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Trading Post

Q: What is the Purpose of a Pricing Index?

A: The concept is not new; indices are used as pricing mechanisms in stock and commodity markets. The ability to buy or sell bandwidth based on an index price is an alternative to the standard “fixed price”bids or offers.

Q: What is an index?

A: An index is a weighted average of reported prices for transactions at a certain transmission route for a certain transmission date. The greater the number of reported transactions and the greater the number of reporters, the more legitimate the index.

Q: What is the purpose of an index?

A: The purpose is to create a benchmark pricing mechanism. A benchmark represents what may be considered a “market”price, i.e., a number that represents a market average.

Q: Who creates the index?

A: A neutral, objective party. Typically this is a publisher that faces no risk of commodity price fluctuations.

Q: How is an index created?

A: Traders report their trades to be represented in the index. The index creator polls the market participants on a regular (typically weekly) basis. Buyers and sellers are asked to note their transactions by location, price and quantity.

Over-the-counter (OTC) brokers and online trading systems should not report prices for the index as the transactions may be a duplicate of those the customer has reported.

Q: Which index should be used?

A: While several companies may attempt to create and publish an index, it is in the market’s best interest to have only one or two generally accepted indices.

To make an index legitimate or representative of the market, the number of trades that comprise it and the number of companies that report their trades should be as large as possible. There could be no better benchmark than one that contains every single transaction.

Q: How do you know if an index is legitimate?

A: An index’s legitimacy can be determined by the types of companies that report trades. For example, if only carriers report trades, then the prices reported may be presumed high. If only ISPs report trades, then the prices reported may be presumed low.

Index users should question which companies participate in the pricing poll. The index that represents the most market segments has the tendency to best represent the market price, as artificially low prices and high prices will cancel each other out.

Q: How is an index used?

A: An index can be used:

* As a measurement tool. Telecom management can judge its sales force by measuring purchase and sales prices against the published index price.

* As a pricing mechanism. Buyers and sellers may transact at the to-be-published index price rather than at a fixed price. For example, a buyer agrees to buy a New York-Los Angeles DS-3 from a seller for delivery in August. The agreed-upon price is the to-be-published August index price. The transaction confirmation between the buyer and seller stipulates the price paid to be the index price rather than a fixed price established at the time of the agreement. Neither party knows the price until publication date, at which time the published price becomes the fixed price. The price obtained in a bandwidth index deal is presumed to be a “market”price.

* As a diversification mechanism. The buyer or seller may choose to diversify its pricing by transacting bandwidth at the index price and an amount at a fixed price (or establishing a pricing portfolio). In a declining market, a buyer would obtain better pricing when purchasing at index as opposed to fixed. In a rising market, a buyer would obtain better pricing when purchasing at fixed as opposed to index.

* As a price hedging tool. Bandwidth buyers and sellers can hedge against adverse price move ments by entering into financial swap transactions using the established index. As an example, a carrier may agree to protect against declining prices by selling a swap.

The carrier receives from the counter-party a fixed price, which will be the going fixed price rate if transacted at that moment. In exchange, the carrier pays the counter-party the to-be-published index price. No physical bandwidth changes hands as the transaction is purely financial in nature. The carrier and its counter-party pay each other the difference between the fixed price and the published index price. It is only the price difference exchanged.

For example, if the fixed price is $20,000 and the published index price is $19,500, the carrier receives $500 from the counter-party ($20,000 – $19,500.) Should the index be published at $20,500, the carrier pays $500.

Q: Should my carrier company contribute to the index?

A: Yes. An index is only successful if the market participants contribute transaction information.

Answers to this month’s Trading Post questions were provided by Jeff
Rosenzweig, first vice president of marketing and business development for SDI Energy
(www.sdienergy.com), and Ron Banaszek, manager of SDI Bandwidth. SDI, Sakura Dellsher Inc.
(www.sdinet.com), is a global OTC commodities brokerage firm. SDI is a bandwidth broker, assisting clients in the purchase and sale of bandwidth, bandwidth forwards and financial products. They can be reached at
jrosenzweig@sdinet.com and rbanaszek@sdinet.com
.

CARRIERpublished index priceCOUNTER-PARTYfixed price (L.E., $20.000)

Got a Question?

All the talk and press about trading telecommunications capacity is sure to raise questions. That’s why PHONE+ has introduced a new column to address reader questions about this new market model. E-mail your questions to
phonplus@vpico.com. Answers will appear on our website and the most common will be reprinted in a subsequent issue of the magazine.


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