Major WTF moment with Human Capital (2012 - AM)

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Viceroy

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I would like to share thoughts on this Question 1-E (2012 AM) :
It seems that Alonso’s HC resembles an A-rated corporate amortizing ABS.
Mmmmm k. LULZ.
The justification is that :
- 1) he has a fixed working contract –> therefore Bond-like
- 2) his contract is subject to the creditworthiness of his employer (actually in this specific case, the shareholder of his employer, but this in not relevant) –> therefore Corporate Securities (as opposed to Treasury Bills)
- 3) Just like an ABS, Alonso’s HC will deplete over time –> therefore ABS
What sounds like a ridiculous in CFA-land-only-autistic-answer is actually the result of a logical sequence. However, my problem is with the bond-like aspect.
For me, working for a private corporation, especially a risky one ( a fuckin’ soccer club that had financial issues in the past, FFS) is absolutely equity-like, regardless of the type of working contract.
For those that did the Mock, I had answered that his HC was like small-cap domestic equity (IMO the best fit for the soccer club).
Thoughts ?
tl;dr : A long-term working contract with a shitty private soccer club makes the HC bond-like.
 
Small-cap equity is not amortizing nor does it have a fixed term. The riskiness of his position is captured in the A-rating of the ABS. His position and contract are absolutely not equity-like
 
Viceroy wrote:
- 1) he has a fixed working contract –> therefore Bond-like
Click to expand...
This is the main point. Companies also issue (corporate) bonds, right? So, your reasoning:
Viceroy wrote:
working for a private corporation, especially a risky one ( a fuckin’ soccer club that had financial issues in the past, FFS) is absolutely equity-like, regardless of the type of working contract.
Click to expand...
is not fully convincing, because corporate bonds include your explained risk, too (i.e., higher yields).
 
kjames05 wrote:
Small-cap equity is not amortizing nor does it have a fixed term. The riskiness of his position is captured in the A-rating of the ABS. His position and contract are absolutely not equity-like
Click to expand...
Conversely and based on that criteria alone, since HC is always amortizing, does this mean that HC is NEVER equity-like ?
Of course it doesn’t mean that. Therefore I find this argument fallacious.
 
I got this question correct out of process of elimination. All of the choices provided just didn’t fit as well as an A-rated corproate
 
Viceroy wrote:
Conversely and based on that criteria alone, since HC is always amortizing, does this mean that HC is NEVER equity-like ?
Click to expand...
Its not about the whole HC, its only about this special 10-y contract.
 
I think that Alonso’s cash flow pattern is quite opposite to that of an ABS investor and hence ABS should not be the right answer because……
Alonso’s stream of income is linked to inflation. Higher inflation is associated with increasing interest rates and so Alonso will receive higher income when interest rates increase.
However, an ABS investor will receive lower cash flows when interest rates increase because of lower prepayment rates and lower refinancing rates of the underlying securities
 
Ofcourse, I am assuming above that the underlying assets for the ABS consists of loans
 
I found the name Juan Pablo Alonso very amusing because the name is a mating between the two Formula 1 drivers, Juan Pablo Montoyo and Fernando Alonso.
 
tinnit wrote:
I think that Alonso’s cash flow pattern is quite opposite to that of an ABS investor and hence ABS should not be the right answer because……
Alonso’s stream of income is linked to inflation. Higher inflation is associated with increasing interest rates and so Alonso will receive higher income when interest rates increase.
However, an ABS investor will receive lower cash flows when interest rates increase because of lower prepayment rates and lower refinancing rates of the underlying securities
Click to expand...
You’re assuming lnflation increases - that’s not a component of the question. Additionally, his cashflow from an ABS will not decrease with higher interest rates. The YTM would increase due to higher reinvestment rate, which is the same as what his salary linked to inflation would be doing.
 
I guess I was looking at the ABS on a standalone basis ignoring the reinvestment aspect. Thanks
 
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