There is a need to place clear and unambiguous terms of “credit event” and “reference entity” in the contract. The ISDA, International Swaps and Derivatives Association, sets standards for all derivative contracts.
In the case of in Ursa Minor Ltd. v. Aon Fin. Prods., Inc., 2000 WL 1010278 (S.D.N.Y. 2000) , Escobel Land Inc. (a company in the Philippines), obtained a $10M loan from Bear Stearns for the construction of condominiums in the Philippines. Escobel also secured a surety bond from Government Service Insurance System ("GSIS"), a Philippines government entity, which guaranteed Escobel's payment to Bear Stearns (BS). BS in turn obtained 1) a CDS from Aon Financial Products Limited ("Aon") as well as 2) an unconditional guarantee ("Guarantee") from Aon Corporation ("Aon") “for whatever reason or cause,” together promising to pay BSIL $10 million plus expenses if GSIS failed to satisfy its obligations under the surety bond. To reduce its own exposure, Aon entered into its own CDS agreement with Société Générale ("SG"), wherein SG agreed to pay Aon upon the occurrence of a defined "credit event," which is default of the Republic of the Philippines or any of its successors.” When Escobel's payment under its BS loan came due, Escobel failed to pay, triggering a demand on GSIS. GSIS refused, arguing that the surety bond might not be enforceable against GSIS because the GSIS representative who supposedly assigned the bond to BS did not have the authority, and because GSIS already had canceled the bond after discovering the collateral that Escobel had offered to secure the bond was not genuine. Due to GSIS' refusal to pay, BS was able to recover from its CDS with Aon agreeing to cover GSIS' default "'for whatever reason or cause," even if the underlying obligation was illegal or invalid.
By this reason, Aon sought to recover from SG based on the same credit event and by its reference entity, which is default of GSIS which is a successor or agency of the Republic of the Philippines. Unfortunately, Aon was not able to recover from SG because the basis or reference entity, the default of GSIS was held not to be a default of the Republic of the Philippines. The GSIS was held not to be a government of the Republic of the Philippines, being a separate entity altogether.
In the case of Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co., 2003 WL 21305355 (S.D.N.Y.), Argentina obtained a loan from Eternity Global in turn obtained a CDS from JP Morgan for a guarantee and promise to pay Eternity Global in case of Argentina’s bankruptcy or default in payment. Subsequently, Argentina sought a “voluntary debt exchange” by exchanging its debts to other foreign bonds in order to minimize payment of interests. By this reason, Eternity Global sought to recover from JP Morgan by reason of such “voluntary debt exchange”. It was held that Eternity Global cannot recover from the CDS because a “voluntary debt exchange program” does not constitute a term for bankruptcy or default in payment.
Another innovation in the over the counter CDS market is the reduction of the notional amount of CDS through a series a portfolio compression cycles, also known as tear-ups (according to ISDA) and has reduced operational, legal and capital costs and improved efficiency of the CDS market. Portfolio compression reduces the number of line items in CDS portfolios without changing the risk parameters of the portfolio. It is done by terminating existing trades and replacing them with smaller number of trades with the same risk profile and cash flows as initial portfolio.
CDS contracts are subject to clearing house rules and regulations. In the US, the Depository Trust and Clearing Corporation (DTCC), considering one of the world’s largest clearing houses.
REFERENCES:
Mike Jakola, Kellog School of Management, Northwestern University, Credit Default Swaps Index Options, June 2, 2006.
“Central Clearinghouse Planned to reduce Counterparty Risk in Credit Default Swaps Market,” Global Finance, July-August 2008.
“Credit Default Swaps Market Outstandings Shrinks as Dealers Tear-up Offsetting Agreements,” Global Finance, December 2008.
“Credit Default Swaps 101: A Primer on Legal Remedies,” Robins, Kaplan, Miller & Ciresi, February 16, 2009 (i.e. visit www.google.com)
“Credit Default Swaps: The Next Crisis?” by Janet Morrissey, March 17, 2008, (i.e. Search time.com)
Sunday, October 10, 2010
Credit Default Swaps (Part 1)
Credit default swaps are a financial instrument used to transfer and mitigate the risk of credit exposure. They are a bilateral contract between the buyer, who purchases protection of the credit risk, and the seller, who provides protection.
A credit default swap (CDS) is a contract between two parties where a protection buyer pays a premium to the protection seller in exchange for a payment if a credit event occurs to a reference entity. CDS are customizable, over-the-counter products and can be written to trigger in the event of bankruptcy, default, failure to pay, restructuring, or any other credit event of the reference entity. "Credit event" will usually determine whether the protection buyer has reason to demand payment from the protection seller. "Reference entity," which is the entity whose obligation is the subject of the swap.
Credit default swaps are a type of credit derivative that can be used to function as a sort of insurance or hedge against an existing investment. Credit default swaps are the largest type of credit derivative in terms of trading volume.
The CDS market has grown $180 billion in 1997; By 2004 it has grown to $5 trillion; In the 2006, $17 trillion; In 2010, it has an annual business of $70 trillion (notional amount).
As the CDS market increased in importance, tradable CDS indexes arose to allow players to trade a broader spectrum of credits at a lower cost and in a more liquid market (i.e. Dow Jones CDX and International Index Company Itraxx). The composition of each index is determined by member banks and a particular name remains in the index until the CDS is triggered due to a credit event. A new index is formed periodically but each incarnation of the index shares the majority of its names with the previous index. The member banks that help compose and price the index include sixteen major international banks. Each of the member banks makes a market in the CDS index and it is freely tradable with low bid-ask spreads of ½ to ¼ of a basis point. It pays the seller a premium relative to the amount of the debt obligation being covered—typically calculated by multiplying the principal amount by a number of basis points—called the spread—whose value is determined by the credit-worthiness of the third party.
