What about the risk to institutions ?

In all transactions there are risks. Their risks will depend on how well they manage their eduoption portfolio. For example, if the institution is 'greedy' and sell too many eduoptions and assuming all the students who bought them manage to gain admission then, they have to provide the courses at the fixed price even when the market value of these courses are higher. Of course, they can raise the admission standard to limit the quantity. Click here for a detail strategy analysis for university users.

Education cost contrary to popular belief is rising and has observable high volatility. This article in the US shows the cost trend for public education. We have discovered that certain courses like law, medicine exhibit high volatility particularly when the targets are overseas students. For instance, increase of 25 % is considered high. Our initial survey showed young married professionals cited education cost as the second most important factor to be planned after getting their home. For married couples with children, education cost is ranked the highest where parents are even willing to get into debt or sell their home to prepare for this cost. Our Survey was done in 1999-2000 in Singapore, Malaysia and Australia by emails. We had 1672 respondents out of 5000 requests. So we are pretty sure there is a market. After all, even if education cost remains fixed, the salaries of educators must rise somewhere and someone has to fund this. Consider the option of the university or government having to determine and debate the fee and then raise them, isn't it simpler to let the potential students decide on their own how much they can pay in the future. Click here for a step by step how it works for eduoption purchaser.

Mechanism

Eduoption is not a prepaid instrument or a loan or a partial payment, it is a fee (premium) to fix a future education cost which you determine. By paying this fee to the institution you are transfering the risk of any rise or fall to them. Institution and most parents face the daunting task of financing their children's education cost but with no way of knowing this future cost. Say for example, today's cost of a law course is about 15 K and we have a customer wanting to pay 20 K say in 5 years. From past data, we know that the course will probably be 21K, 17K, 22K, 23K, 19K, 18.7K, 21.5K, 22K, etc with their high and lows. We use a measurement call standard deviation or volatility to find the range between the mean of said figures. In short this is a measurement of its potential dispersion over possible education prices. High volatility means a high degree of dispersion. We also have to assume that these cost distribution will converge onto the lognormal distribution. We further assume that within the contracted period the institution will not fail or bankrupt. Well, we can always build a credit rating for institutions later. We also applied interest rate to cover the cost of funding of the course today which means as interest rate increases over time, our eduoption value increases as well. Now back to our customer wishing to pay 20 K and further making an offer to pay 20 K in the future provided having gain admission as well. The dilemma at the institution is that they will lose income should the cost be more than 20 K but at the same time they will make money should our customer guess wrongly or failed to gain admission. This is where volatility comes in. By considering this volatility, we can calculate the possible 'mis-guess' ranges and value this as dollars in the form of a premium using our formula. So if our customer wants to pay 20 K, then he has to pay a premium of say 2 K (example) to secure this cost at 20 K in 5 years. The institution is happy to accept this 2 K since it will add immediate funds and secure in the knowledge that only three things can happen, prices move beyond expectation or this customer changes his mind and enroll elsewhere or failed to gain admission. The possibility of prices going 'wild', while a common occurrence in the stock market but not so in the education market because the main players are the institutions themselves. This means, well at least within 12 months prior to enrolment, they would have a clear idea what the pricing will be. In fact this means they would have 4 years of planning time based on the number of customers who bought eduoption to fix course fees. In short better forecasting and predictability for both supplier of education and their customers.

Difference with Prepaid.

This is where eduoption is different from a prepaid education system where institution has to price into the future hopefully with some vision. The states do this by trying to invest these funds in the stock market to get the maximum return to beat the rising fee cost. So as long as the bull market remains, everyone is happy but in bear market, your guess is as good as mine. In prepaid, the customer is actually paying for the full course fee while eduoption merely locks in the fee. In prepaid, only the time cost of money is used as a determinant while in eduoption, we use both the time cost of money and implied volatility (ie the likely changes to the price either by supply or demand factors). We assume that education cost is unpredicatable but it does move within certain ranges which we are certain. We know it does not exhibit wild swings like company stocks hence we do not suffer from 'unexpected' risk like bankruptcy at least not at the public university levels. Using eduoption, the client need only to fork out 1.5 K and the price is locked at 19 K. If it falls to 10 K, then customer pays 10 K and forfeits the 1.5 K. If the price goes to 22 K then customer merely pays 19 K. If we include the original 1.5 K, total outlay is still short of 22 K. In short the client will gain once the price moves down to below 17.5 K or above 20.5 K. No doubt, prepaid is a much more generous instrument since the States actually take all the risk for you. But as you can see from a recent article in http://www.collegejournal.com/aidadmissions/financialissues/20021218-tomsho.html or here for a cache copy, the states are beginning to wake up.

A central fund proposal for education.

While eduoption will help to fix future education price with limited downside risk, it may not practical in all cases. For instance say our customer wishes to fix his future education cost for a law course. There are however 30 law schools that he wishes to enroll in. So in practice he would have to purchase an eduoption for each one of the school which will be beyond his means. It would be better if he could be certain of one but being only 10 years old now, he really cannot make up his mind nor can his parents.

