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Here’s another example of partners investing in each other’s success. I know of a company that paid to have consultants teach strategic planning to their employees’ union.Many members of management were dumbfounded when they heard about this. They wondered why the company would pay to have the union become more organized and stronger through company-provided strategic planning. When the question was asked of the CEO, her answer demonstrated her high PQ: “In the next round of negotiations with the union, I want them to know what their members want so we can get down to the critical issues that are facing our industry. Neither side wants to drag out these talks. It’s an investment in our management’s time to have the union be strategically prepared for these negotiations.”

The refinancing sensitivity increases with a decreasing credit quality. This means that weak B- and C-rated companies are the most refinancing sensitive. There is a close relationship between the ratings cycle and the Fed fund cycle. Atight Fed policy goes hand in hand with a lower amount outstanding of CCC paper. If the Fed switches to an easing mode the proportion of CCC-rated bonds will increase in the credit market. AFed tightening policy goes along with credit rating upgrades whereas an easing policy cycle is usually associated with credit rating downgrades. This is because the effects of the Fed policy will have an impact on the credit markets with a time lag of several months.

Asteepening of the treasury curve – driven by declining short-term rates will provide the credit market with liquidity, which in turn helps to lower default rates. In this scenario, companies will have easier access to liquidity (e.g. bank loans, debt and equity markets).

Operating leverage is the idea that companies can make more money from each additional sale if they do not have to increase fixed costs to produce more. In general, operating leverage refers to the fact that a lower ratio of variable cost per unit to price per unit causes profit to vary more with a change in the level of output than it would if this ratio was higher. So operating leverage is a function of fixed unit costs and output. The benefits of operating leverage unfold when business picks up. Then the existing workforce, plant and equipment can produce more without additional costs. Profit margins expand, and profits boom. Obviously, the profit of a business with a high degree of operating leverage varies more, everything else remaining the same, than do those profits of businesses with less operating leverage.

Greater variability of profits, of course, means that the credit risk is higher. Conversely, with a lower level of operating leverage, the business shows poor growth in profits as sales rise, but faces a lower risk of loss as sales decline.

Stock prices will always be volatile. Every form of media extensively covers the stock market. As a result, stock prices are influenced by all major events, whether they are political, social, or economic. Elections, earthquakes, terrorists, unemployment, assassinations, foreign affairs, the dollar, war, peace, and much more: All send stock prices up and down.

During bubbles, extensive media coverage will lead you to be overconfident in your ability to pick stocks. If you are caught up in the herd hysteria, you may even reach a sense of grandiosity, believing yourself an investment genius. Addiction can take over as you constantly seek the high of easy money.

A sudden drop in stock prices triggers more troubling emotions. Some investors panic and sell everything. Panic is highly discouraged by those who make a living selling stocks. Investors who panic and sell out often feel guilty that they went against the advice of investment professionals. However, panic is the clearest sign that stocks are outside your comfort zone. A good panic can save you decades of trouble. Investors who panicked and sold in 1929 got over the guilt and had no regrets for the next 21 years.

Investors who panicked in 1966, 1970, and 1974 got over the guilt and had no regrets until the mid-1980s.

Step 2 explains in detail how you can gain self-knowledge from an emotions inventory. An emotions inventory is similar to a physical inventory of goods in a shop or investments in a portfolio. It is done for the same purpose as well. Goods that are defective must be discovered and discarded; investments that have no future must be liquidated. Emotions that prevent investment compatibility must be recognized and isolated to make room in the psyche for those that are functional. Thereafter you will be investing in your comfort zone.

This simple process has worked for me, an ordinary investor, and it will work for most of you. I do not claim any high level of emotional maturity or spiritual development. No one who knows me would describe me as a saint or a guru. I am not a trained therapist. I do not have an MBA. I am not a Certified Financial Planner, and I am not a Chartered Financial Analyst.

After 21 years of living off my investments and taking regular investment emotional inventories, I do know which investments work best with my personality and which investments irritate me or keep me awake at night. By staying in my comfort zone, investing is fun for me. It will be fun for you too, though you may not see that yet.

Another important measure and motivating factor as you do battle with debt is whether or not you could get pre-qualified or pre-approved for a loan if you really wanted one. What if your car needs a major repair and you’d rather just buy a new one instead of repairing the old? What if you found the house of your dreams?

Aside from credit cards, which companies seem to hand out like candy on Halloween, many loans are approved based on a couple of key ratios that consider your monthly debt service. Now granted, you still have to have a good credit score, but many lenders would not approve someone with the best credit score if they fell outside these ratios:

A front-end ratio is a comparison of your loan payment for the purchase you’re making against your total household pre-tax monthly income. For example, a $500 payment compared against a $2,000 per month income would give you a front-end ratio of 25% ($500 divided by $2,000). For most car and home loans, the front-end ratio needs to be in the ballpark of 30%, though this changes based on the lender and the size of the loan.

A back-end ratio is a comparison of the payment on the loan you’re applying for plus all your other types of monthly debt service, compared against your income. (This is the one that gets most people denied for a loan.) For example, the back-end ratio on a new monthly car payment of $500 and an existing monthly mortgage payment of $1,000, when compared against $2,000 in monthly income, would be 75% ($1,500 divided by $2,000). For most auto and home loans, the maximum back-end ratio is 50%, though 35–40% is common.

So what is your back-end ratio? Let’s figure them out:

Total monthly debt payments (short + long term) $________
Total monthly income before taxes $________
Back-end ratio (monthly debt payments divided by your income) $________

Legal risk is an especially important case of unique risk in the United States, affecting companies of all sizes. First, a transaction on which one is relying may prove unenforceable in law. It may be a contract with a supplier, an insurance policy, or a regulation. Long-term supply contracts that seem to lock in a price may be difficult to enforce if the price moves significantly out of line with the market. The copyrights of publishers and musicians may be contested in the courts. Employment agreements can be challenged and often prove unenforceable in practice.

A second set of risks is exposure to lawsuits. There are many classes of suit that arise in the normal course of business. For the vast majority, the stakes are not material and are sometimes insurable. They arise from differences over contracts, auto and truck accidents, complaints against supervisors, and the like.

Collectively, these are an element of risk and an ongoing cost of business, but usually not a major concern for investors.

The following four property types constitute the majority of CMBS collateral—apartment buildings, shopping or strip malls, office properties and industrial properties. Other asset types included in CMBS pools are hotels, manufactured housing, self-storage, and healthcare properties.

One appealing factor for borrowers is that the loans are nonrecourse (or limited recourse) to the borrower. Ultimate repayment comes solely from the collateral and not the borrower. There are exceptions for fraudulent borrower activities or representations, and the like. Borrowers typically make their borrowing decisions either on price (which conduit or other lender is offering the cheapest financing) and/or proceeds (which lender is willing to lend the largest amount of proceeds—that is, allowing the borrower the greatest leverage).

In exchange for nonrecourse and favorable rates, the loans come with prepayment restrictions, making it possible to create bonds that have excellent call protection and average life stability. Most loans amortize over a 25-to 30-year period. However, most loans also balloon at 10 years and must be paid in full. Since 2004, the amount of loans with IO periods (where no amortization is taking place) has been increasing. For many years, IO periods as a percentage of a loan’s term has hovered around 5%. This percentage has grown to nearly 70%.