Unlike hedging with less risky bonds which requires a cash outlay upfront, CDS do not subject the buyer to interest rate risk or funding risk. CDS allow hedgers or speculators to take an unfunded position solely on credit risk. The market originally started as an inter-bank market to exchange credit risk without selling the underlying loans but now involves financial institutions from insurance companies to hedge funds.
The ISDA, International Swaps and Derivatives Association, sets standards for all derivative contracts.
A credit default swap (CDS) is a contract between two parties where a protection buyer pays a premium to the protection seller in exchange for a payment if a credit event occurs to a reference entity. CDS are customizable, over-the-counter products and can be written to trigger in the event of bankruptcy, default, failure to pay, restructuring, or any other credit event of the reference entity. "Credit event" will usually determine whether the protection buyer has reason to demand payment from the protection seller. "Reference entity," which is the entity whose obligation is the subject of the swap.
Credit default swaps are a type of credit derivative that can be used to function as a sort of insurance or hedge against an existing investment. Credit default swaps are the largest type of credit derivative in terms of trading volume.
The CDS market has grown $180 billion in 1997; By 2004 it has grown to $5 trillion; In the 2006, $17 trillion; In 2010, it has an annual business of $70 trillion (notional amount).
As the CDS market increased in importance, tradable CDS indexes arose to allow players to trade a broader spectrum of credits at a lower cost and in a more liquid market (i.e. Dow Jones CDX and International Index Company Itraxx). The composition of each index is determined by member banks and a particular name remains in the index until the CDS is triggered due to a credit event. A new index is formed periodically but each incarnation of the index shares the majority of its names with the previous index. The member banks that help compose and price the index include sixteen major international banks. Each of the member banks makes a market in the CDS index and it is freely tradable with low bid-ask spreads of ½ to ¼ of a basis point. It pays the seller a premium relative to the amount of the debt obligation being covered—typically calculated by multiplying the principal amount by a number of basis points—called the spread—whose value is determined by the credit-worthiness of the third party.
Unlike hedging with less risky bonds which requires a cash outlay upfront, CDS do not subject the buyer to interest rate risk or funding risk. CDS allow hedgers or speculators to take an unfunded position solely on credit risk. The market originally started as an inter-bank market to exchange credit risk without selling the underlying loans but now involves financial institutions from insurance companies to hedge funds.
The ISDA, International Swaps and Derivatives Association, sets standards for all derivative contracts.
Balance of Payment (Part 2)
IV. Methodology
The BOP Methodology Uses a double-entry accounting system. This means that every recorded item should have a debit and a credit, and there should be a net balance of zero.
Balance of Payments credits (act of making an entry) denote increases in liabilities, owners’ equity, revenue and gains; and decreases assets and expenses; debits denote decreases in liabilities, owners’ equity, revenue and gains; and increases in assets and expenses.
The ideal balance of payment should be:
Current Account = Capital Account+ Financial Account
In practice, however, the accounts frequently do not balance. Data for balance of payments estimates often are derived independently from different sources. As a result, there may be a summary net credit or net debit (i.e., net errors and omissions in the accounts). A separate balancing item is used to offset the credit or debit. In our country we call it NET UNCLASSIFIED ITEMS.
Hence:
Current Account= Capital Account+Financial Account (+ - Net Unclassified Items or Balancing Items)
NET UNCLASSIFIED ITEMS (or errors and ommissions) is an offsetting account to bring above-the-line and below-the-line into balance. A positive discrepancy denotes an understatement of receipts and/or overstatement of payments. Conversely, a negative entry denotes an overstatement of receipts and/or understatement of payment.
This separate entry, equal to that amount with the sign reversed, is then made to balance the accounts. Because inaccurate or missing estimates may be offsetting, the size of the net residual cannot be taken as an indicator of the relative accuracy of the balance of payments statement. Nonetheless, a large, persistent residual that is not reversed should cause concern. Such a residual impedes analysis or interpretation of estimates and diminishes the credibility of both. A large net residual may also have implications for interpretation of the investment position statement.
V. Standard Components of the Balance of Payment (BOP)
The following are the Standard components of the BOP:
Current Account which includes goods and services; income; and current transfer
Capital Account and Financial Account (Capital transfer is included in this component which includes debt forgiveness of nonresidents and donations of fixed assets by one econony to another economy. This also includes taxes on capital transfers like gift tax, estate tax)
Current Account
It covers import and export of goods and services. Goods which involves:
General merchandise
Goods for processing
Goods procured in ports by carriers
Non monetary gold
Services involves:
Transportation
Travel
Communication services
Construction services
Insurance services
Financial services
Computer and information Services
Royalties and license fees
Other business services
Personal, cultural and recreational services
Government services
Another classification under Current Account is Income which includes compensation for employees and investment income. Investment income consists of direct investment income, portfolio investment income and other investment income.
Another classification under Current Account is Current Transfer – transfers where no quid pro quo (economic value) is placed. It is classified as a current transfer when it directly affect the level of disposable income and should influence the consumption of goods or services. That is, current transfers reduce the income and consumption possibilities of the donor and increase the income and consumption possibilities of the recipient.
Included in the Current Transfer are:
cash transfers effected between governments for the purpose of financing current expenditures by the recipient government
gifts of food, clothing, other consumer goods associated with relief efforts
Gifts of certain military equipment
Annual contributions made by member governments to international organizations
Payments made by government or international organizations to governments for salaries for technical assistance.
Workers’ remittances (migrants who stay in an economy for a year or more)
Capital Account and Financial Account
Capital account covers all transactions that involve the receipt or payment of capital transfers and acquisition or disposal of nonproduced, nonfinancial assets.
The financial account covers all transactions associated with changes of ownership in the foreign financial assets and liabilities of an economy. Such changes include the creation and liquidation of claims on, or by, the rest of the world.
The foreign financial assets of an economy consist of holdings of monetary gold, SDRs (Special Drawing Rights), and claims on nonresidents. The foreign liabilities of an economy consist of indebtedness to nonresidents.
