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Backstop Print E-mail

Backstop

What is it?

A backstop in financial terms refers to a type of insurance or last-resort support. When stocks or bonds are issued in order to raise capital, a backstop can be put in place to make sure that the security will be bought. In order to do this a group of underwriters together with a group of sub-underwriters (usually institutional investors) guarantee that they will buy whatever parts of the offering are not sold. A backstop is also used to describe the safety procedure put in place by a government or loan guarantee programme which insures the debt of a company or its credit line.

The term originated in sports as in baseball the backstop prevents the ball from leaving the playing area and in finance it is used to guarantee the company can raise the funds it needs. A bank backstop is seen as financial support for banks whereas for governments it is often used to mean that their debts can be guaranteed by a central bank or monetary fund.

Why is it in the news?

With bailouts occurring in the eurozone to boost both struggling governments and banks, the concept of providing security for bonds or loans is seen as an important part of fiscal responsibility. With the European Council looking at the idea of a eurozone banking union, one of the discussion points involved in this idea are financial backstops for the banks.

How can I use it in class?

Ask the class if they know the word ‘backstop’ from sports. Explain the meaning from baseball and explain that this term has moved into finance to mean a type of support when banks run into problems raising capital or guaranteeing their loans. Explain the original meaning of underwriting securities and then have students look at these headlines and statements in articles in which the word has become a synonym for guarantee.

‘California begs U.S. Treasury to backstop loans’
‘The loan backstop is designed to cover a pool of financial instruments.’
‘A government backstop may be available for a private financing of a bridge loan for AIG,’

Vocabulary

Match the definitions to the terms.

1 to suggest something for discussion A quad
2 relating to or affecting the whole of a system, organisation, etc. rather than just parts of it B levies
3 an agreement between two or more countries, formally approved by their governments C to back
4 a group of four people or things D to skirt
5 to support E to outrun
6 amounts of money, such as taxes, that have to be paid to a government or organisation F  mooted
7 to avoid G spike
8 a higher price usually before a drop in the price H treaty
9 to move faster or further than someone or something I circuit breaker
10 a rule that stops trade on a stock market or closes it when prices go down to a particular level too quickly – also used to describe a device which stops the flow of electricity when there is a problem in the line J systemic

Reading

Read the article from the BBC:  Eurozone banking union: The big bazooka
Explain to students that a bazooka is a powerful weapon. Ask them why they think it is used here.

Discussion

Discuss these questions.

  • Do you think that a eurozone banking union is a good solution to economic problems in the zone? Why or why not?
  • Why are financial backstops important?
  • How do you think a common deposit guarantee would work?
  • Why are some banks in the EU systemically important?
  • How would this proposal fund the common bailout fund?
  • How is the word ‘circuit breaker’ used in the article?
  • What does the last sentence in the article mean? Can you explain it in your own words?

Where can I read about it?

Eurozone banking union: The big bazooka, BBC, 12 June 2012
Cyprus would seek EU bailout money 'if necessary', BBC, 3 June 2012
Germany Prefers Permanent Fund for Spain, Stirring Conflict, Bloomberg, 11 June 2012
Backstop for Spain need not go directly to banks, Financial Post, 7 June 2012

Key

1F, 2J, 3H, 4A, 5C, 6B, 7D, 8G, 9E, 10I

 
Bad debt Print E-mail

overdue bills

See bad debt in the Cambridge Business English Dictionary

What is it?

The term “bad debt” refers to accounts receivable which will likely remain uncollectable and will be written off. Bad debts appear as an expense on the company’s profit and loss statement and reduce the net income. Companies make an estimate of bad debt expenses in advance based on their past records as part of the process when they estimate their earnings for the future. Most companies have bad debt allowances as they assume that not all their debtors will pay their bills in full. In addition, banks made provisions again bad debt and these play a major role in their earnings reports.

Why is it in the news?

As companies are beginning to report their earnings for 2010, looking at the amount of bad debts they recorded is part of the annual report.  When the amount of bad debt goes down, companies may have a higher net income even if they did not earn more money. On the other hand, a larger amount of uncollectable bills can adversely affect the bottom line.

How can I use it in class?

Vocabulary

Look at these words and expressions from the Bloomberg article and choose the correct of the two definitions.

1 to dent (earnings growth) 
A to reduce an amount of money   B to increase an amount of money

2 peers
A those who are members of a group you are a part of  
B those who are members of a different group

3 revenue
A expenses    B income

4 to bet
A to be certain   B to estimate or speculate

5 to sap profits
A to make profits stronger   B to make profits weaker

6 stellar
A excellent   B not very good

7 to beat the average
A to be better than the average   B to be worse than the average

8 to decline to say
A to publicly state   B to refuse to say

9 to remain elevated
A to stay high   to B fall

10 the economy contracted
A the economy got stronger   B the economy got weaker

11 quarterly
A every three months   B every four months

12 systemically important
A important on its own   B important to the system

Discussion questions

1 What reasons might a company have for not paying back a loan? Do you know of any specific example?
2 How important is it that banks and other companies make provisions for bad debt? What could happen if they don’t do this?
3 Do you think that bad loans are simply a fact of business or can this be changed? If so, how?
4 Have you had any personal experiences in your job where you had to deal with uncollectible debts? Did your company have any particular process for doing this?

Where can I read about it?

  • Erste Shares Fall on Revenue as Hungary, Romania Curb Growth, Bloomberg, February 25th 2011
  • HSBC sees full year profits more than double, BBC, February 28th 2011
  • Lloyds returns to profit to make £2.21bn, BBC, February 25th 2011
  • Ulster Bank reports operating losses of £761m for 2010, BBC, February 24th  2011

Key

1A, 2A, 3B, 4B, 5B, 6A, 7A, 8B, 9A, 10B, 11A, 12B

 

 

 
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