The solution is then to set up a central fund run by a state agency with the sole purpose of hedging all the education cost risk for him. In short, one special eduoption which hedges all selected universities with law courses so that when he actually gain admission the same eduoption can be used, ie making eduoption transferable.

Such a system means, all funds collected in the form of a premium will be in one account. Now the trick is to divide this premium paid by our customer to each one of the schools. This means, each school will only get 10 percent of the premium and when the customer actually selects the school, the balance 90 percent will be transferred to the school at the time of enrolment. The result is that all universities get some kind of funding or free ride even though it may be only 10 percent. However, we do lose the forecasting ability at individual institution level. At the central level, we can track education course demand more systematically.

Alternatively, the customer can select only a max of 5 and each will get 20 percent or the premium can be increase to reflect the choices made. The more choices the higher the premium.

This may not be a 'perfect' solution but given the alternative for the customer to purchase 10 eduoptions, this will be more acceptable. A central fund would also centralized administration cost and reduces the work load at individual institution. Of course eduoption will need to be redesigned again to reflect the choices.

Who are our potential clients ?

Typically our clients are institutions of higher learning. They usually purchase such system to offer eduoption as part of their business.

What are the benefits for them ?

For insitututions of higher learning, the benefits are two folds. : By using our fair value eduoption formula, university will be able to calculate the affordability of future course fees as determined by their potential clients. By offering this option, university will be able to map a realistic demand curve for a given course. Current systems can only forecast by using past data but our system uses current data as provided by potential users. This system provides the best indicator of what the market can afford in the future. By planning this requirement, institutions will be better equipped to manage the needs of these potential 'clients'. Of course it will be better if we can also predict future living cost so we can include this as an overall package. In order to compensate the risk in locking the future cost of education which is transferred to the Institution, said institution receives some compensation in the form of a premium. The Institution may use this premium to invest and to prepare for tomorrow's education today. In short, they will be able to raise funds at almost no cost.

An example calculation

Say an Law Degree cost US 15,000 a year now and our client wish to enroll in one in 8 years time. Our client is willing to pay US 19,000 a year provided he gets admitted. The course is 3 years. Using our system, we calculated the premium for the 3 years to be US 1550 (1st Year) + US 1987 (2nd Year) + US 2433 (3rd Year). By paying the sum of US 5970, the user will secure paying US 19,000 for 3 years in the law course. This simple calculation does not take into account, the potential demand of the course and whether this is the user's first choice. Interest rate is calculated to be at 4% for the period and historical volatility of the course fee is 5%. Obviously, the user will have to find US 19,000 to pay each year. We can only gaurantee the cost will be fixed and not the funding of the course fees. But without fixing the future course fee now, the user will not know how much to save or borrow in the first place.

What are the benefits for the purchaser of such eduoption ?

The main benefit is that the purchaser can lock in the cost that he/she is willing to pay in the future for a particular course at a particular institution at a particular time frame. The purchaser can transfer this option to another willing to purchase it. The main consideration for exercising the option is admission to the course. What if the course fee should fall to say US 12,000 in year 8 as per above example ? In this scenario, the user is better off paying the US 12,000 a year. The premium paid would be useless for him. Remember that the premium is used to buy certainty of course fee and not admission. In eduoption, you have the right but not obligation to pay the pre-agreed fee.

So what if the purchaser fail to gain admission to the course ?

In most cases, the eduoption will expire worthless. The initial premium that is used to fix the final fees (ie to purchase the option) is not refundable. As one can appreciate, higher institutions would recieve this initial premium and invest this in staff and equipment in anticipation of purchaser's admission. Hence purchaser's failure to gain entry is no reason for a refund. However in terms of market reality, I can envisage institutions refunding a part of these premium as an incentive to attract buyers. In any event, they would have benefitted from zero cost funding for the period. This again is a policy decision and is up to the institutions. In eduoption, the only uncertainty is whether the purchaser can gain admission to the course which is a prerequiste for exercising the eduoption.

So why should poeple use eduoption ?

First to lock in the future cost of education according to their own determined means. We are the only people who spend time studying the factors affecting the future cost and quantify this uncertainty in dollars. In layman's term, we provide the tools to measure this risk but the actual transaction to purchase an option is a matter of market forces. As one can appreciate, we provide the first uniform way to determine the price of this risk. Secondly, as a matter of financial sensibility. By "investing" in our public institutions of learning benefits all of us in some way. Most people expect tax dollars to do this but the reality as we discover is that such tax dollars are diminishing from external competition. In some instances, companies have stringed their interest at institutions to benefit themselves disguised as research funding. While this might benefit said companies in the short run, the downside is that university losses their independence and their status is diminished to one of a training center for these companies. My personal stand is that university should be a center of knowledge first rather than merely churning out graduates to feed into industries' needs. A center of knowledge means an originator of knowledge which in part requires independence to pursue subjects that are not merely for commercial exploitation in order to benefit society as a whole.

Can eduoption be transferable to another institution ?

In theory yes given that the other institution shares the same cost and course. However this is an administrative issue which need to be discussed and agreed between participating institutions. Afterall, institutions are competing for 'clients' and as public funding get less and less, this competition will intensify. On the other hand, harderned battle strategist will be quick to remind us that to win, it means taking in partners against a bigger enemy.