Components of the Financial Account as a Functional Type
The following are the components of the Financial Account as a Functional Type:
Direct Investment
Portfolio Investment
Reserve Assets
Other Investment
Direct Investment means a significant voice in the management of an enterprise operating outside his or her resident economy, often having substantial equity capital in the enterprise. Combined ownership of 10% or more. Ownership of less than 10% of total equity in an enterprise is already classified as Portfolio Investment.
Portfolio Investment – includes equity securities and debt securities which are traded and tradable in organized and other financial markets. Debt securities include bonds and notes, money market instruments, and financial derivatives that include a variety of new financial instruments. Equity securities covers all instruments and records acknowledging, after the claims of all creditors have been met, claims to the residual values of incorporated enterprises; holders of preferred shares are also included.
Reserve Assets - consist of those external assets that are readily available to and controlled by monetary authorities for direct financing of payments imbalances, for indirectly regulating the magnitude of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes.
The category of reserve assets, comprises monetary gold, SDRs, reserve position in the Fund, foreign exchange assets (consisting of currency and deposits and securities), and other claims.
Other Investment – these are neither classified as direct investment, portfolio investment and reserve assets. This includes short-term (contractual maturity of one year or less) and long-term investments (contractual maturity of more than one year or with no stated contractual maturity)
VI. Functions of the BOP Data
The following are the functions of the BOP data:
• Important for national and international policy formulation (i.e. for external aspects which are necessary for an interdependent world economy);
• Used for analytical studies (causes of payment imbalances and necessity of implementing adjustment measures)
• Indispensable link in the compilation of data for various components of national accounts (those related to the measurement of national wealth)
• The need to account for flows of foreign currency across national boundaries.
• Helps a country evaluate its competitive strengths and weaknesses, and forecast the strength of its currency.
REFERENCES:
John Downes and Jordan Elliot Goodman, Barrons Financial Guides: Dictionary of Finance and Investment Terms, Seventh Edition, 2006.
Bangko Sentral ng Pilipinas, Selected Philippine Economic Indicators, August 2009.
www.bsp.gov.ph
International Monetary Fund, Balance of Payments Manual 5th Edition.
The BOP Methodology Uses a double-entry accounting system. This means that every recorded item should have a debit and a credit, and there should be a net balance of zero.
Balance of Payments credits (act of making an entry) denote increases in liabilities, owners’ equity, revenue and gains; and decreases assets and expenses; debits denote decreases in liabilities, owners’ equity, revenue and gains; and increases in assets and expenses.
The ideal balance of payment should be:
Current Account = Capital Account+ Financial Account
In practice, however, the accounts frequently do not balance. Data for balance of payments estimates often are derived independently from different sources. As a result, there may be a summary net credit or net debit (i.e., net errors and omissions in the accounts). A separate balancing item is used to offset the credit or debit. In our country we call it NET UNCLASSIFIED ITEMS.
Hence:
Current Account= Capital Account+Financial Account (+ - Net Unclassified Items or Balancing Items)
NET UNCLASSIFIED ITEMS (or errors and ommissions) is an offsetting account to bring above-the-line and below-the-line into balance. A positive discrepancy denotes an understatement of receipts and/or overstatement of payments. Conversely, a negative entry denotes an overstatement of receipts and/or understatement of payment.
This separate entry, equal to that amount with the sign reversed, is then made to balance the accounts. Because inaccurate or missing estimates may be offsetting, the size of the net residual cannot be taken as an indicator of the relative accuracy of the balance of payments statement. Nonetheless, a large, persistent residual that is not reversed should cause concern. Such a residual impedes analysis or interpretation of estimates and diminishes the credibility of both. A large net residual may also have implications for interpretation of the investment position statement.
V. Standard Components of the Balance of Payment (BOP)
The following are the Standard components of the BOP:
Current Account which includes goods and services; income; and current transfer
Capital Account and Financial Account (Capital transfer is included in this component which includes debt forgiveness of nonresidents and donations of fixed assets by one econony to another economy. This also includes taxes on capital transfers like gift tax, estate tax)
Current Account
It covers import and export of goods and services. Goods which involves:
General merchandise
Goods for processing
Goods procured in ports by carriers
Non monetary gold
Services involves:
Transportation
Travel
Communication services
Construction services
Insurance services
Financial services
Computer and information Services
Royalties and license fees
Other business services
Personal, cultural and recreational services
Government services
Another classification under Current Account is Income which includes compensation for employees and investment income. Investment income consists of direct investment income, portfolio investment income and other investment income.
Another classification under Current Account is Current Transfer – transfers where no quid pro quo (economic value) is placed. It is classified as a current transfer when it directly affect the level of disposable income and should influence the consumption of goods or services. That is, current transfers reduce the income and consumption possibilities of the donor and increase the income and consumption possibilities of the recipient.
Included in the Current Transfer are:
cash transfers effected between governments for the purpose of financing current expenditures by the recipient government
gifts of food, clothing, other consumer goods associated with relief efforts
Gifts of certain military equipment
Annual contributions made by member governments to international organizations
Payments made by government or international organizations to governments for salaries for technical assistance.
Workers’ remittances (migrants who stay in an economy for a year or more)
Capital Account and Financial Account
Capital account covers all transactions that involve the receipt or payment of capital transfers and acquisition or disposal of nonproduced, nonfinancial assets.
The financial account covers all transactions associated with changes of ownership in the foreign financial assets and liabilities of an economy. Such changes include the creation and liquidation of claims on, or by, the rest of the world.
The foreign financial assets of an economy consist of holdings of monetary gold, SDRs (Special Drawing Rights), and claims on nonresidents. The foreign liabilities of an economy consist of indebtedness to nonresidents.
Components of the Financial Account as a Functional Type
The following are the components of the Financial Account as a Functional Type:
Direct Investment
Portfolio Investment
Reserve Assets
Other Investment
Direct Investment means a significant voice in the management of an enterprise operating outside his or her resident economy, often having substantial equity capital in the enterprise. Combined ownership of 10% or more. Ownership of less than 10% of total equity in an enterprise is already classified as Portfolio Investment.
