It’s difficult to recall the earth-shattering events of the 20th century without asking the moving question: what if they had been prevented? What if radar operators had correctly identified the Japanese warplanes approaching Pearl Harbor on December 7th, 1941 as a massive attack wave, rather than assuming it was the scheduled arrival of six B-17 bombers? What if NASA managers had listened to the solid rocket engineers’ concerns that the ultra-cold temperatures on January 28th, 1986 would compromise the rubber O-rings that sealed together the Challenger’s boosters? And what if Secret Service agents had left the plastic cover on the presidential limousine on November 22nd, 1963, potentially obscuring President Kennedy from an Ordnance Optics scope?
Over the years, many historians and pundits have speculated intensely about that fateful November day – 50 years ago this Friday – when Kennedy was assassinated as he rode in an open limousine through the streets of Dallas. They have just as feverishly discussed how the world might have turned out had the attempt failed. In addition to several hypothetical pieces by academics, even Stephen King published a 2011 novel, 11-22-63, devoted to an alternate history of the world that ensued after his protagonist distracted Lee Harvey Oswald while the presidential motorcade passed. Theories abound on how the last fifty years would have unfolded differently, in realms as diverse as:
Vietnam: Historians James Blight and Janet Lang argue that if Kennedy had lived, the nation almost certainly would not have been embroiled in the Vietnam War. They note that six separate times, his hawkish advisors intensely pressed him to use military force in Berlin, Cuba, Laos, and South Vietnam, and all six times he resisted. When Lyndon Johnson inherited these national security advisors, he took their counsel and escalated American involvement in Vietnam rapidly. So if Kennedy had kept us out of all but an advisory role in Vietnam, would John Lennon still have spent his honeymoon writing Give Peace a Chance, or more likely, Give PCP a Chance?
Economic policy: Early in 1963, President Kennedy sent a message to Congress to accompany his proposed budget. The message contained the following statement: “Because my proposals incorporate lower rates of taxation, they will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased–not a reduced–flow of revenues to the Federal Government.” So with as eloquent an advocate as Kennedy arguing for cutting taxes to increase government revenues, would econ students read more Laffer than Keynes?
Civil Rights: In Stephen King’s retelling, Kennedy’s survival and reelection meant that the Civil Rights Act would never pass. While Kennedy had comparatively little influence over Congress, Lyndon Johnson had been one of the most powerful Senate majority leaders ever, and his relentless advocacy and obstinate will finally broke down the Southern Democrats in Congress lined up to oppose the Civil Rights Act. While one hopes that the country would soon have rejected racial segregation even without Johnson, how much longer might it have taken?
Just about anyone can pose historical “what ifs?”, but who is asking the “what ifs?” when it comes to the prudent management of your financial risks? Whether you are thinking about past or future financing decisions, capital exposures, potential market scenarios, or possible hedges, what-if analysis can be invaluable in clarifying alternatives and ultimately deciding on a course of action. Here are five practical what-if scenarios we’ve helped clients answer:
Estimating hedge ineffectiveness: What if I’m hedging with an interest rate swap that does not perfectly match my underlying financing, and using the hypothetical derivative method to test for hedge effectiveness? How much hedge ineffectiveness can I reasonably expect to flow through my income statement?
Projecting collateral posting requirements: What if I decide to put seven FX forwards on my line with a relationship bank that requires me to post collateral above a certain mark-to-market liability threshold? Where would exchange rates have to move before I needed to post collateral? And could I obviate collateral posting altogether if I purchased deferred-premium options instead?
Modeling future potential interest rate scenarios: What if the yield curve rises by 100 basis points over the next six months? Or if the curve steepens instead, with the latter end rising more sharply and the shorter end staying where it is? What will happen to my existing debt portfolio, and what would happen if I refinanced three properties?
Attaining risk reduction targets: What if our company has operations in twenty countries, with meaningful currency exposure in twelve of those, and we would like to reduce our cashflow-at-risk by 50%? In what order should we hedge these currencies, and how much should we hedge of each, to attain this target?
Analyzing impact of historical hedging decisions: What if we had used a swap, or a purchased swaption, or gone unhedged, or some combination of these, instead of buying a cap three years ago? What would our interest expense have been under each scenario?
What-if questions hold value in many different areas of financial decision-making. If Stephen King is writing your financial risk management strategy, then you’ve probably got a gripping read full of doom, gloom, and alternate realities. By contrast, at Chatham we have spent more than twenty years building risk management expertise and market-calibrated financial models to help you understand what would happen “if.” So if you’re wondering what the future might hold for your business, please don’t hesitate to contact us. We would be delighted to help you think through all the what-ifs on your mind.
Give us a call at 610.925.3120 or email us