Wednesday, 30 January 2008

Risk and Capital Financing

How much am I risking by carrying out this experiment?

To calculate the opportunity cost of this experiment, I need to calculate the lost income and increased costs that I am likely to face as a result of this experiment.

§ Lost income from work - £337 a month or £4,044 for the duration of The Experiment. This includes reducing my current salary to 75% of its current level (plus a small increase for inflation) as well as foregoing 25% of an estimated performance related bonus for the 12 months of The Experiment. (Incidentally, reducing my salary by 25% only leads to a reduction of 20% in my net pay due to tax deductions and student loan deductions decreasing.)
§ Increased travelling costs – Since my girlfriend and I both work for the same company, we obviously benefit from reduced travelling costs as we share a car to work. As a result of The Experiment, our travelling costs will increase by circa. £100 a month or £1,200 a year.
§ Software costs – I need to invest in some software (Bet Angel Pro) to enable me to carry out The Experiment in an appropriate manner. This software will cost me £320 for the duration of The Experiment.

In total, the opportunity cost of this experiment is £5,564 for 12 months. This is equivalent to £464 a month. Of course, this excludes the capital required to carry out The Experiment in the first place!

How do I plan to fund this experiment?

I believe that there are only two ways to fund the £15,000 capital that I need to carry out this experiment. These are a Personal Loan of £15k or increasing my mortgage by £15k. The figures for both options are:

o Personal Loan

Ø A £15k loan across 5 years means that I would have to pay £3k in interest repayments.
Ø My monthly repayment would be £300 for 60 months.

o Increased Mortgage

Ø Increasing my mortgage by £15k would result in me having to pay around £13k in interest payments across the next 24 years.
Ø My increased monthly repayment would be around £100 a month for the next 24 years (varies depending on interest rate changes).

I believe that the mortgage option is the correct finance option for me as it is basically a risk-free option. If The Experiment fails, I could easily afford to be penalised by paying an extra £100 a month towards my mortgage. However, if The Experiment were to fail, I would be heavily penalised by the Personal Loan option as I would struggle to meet the repayments of £300 a month without changing my lifestyle.

As I don’t want to be paying an extra £100 towards my mortgage for the next 24 years, I am going to aim to pay back the £15k in 5 years time. Hence, I effectively get a £15k loan for a reduced interest rate with the safety-net of knowing that if The Experiment fails, I will only have to meet repayments of £100 a month (although it would be for 24 years!)

Cost of Capital Financing

As stated above, I want to pay back the £15k in 5 years time. Until I pay this back, I will face interest payments of £100 a month. Hence, the cost of the loan is effectively:

Finance Cost = £100 a month for 60 months and £15k at month 60.

For simplicity, if we exclude discounting, the cost to me is £21,000 over 5 years or £350 a month.

Summary

By looking at the opportunity cost of this experiment, I can see that the cost to me every month for carrying out this experiment is around £814 a month! This of course assumed that I want to pay my £15k loan back at the end of 5 years. If I decided to live with the increased mortgage costs for the next 24 years, the cost to me every month is around £564. Whatever way you look at it, it’s going to be an expensive experiment……..

leonthefixer said...

Just starting to read through your blog mate and it is excellent so far! You seem to be taking a very methodical approach to it all - exactly the same as I did, I was abused on the BF forum from some people but I believe get the basics right and you have a good foundation.

Only read to this post so far but you have not included the opportunity cost of interest forgone. I.e. wack the £15k in a bank account and you would be earning interest, put it in BF and they earn the interest not you :-)If I know I am not going to be trading for a few days i.e. long enough to withdraw the money and get it in my account I will do it so I earn a little bit of interest on it.

With regards to the software you are using I would recommend BA Pro - excellent reliability and customer service and also it has been reduced in price! Not sure if you mention it later but you havn't said anything about subscribing to Sky for ATR and RUK?

Graeme Dand said...

Thanks Leon. I already subscribe to ATR and RUK and would continue to do so whether I did this project or not, so not wanting to look at this as an additional cost.

As you say, BA Pro is definitely the best software and I have already purchased this.

Thanks,

Graeme