Portfolio Investment – includes equity securities and debt securities which are traded and tradable in organized and other financial markets. Debt securities include bonds and notes, money market instruments, and financial derivatives that include a variety of new financial instruments. Equity securities covers all instruments and records acknowledging, after the claims of all creditors have been met, claims to the residual values of incorporated enterprises; holders of preferred shares are also included.
Reserve Assets - consist of those external assets that are readily available to and controlled by monetary authorities for direct financing of payments imbalances, for indirectly regulating the magnitude of such imbalances through intervention in exchange markets to affect the currency exchange rate, and/or for other purposes.
The category of reserve assets, comprises monetary gold, SDRs, reserve position in the Fund, foreign exchange assets (consisting of currency and deposits and securities), and other claims.
Other Investment – these are neither classified as direct investment, portfolio investment and reserve assets. This includes short-term (contractual maturity of one year or less) and long-term investments (contractual maturity of more than one year or with no stated contractual maturity)
VI. Functions of the BOP Data
The following are the functions of the BOP data:
• Important for national and international policy formulation (i.e. for external aspects which are necessary for an interdependent world economy);
• Used for analytical studies (causes of payment imbalances and necessity of implementing adjustment measures)
• Indispensable link in the compilation of data for various components of national accounts (those related to the measurement of national wealth)
• The need to account for flows of foreign currency across national boundaries.
• Helps a country evaluate its competitive strengths and weaknesses, and forecast the strength of its currency.
REFERENCES:
John Downes and Jordan Elliot Goodman, Barrons Financial Guides: Dictionary of Finance and Investment Terms, Seventh Edition, 2006.
Bangko Sentral ng Pilipinas, Selected Philippine Economic Indicators, August 2009.
www.bsp.gov.ph
International Monetary Fund, Balance of Payments Manual 5th Edition.
Balance of Payment (Part 1)
I. Introduction
This introduces the concept of the balance of payment (BOP). The format of the balance of payment shall be presented as provided in the BOP Manual, 5th edition as approved by the International Monetary Fund.
Measurement of the external positions of member countries has been a central feature of International Monetary Fund operations since inception. Such measurement is conducted in the dual context of Fund responsibility for surveillance of countries’ economic policies and provision of financial assistance in support of adjustment measures to correct balance of payments disequilibria. Consequently, the Fund has a compelling interest in developing and promulgating appropriate international guidelines for the compilation of sound and timely balance of payments statistics. Such guidelines, which have evolved to meet changing circumstances, have been embodied in successive editions of the Balance of Payments Manual (the Manual) since the first edition was published in 1948. Because of the important relationship between external and domestic economic developments, timely, reliable, and comprehensive balance of payments statistics based on an appropriate and analytically oriented methodology are an indispensable tool for economic analysis and policy making. Indeed, with the growing interdependence of the world’s economies, the need for such statistics—which reflects in part the underlying movement towards greater liberalization and integration of markets—has increased over time.
The revised Manual has been prepared by the Fund’s Statistics Department in close consultation with balance of payments experts in member countries and international and regional organizations (including the Statistical Office of the European Communities, the Organisation for Economic Cooperation and Development, the United Nations, and the World Bank).
II. Concept
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.
It is a systematic record of a nation's total payments to foreign countries, including the price of imports and the outflow of capital and gold, along with the total receipts from abroad, including the price of exports and the inflow of capital and gold.
It also draws a series of balances between inward and outward transactions, provides a net flow of transactions between residents of one country and the rest of the world; and reports how that flow is funded. Economic transactions include:
• Exports and imports of goods, such as oil, agricultural products, other raw materials, machinery and transport equipment, computers, white goods and clothing
• Exports and imports of services such as international transport, travel, financial and business services
• Income flows, such as dividends and interest earned by foreigners on investments in a country and by such country investing abroad.
• Financial flows, such as direct investment, investment in shares, debt securities, loans and deposits
• Transfers, which are offsetting entries to any one-sided transactions listed above such as foreign aid and funds brought by migrants to the country.
As defined by the Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas, balance of payment systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world.
As one of the primary functions of the IMF is to prevent financial crises and assist countries in balance of payment difficulties, the collection of standardized, comparable balance of payment data is seen as a core task.
III. Conceptual Framework of the Balance of Payment (BOP)
Most entries in the balance of payments refer to transactions in which economic values are provided or received in exchange for other economic values. These economic values consist of real resources (goods, services and income) and financial items (recorded in the balance of payments at the prices at which the items are acquired or disposed of).
Economic Territory consists of a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely.
An institutional unit has a center of economic interest and is a resident unit of a country when, from some location (dwelling, place of production, or other premises) within the economic territory of the country, the unit engages and intends to continue engaging (indefinitely or for a finite period) in economic activities and transactions on a significant scale. (One year or more may be used as a guideline but not as an inflexible rule.)
A uniform basis of valuation for the international accounts (both real resources and financial claims and liabilities) is necessary for compiling, on a consistent basis, any aggregate of individual transactions and an asset/liability position consistent with such transactions. In this Manual, the basis of transaction valuations is generally actual market prices agreed upon by transactors.
In the BOP Manual and the System of National Accounts, the principle of accrual accounting governs the time of recording for transactions. Therefore, transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is change of ownership.
This introduces the concept of the balance of payment (BOP). The format of the balance of payment shall be presented as provided in the BOP Manual, 5th edition as approved by the International Monetary Fund.
Measurement of the external positions of member countries has been a central feature of International Monetary Fund operations since inception. Such measurement is conducted in the dual context of Fund responsibility for surveillance of countries’ economic policies and provision of financial assistance in support of adjustment measures to correct balance of payments disequilibria. Consequently, the Fund has a compelling interest in developing and promulgating appropriate international guidelines for the compilation of sound and timely balance of payments statistics. Such guidelines, which have evolved to meet changing circumstances, have been embodied in successive editions of the Balance of Payments Manual (the Manual) since the first edition was published in 1948. Because of the important relationship between external and domestic economic developments, timely, reliable, and comprehensive balance of payments statistics based on an appropriate and analytically oriented methodology are an indispensable tool for economic analysis and policy making. Indeed, with the growing interdependence of the world’s economies, the need for such statistics—which reflects in part the underlying movement towards greater liberalization and integration of markets—has increased over time.
The revised Manual has been prepared by the Fund’s Statistics Department in close consultation with balance of payments experts in member countries and international and regional organizations (including the Statistical Office of the European Communities, the Organisation for Economic Cooperation and Development, the United Nations, and the World Bank).
II. Concept
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time.
It is a systematic record of a nation's total payments to foreign countries, including the price of imports and the outflow of capital and gold, along with the total receipts from abroad, including the price of exports and the inflow of capital and gold.
It also draws a series of balances between inward and outward transactions, provides a net flow of transactions between residents of one country and the rest of the world; and reports how that flow is funded. Economic transactions include:
• Exports and imports of goods, such as oil, agricultural products, other raw materials, machinery and transport equipment, computers, white goods and clothing
• Exports and imports of services such as international transport, travel, financial and business services
• Income flows, such as dividends and interest earned by foreigners on investments in a country and by such country investing abroad.
• Financial flows, such as direct investment, investment in shares, debt securities, loans and deposits
• Transfers, which are offsetting entries to any one-sided transactions listed above such as foreign aid and funds brought by migrants to the country.
As defined by the Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas, balance of payment systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world.
As one of the primary functions of the IMF is to prevent financial crises and assist countries in balance of payment difficulties, the collection of standardized, comparable balance of payment data is seen as a core task.
III. Conceptual Framework of the Balance of Payment (BOP)
Most entries in the balance of payments refer to transactions in which economic values are provided or received in exchange for other economic values. These economic values consist of real resources (goods, services and income) and financial items (recorded in the balance of payments at the prices at which the items are acquired or disposed of).
Economic Territory consists of a geographic territory administered by a government; within this geographic territory, persons, goods, and capital circulate freely.
An institutional unit has a center of economic interest and is a resident unit of a country when, from some location (dwelling, place of production, or other premises) within the economic territory of the country, the unit engages and intends to continue engaging (indefinitely or for a finite period) in economic activities and transactions on a significant scale. (One year or more may be used as a guideline but not as an inflexible rule.)
A uniform basis of valuation for the international accounts (both real resources and financial claims and liabilities) is necessary for compiling, on a consistent basis, any aggregate of individual transactions and an asset/liability position consistent with such transactions. In this Manual, the basis of transaction valuations is generally actual market prices agreed upon by transactors.
In the BOP Manual and the System of National Accounts, the principle of accrual accounting governs the time of recording for transactions. Therefore, transactions are recorded when economic value is created, transformed, exchanged, transferred, or extinguished. Claims and liabilities arise when there is change of ownership.
Utilitarianism by John Stuart Mill
I. Summary of Utilitarianism by John Stuart Mill
“Utilitarianism”, by John Stuart Mill, is an essay written to provide support for the value of utilitarianism as a moral theory, and to respond to misconceptions about it.
Mill defines utilitarianism as a theory based on the principle that "actions are right in proportion as they tend to promote happiness, wrong as they tend to produce the reverse of happiness." Mill defines happiness as pleasure and the absence of pain. He argues that pleasure can differ in quality and quantity, and that pleasures that are rooted in one's higher faculties (intellectual, moral and aesthetic faculties) should be weighted more heavily than pleasures of lower qualities (i.e. animal pleasures). Furthermore, Mill argues that people's achievement of goals and ends, such as virtuous living, should be counted as part of their happiness. Mill further argues that utilitarianism coincides with "natural" sentiments that originate from humans' social nature. Therefore, if society were to embrace utilitarianism as an ethic, people would naturally internalize these standards as morally binding. Mill argues that happiness is the sole basis of morality, and that people never desire anything but happiness. He supports this claim by showing that all the other objects of people's desire are either means to happiness, or included in the definition of happiness. Mill explains at length that the sentiment of justice is actually based on utility, and that rights exist only because they are necessary for human happiness.
II. Use of the Utilitarian Theory in Ethical Decision Making Process
From the perspective of the organizations, the utilitarian theory is the most frequently advocated theories. It is in fact the philosophical basis for our contemporary notion of democracy as well as the underpinning for microeconomic theory. The local utilitarian view can be considered from local and cosmopolitan organizational perspectives. The local utilitarian view is oriented toward the greatest good for the firm, whereas the cosmopolitan view would encompass a broader perspective that extends beyond the firm (i.e. greatest good for the society at-large).
This theory does provide an objective method for choosing among ends. Initially termed as “hedonistic calculus,” its contemporary terminology is the rational decision making process.
This process involves: identification of the problem, the generation of alternatives, the quantitative evaluation of the alternatives, the selection and implementation of the ‘best’ alternative, and the evaluation of the performance of this decision. While this process has proved to be an efficient method of resolving many organizational dilemmas, it is often found to be lacking when ethical dilemmas are considered. The impact of utilitarian decisions upon the individual or minority presents a further problem. If the greatest good for the greatest number results in the obfuscation or outright denial of individual rights, then the use of utilitarianism as an exclusive theoretical outlook may not be acceptable to those whose rights are being denied.
III. References:
William F. Lawhead, Philosophical Questions (Classic and Contemporary
Readings), 1st Edition, McGraw Hill Higher Education, 2003.
David Lyons, Rights, Welfare and Mill’s Moral Theory, Oxford University
Press, 1994.
James Agarwal & David Cruise Malloy, “The role of existentialism in ethical
business decision-making,” Business Ethics: A European Review, Vol.
9, Number 3, July 2000.
“Utilitarianism”, by John Stuart Mill, is an essay written to provide support for the value of utilitarianism as a moral theory, and to respond to misconceptions about it.
Mill defines utilitarianism as a theory based on the principle that "actions are right in proportion as they tend to promote happiness, wrong as they tend to produce the reverse of happiness." Mill defines happiness as pleasure and the absence of pain. He argues that pleasure can differ in quality and quantity, and that pleasures that are rooted in one's higher faculties (intellectual, moral and aesthetic faculties) should be weighted more heavily than pleasures of lower qualities (i.e. animal pleasures). Furthermore, Mill argues that people's achievement of goals and ends, such as virtuous living, should be counted as part of their happiness. Mill further argues that utilitarianism coincides with "natural" sentiments that originate from humans' social nature. Therefore, if society were to embrace utilitarianism as an ethic, people would naturally internalize these standards as morally binding. Mill argues that happiness is the sole basis of morality, and that people never desire anything but happiness. He supports this claim by showing that all the other objects of people's desire are either means to happiness, or included in the definition of happiness. Mill explains at length that the sentiment of justice is actually based on utility, and that rights exist only because they are necessary for human happiness.
II. Use of the Utilitarian Theory in Ethical Decision Making Process
From the perspective of the organizations, the utilitarian theory is the most frequently advocated theories. It is in fact the philosophical basis for our contemporary notion of democracy as well as the underpinning for microeconomic theory. The local utilitarian view can be considered from local and cosmopolitan organizational perspectives. The local utilitarian view is oriented toward the greatest good for the firm, whereas the cosmopolitan view would encompass a broader perspective that extends beyond the firm (i.e. greatest good for the society at-large).
This theory does provide an objective method for choosing among ends. Initially termed as “hedonistic calculus,” its contemporary terminology is the rational decision making process.
This process involves: identification of the problem, the generation of alternatives, the quantitative evaluation of the alternatives, the selection and implementation of the ‘best’ alternative, and the evaluation of the performance of this decision. While this process has proved to be an efficient method of resolving many organizational dilemmas, it is often found to be lacking when ethical dilemmas are considered. The impact of utilitarian decisions upon the individual or minority presents a further problem. If the greatest good for the greatest number results in the obfuscation or outright denial of individual rights, then the use of utilitarianism as an exclusive theoretical outlook may not be acceptable to those whose rights are being denied.
III. References:
William F. Lawhead, Philosophical Questions (Classic and Contemporary
Readings), 1st Edition, McGraw Hill Higher Education, 2003.
David Lyons, Rights, Welfare and Mill’s Moral Theory, Oxford University
Press, 1994.
James Agarwal & David Cruise Malloy, “The role of existentialism in ethical
business decision-making,” Business Ethics: A European Review, Vol.
9, Number 3, July 2000.
Law on Obligations and Contracts (Part 3)
C O N T R A C T S
The Law
“Article 1305. A contract is a meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or to render some service. (1254a)”
Discussion of the Law
Characteristics of a Contract
(1) Mutuality of Contracts. Its validity and performance cannot be left to the will of only one of the parties.
(2) Autonomy of Contracts. Parties are free to stipulate terms and provisions in a contract, as long as these terms and provisions are not contrary to law, morals, good customs, public order and public policy.
The following are valid stipulations in an employment contract:
a) Non-competition agreements – those that impose restrictions on an employer’s ability to compete with a former employer are valid as long as:
It is supported by adequate consideration;
The restraint is confined within the limits that are reasonably necessary for the protection of the employer’s business
Restraint does not impose undue hardship on the employee.
b) Non-solicitation agreements – requirement to newly-hired employees to sign a non-solicitation agreement to obligate the employee not to solicit contacts and fellow employees of the employer. Non-solicitation agreements run for an indefinite period.
c) Confidentiality – imposes upon an employee a duty to keep confidential trade secrets and other confidential company information during employment and after employment. This may also run for an indefinite period.
A Yellow Dog Contract is a promise exacted from workers as a condition of employment that they are not to belong to, or attempts to foster, a union during their period of employment. This constitutes Unfair Labor Practice and considered an illegal stipulation.
(3) Relativity of Contracts. Contracts are binding only upon the parties and their successors-in-interest.
Exceptions:
Stipulation in favor of a third person (stipulation pour autrui) as in a beneficiary of an insurance policy.
Contracts creating real rights
Third person liable to pay damages in case he induces a party to violate his contract.
A Stipulation pour autrui (stipulation in favor of a third person) will prosper as long as the following requisites are present:
It must be for the benefit or interest of the third person;
Such benefit must not be merely incidental;
Contracting parties must clearly and deliberately conferred such benefit or interest upon the third person
That the third person must have communicated his acceptance to the obligor before his revocation.
(4) Consensuality of Contracts. Contracts are perfected by mere consent. and no form is prescribed by law for their validity. Exception: (a) real contracts (such as pledge, chattel mortgage); (b) contracts covered under the Statute of Frauds.
(5) Obligatory Force of Contracts. By the obligatory force of contracts, it constitutes the law as between the parties who are compelled to perform under the threat of being sued in the courts of law.
The Law
“Article 1305. A contract is a meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or to render some service. (1254a)”
Discussion of the Law
Characteristics of a Contract
(1) Mutuality of Contracts. Its validity and performance cannot be left to the will of only one of the parties.
(2) Autonomy of Contracts. Parties are free to stipulate terms and provisions in a contract, as long as these terms and provisions are not contrary to law, morals, good customs, public order and public policy.
The following are valid stipulations in an employment contract:
a) Non-competition agreements – those that impose restrictions on an employer’s ability to compete with a former employer are valid as long as:
It is supported by adequate consideration;
The restraint is confined within the limits that are reasonably necessary for the protection of the employer’s business
Restraint does not impose undue hardship on the employee.
b) Non-solicitation agreements – requirement to newly-hired employees to sign a non-solicitation agreement to obligate the employee not to solicit contacts and fellow employees of the employer. Non-solicitation agreements run for an indefinite period.
c) Confidentiality – imposes upon an employee a duty to keep confidential trade secrets and other confidential company information during employment and after employment. This may also run for an indefinite period.
A Yellow Dog Contract is a promise exacted from workers as a condition of employment that they are not to belong to, or attempts to foster, a union during their period of employment. This constitutes Unfair Labor Practice and considered an illegal stipulation.
(3) Relativity of Contracts. Contracts are binding only upon the parties and their successors-in-interest.
Exceptions:
Stipulation in favor of a third person (stipulation pour autrui) as in a beneficiary of an insurance policy.
Contracts creating real rights
Third person liable to pay damages in case he induces a party to violate his contract.
A Stipulation pour autrui (stipulation in favor of a third person) will prosper as long as the following requisites are present:
It must be for the benefit or interest of the third person;
Such benefit must not be merely incidental;
Contracting parties must clearly and deliberately conferred such benefit or interest upon the third person
That the third person must have communicated his acceptance to the obligor before his revocation.
(4) Consensuality of Contracts. Contracts are perfected by mere consent. and no form is prescribed by law for their validity. Exception: (a) real contracts (such as pledge, chattel mortgage); (b) contracts covered under the Statute of Frauds.
(5) Obligatory Force of Contracts. By the obligatory force of contracts, it constitutes the law as between the parties who are compelled to perform under the threat of being sued in the courts of law.
Law on Obligations and Contracts (Part 2)
Nature and Effects of Obligations
The following are the rights available to a creditor in obligations to give:
If it is a determinate thing:
1. To compel specific performance
2. To recover damages in case of breach
3. Acquires personal right to the fruits of the thing from the time the obligation to deliver arises
4. Acquires real right over the thing once the thing has been delivered to him
5. Rights over the accessories and accessions.
If it is a generic thing:
1. To ask for performance of the obligation
2. To ask that the obligation be complied with at the expense of the debtor.
A determinate thing is one that is particularly designated or physically segregated from all others of the same class. A generic thing is one whose determination is confined to that of its nature, to the genus to which it pertains such as a horse, a chair. A contract of sale uses a determinate thing, while a contract of loan uses a generic thing.
The following are the obligations of the passive subject in:
a) Obligations to give a determinate thing:
1. To deliver the thing which he has obligated himself to give.
2. To take care of the thing with the proper diligence of a good father of a family.
3. To deliver all its accessories and accessions.
4. To pay damages in case of breach of obligation.
b) Obligations to do:
1. If the debtor fails to do what he is obliged to do, it will be done at his expense.
2. If the work is done in contravention of the tenor of the obligation, it will be re-done at debtor’s expense.
3. If the work is poorly done, it will be re-done at debtor’s expense.
In obligations to do, you will note that you cannot compel the passive subject to perform, otherwise, it will constitute involuntary servitude which is in violation of the Constitution. However, the passive subject may be held liable for damages.
The sources of liability (for damages) of a party in an obligation are as follows:
(1) Fraud. The fraud is incidental fraud (dolo incidente) which is fraud incident to the performance of an obligation. In fraud, there is an intent to evade the normal fulfillment of the obligation and to cause damage.
The fraud is causal (dolo causante) or when fraud used to induce a person to agree to a contract. This kind of fraud is a ground for annulment of the contract plus damages;
(2) Negligence. The negligence referred here, in the case of contracts (i.e. common carrier) is culpa contractual, the lack of diligence or carelessness. Negligence consists in the omission of that diligence which is required by the nature of the obligation and corresponds with the circumstances of the persons, or the time and of the place.
(3) Delay (Mora). The debtor can be held liable for the delay or default in the fulfillment of his obligation only after the creditor has made a demand, judicial or extrajudicial, on the debtor, except:
When the law expressly provides that demand is not necessary;
When the contract expressly stipulates that demand is not necessary;
When time is of the essence;
When demand would be useless.
In a contract of loan, if a particular rate of interest has been expressly stipulated by the parties, such stipulated interest shall be applied. If the exact rate of interest is not mentioned, the legal rate shall be payable (which is 12% per annum under Sec. 1 of the Usury Law).
It is only in contracts of loan, with or without security, that interest may be stipulated and demanded. This interest by way of compensation, must be in writing, otherwise, no interest by way of compensation may be collected.
The debtor in delay is also liable to pay legal interest by way of indemnity for damages, which interest may be agreed upon, and in the absence of any stipulation, the legal interest shall be 12% per annum.
In all cases, interest due shall earn legal interest from the time it is judicially demanded although the obligation may be silent upon this point.
(4) Contravention of the tenor of the obligation. Performance in contravention of the tenor or terms of the obligations means where performance is contrary to what is agreed upon or stipulated thus making the debtor liable for damages.
The following are the rights available to a creditor in obligations to give:
If it is a determinate thing:
1. To compel specific performance
2. To recover damages in case of breach
3. Acquires personal right to the fruits of the thing from the time the obligation to deliver arises
4. Acquires real right over the thing once the thing has been delivered to him
5. Rights over the accessories and accessions.
If it is a generic thing:
1. To ask for performance of the obligation
2. To ask that the obligation be complied with at the expense of the debtor.
A determinate thing is one that is particularly designated or physically segregated from all others of the same class. A generic thing is one whose determination is confined to that of its nature, to the genus to which it pertains such as a horse, a chair. A contract of sale uses a determinate thing, while a contract of loan uses a generic thing.
The following are the obligations of the passive subject in:
a) Obligations to give a determinate thing:
1. To deliver the thing which he has obligated himself to give.
2. To take care of the thing with the proper diligence of a good father of a family.
3. To deliver all its accessories and accessions.
4. To pay damages in case of breach of obligation.
b) Obligations to do:
1. If the debtor fails to do what he is obliged to do, it will be done at his expense.
2. If the work is done in contravention of the tenor of the obligation, it will be re-done at debtor’s expense.
3. If the work is poorly done, it will be re-done at debtor’s expense.
In obligations to do, you will note that you cannot compel the passive subject to perform, otherwise, it will constitute involuntary servitude which is in violation of the Constitution. However, the passive subject may be held liable for damages.
The sources of liability (for damages) of a party in an obligation are as follows:
(1) Fraud. The fraud is incidental fraud (dolo incidente) which is fraud incident to the performance of an obligation. In fraud, there is an intent to evade the normal fulfillment of the obligation and to cause damage.
The fraud is causal (dolo causante) or when fraud used to induce a person to agree to a contract. This kind of fraud is a ground for annulment of the contract plus damages;
(2) Negligence. The negligence referred here, in the case of contracts (i.e. common carrier) is culpa contractual, the lack of diligence or carelessness. Negligence consists in the omission of that diligence which is required by the nature of the obligation and corresponds with the circumstances of the persons, or the time and of the place.
(3) Delay (Mora). The debtor can be held liable for the delay or default in the fulfillment of his obligation only after the creditor has made a demand, judicial or extrajudicial, on the debtor, except:
When the law expressly provides that demand is not necessary;
When the contract expressly stipulates that demand is not necessary;
When time is of the essence;
When demand would be useless.
In a contract of loan, if a particular rate of interest has been expressly stipulated by the parties, such stipulated interest shall be applied. If the exact rate of interest is not mentioned, the legal rate shall be payable (which is 12% per annum under Sec. 1 of the Usury Law).
It is only in contracts of loan, with or without security, that interest may be stipulated and demanded. This interest by way of compensation, must be in writing, otherwise, no interest by way of compensation may be collected.
The debtor in delay is also liable to pay legal interest by way of indemnity for damages, which interest may be agreed upon, and in the absence of any stipulation, the legal interest shall be 12% per annum.
In all cases, interest due shall earn legal interest from the time it is judicially demanded although the obligation may be silent upon this point.
(4) Contravention of the tenor of the obligation. Performance in contravention of the tenor or terms of the obligations means where performance is contrary to what is agreed upon or stipulated thus making the debtor liable for damages.
Law on Obligations and Contracts (Part 1)
To begin, the Law on Obligations and Contracts is defined as s a kind of positive law which deals with the nature and sources of obligations as well as the rights and duties arising from agreements in contracts.
Before discussing the particular concepts on the Law on Obligations and Contracts, it is important to know that in every obligation, one must always observe the general principles on human relations, to wit:
“ART. 19. Every person must, in the exercise of his rights and in the performance of his duties, act with justice, give everyone his due, and observe honesty and good faith.”
Failure to observe the above principle makes a person civilly liable.
O B L I G A T I O N
"Article 1156. An obligation is a juridical necessity to give, to do or not to do."
An obligation is a legal duty, however created, the violation of which may become the basis of an action of law.
Every obligation has four definite elements, without which no obligation can exist, to wit: (1) an active subject, also known as the obligee or creditor, who has the power to demand the prestation; (2) a passive subject, also known as the debtor, who is bound to perform the prestation; (3) an object or the prestation, which is an object or undertaking to give, to do or not to do; (4) The juridical or legal tie, the vinculum which binds the contracting parties. The juridical tie or vinculum is based on the sources of obligation arising from either the law or contract. Law is defined as a rule of conduct, just and obligatory, promulgated by the legitimate authority, for common observance and benefit. On the other hand, contract is defined as “meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or render service.”
It is important to identify the prestation in a certain obligation. Once the prestation is identified, you can determine who the passive subject is whom the active subject can demand fulfillment of the obligation.
A contract of sale and a contract of loan are examples of prestations to give; A contract of labor or a service contract is an example of a prestation to do.
To illustrate: In an obligation to pay taxes, the passive subject is the taxpayer, the active subject is the government through the Bureau of Internal Revenue, the prestation is “to give,” specifically to pay taxes, the juridical tie is a source of obligation arising from law.
In an obligation to give Avon Products, the passive subject is the seller, the active subject is the buyer, the prestation is “to give,” specifically to deliver the Avon Products, and the juridical tie is a source of obligation arising from contract.
Before discussing the particular concepts on the Law on Obligations and Contracts, it is important to know that in every obligation, one must always observe the general principles on human relations, to wit:
“ART. 19. Every person must, in the exercise of his rights and in the performance of his duties, act with justice, give everyone his due, and observe honesty and good faith.”
Failure to observe the above principle makes a person civilly liable.
O B L I G A T I O N
"Article 1156. An obligation is a juridical necessity to give, to do or not to do."
An obligation is a legal duty, however created, the violation of which may become the basis of an action of law.
Every obligation has four definite elements, without which no obligation can exist, to wit: (1) an active subject, also known as the obligee or creditor, who has the power to demand the prestation; (2) a passive subject, also known as the debtor, who is bound to perform the prestation; (3) an object or the prestation, which is an object or undertaking to give, to do or not to do; (4) The juridical or legal tie, the vinculum which binds the contracting parties. The juridical tie or vinculum is based on the sources of obligation arising from either the law or contract. Law is defined as a rule of conduct, just and obligatory, promulgated by the legitimate authority, for common observance and benefit. On the other hand, contract is defined as “meeting of minds between two persons whereby one binds himself, with respect to the other, to give something or render service.”
It is important to identify the prestation in a certain obligation. Once the prestation is identified, you can determine who the passive subject is whom the active subject can demand fulfillment of the obligation.
A contract of sale and a contract of loan are examples of prestations to give; A contract of labor or a service contract is an example of a prestation to do.
To illustrate: In an obligation to pay taxes, the passive subject is the taxpayer, the active subject is the government through the Bureau of Internal Revenue, the prestation is “to give,” specifically to pay taxes, the juridical tie is a source of obligation arising from law.
In an obligation to give Avon Products, the passive subject is the seller, the active subject is the buyer, the prestation is “to give,” specifically to deliver the Avon Products, and the juridical tie is a source of obligation arising from contract.
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