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					Financial Champions Seminars
   This is the first of the Fall, Investing, series.
   Today: All that jargon, mumbo-jumbo and a little
    (don’t tell anyone) math too...
   Next:
     October 16 - Markets: What Drives’m & How to Invest
      in’m...
     November 20 - Managing Your Money & Those Who
      Manage your Money...
   Pr 3:13: How blessed is the man who finds wisdom
    and the man who gains understanding
   This is going to be a hard seminar to get right...
    The first part is really basic, so be patient you
     sophisticated types...
    The middle is crucial...
    The last part is maybe a challenge to some...
  Please, please, please note: This is just an
  introduction.

There is a lot of Information at places like:
1. Investopedia.com
2. Globe Investor @ globeandmail.com
3. Bloomberg.com etc...
   actual ownership in a company...

   It entitles you to two things:
    1. To vote for stuff at the annual meeting.
    2. To get a dividend, if they issue one.

    It is lowest on the list of safety if the company
     tanks.
   actual ownership in a company...

What do you mean if it issues a dividend??

   Well, mature highly profitable companies often
    offer good dividends to attract investors.
   With the dividend tax credit, one of the companies,
    say a bank, can offer a better return than a
    government bond.
   actual ownership in a company...

What do you mean if it issues a dividend??

   Yet, a new company, or a high flyer (i.e. a fast
    growing, maybe more risky, company), can
    generate more “return” for you by “reinvesting” in
    itself. This is not a bad thing.
   It is good for capital gains.
   actual ownership in a company...

They come in flavours:
    1. Common
    2. Preferred
   It be an equity this is stock:
   a promissory note from a borrower.

   It has Five Parts:
    1.   A Face Value.
    2.   A Price.
    3.   A Maturity Date, or Term.
    4.   A Coupon (um, there is no “q” in coupon).
    5.   A Credit Rating from S&P, or Moody’s, or the like.
   a promissory note from a borrower...

   The Face Value is what the lender promises to pay you
    on the Maturity Date.

   The Price is the amount you have to pay (the
    discounted value) of the Face Value.

   They ain’t the same, very often.
   a promissory note from a borrower...

   The Coupon (no “q”) is an amount that is paid to you
    usually twice a year and is a Percentage of the Face
    Value.

   So a Canada 5% of 2022 bond pays 5% of the Face value
    each year until 2022 when they pay you the Face Value
    back. And is backed by the Federal Government.
   a promissory note from a borrower...

   They also have this thing call yield to maturity.
    Which is the blended return from coupons, the
    reinvesting of the coupons and the difference
    between Face Value and Price.
   a promissory note from a borrower...

   Warning: Most of the total return on a bond is from
    reinvesting the coupons. If you spend them, your
    return will be much lower.

   That return is called the coupon yield and is equal
    to the coupon rate.
   a promissory note from a borrower...

   Bonds are the highest on the Creditors list in
    case of bankruptcy, but that is a faint hope.
   Usually, you settle for a percentage of what is
    owed, but that beats zero from your equity.
   a promissory note from a borrower. ..

   There are two special bonds that are useful:
    1.   Strip Bonds (now behave yourself), which have their coupons
         stripped and sold off separately. This is called a Residual, or
         Resid, for short.
    2.   A Coupon, which is, guess what, one, or all of the coupons,
         stripped from the resid.

    Theses are highly volatile, but offer a potentially
     larger return.
   Risk: Oh yes there is risk!

   The Government is the least risky!
   The Hierarchy is this:
    1. Federal Government (they have the printing press).
    2. Provincial Government (they can tax).
    3. Municipal Governments (oy can they tax).
   Risk: Oh yes there is risk!

   The Governments also have what are
    euphemistically call “creatures”, like CMHC, The
    Export Development Bank, etc.
   The Hierarchy is set by the Backer, or Credit. So
    Federal first etc.
   The rating agencies watch these for you too.
   Risk: Oh yes there is risk!

   Corporate Bonds have much higher risks.
    1. They can go bankrupt. GM, whoda thunk!
    2. They can default on debt.
    3. They can get into balance sheet issues that affect their
       credit ratings.

    The Rating Agencies are of help here!!!
   Safe Havens in Storms...


   They similar to bonds with a term under 1 year.
   They are sold on a discounted basis. So they have
    no coupons.
   Because of the short term, they are seen as low
    risk.
    Safe Havens in Storms...

    There are four major groups:
1.    Treasury Bills - backed by various Governments.
2.    Bank Paper - backed by guess who, Banks.
3.    Commercial Paper - backed by all sorts of people.
4.    Asset Backed Paper - backed by whatever. The
      exception!!!
   Safe Havens in Storms...

   But there is Risk!!
   Like bonds it is the backer that counts!
    1.   T Bills - almost no risk.
    2.   Bank Paper - low risk.
    3.   Commercial Paper – balance sheet risk.
    4.   Asset Backed – can be quite risky and hard to
         understand.
   Dangerous stuff...

   There are four major groups:
    1. Industrial Materials, like copper, lumber etc.
    2. Agricultural, like Coffee, Orange Juice and the best-
       Pork Bellies.
    3. Precious Metals, all the glitters like Gold.
    4. Energy, like West Texas, or Brent, or whatever black
       gold, or Natural Gas.
   Dangerous stuff...

   They are traded with an instrument called a
    Future that commands a lot of money. One
    Gold Future Contract commands $125,500 of
    Gold.
   Dangerous stuff...

   With Bonds and Equities, all you can lose is
    what you have invested!!!
   Futures is Different!!!! You have Unlimited
    Upside and Downside!!!
   Dangerous stuff...

   No matter what they say on the radio, or the TV, or
    a magazine/newspaper/book, whatever,
    commodities are for the Professionals!!!
   And don’t you tell me the story of the one guy who
    made piles of money, or I’ll tell you of the hundreds
    that were ruined by these markets!!
   Dangerous stuff...

   If you just have to trade this stuff, use an ETF,
    or some indirect way, like Options on the
    Futures, of trading Commodities!!!
   Dangerous stuff too...


   Currencies are ratios and they are tricky to
    understand.
   Most a measured versus the US dollar, ‘cause
    it’s the reserve currency.
   Dangerous stuff too...

   Currencies traded with Futures, oh great.
   The only reason to hold Forex is if you have a place
    in Florida, or Palma, or somewhere and you want
    to hedge the currency risk. Even then hold the
    cash in an account, or at the worst an Option on
    the Future, NOT a Future.
   Friends & Foes...


   Options are way of doing one of two things.

    Hedge. That means if I have an equity position
     and I want to buy insurance against it falling, I can
     buy the appropriate type and amount of options
     to hedge, or insure it.
   Friends & Foes...

   The second thing is to essentially gamble. Option
    will rise and fall, far faster than the underlying
    asset.
   And, unlike the Dreaded Futures, you can only lose
    what you invest.
   Options have three parts:
    1. A Underlying Security, like a bond, commodity etc.
    2. A Strike Price.
    3. A Maturity, or time period.
   Options come in two flavours:
    1. Calls that allow you to “call” something in the
       future, or bet on the future price of the underlying
       security. These rise and fall with the security.
    2. Puts, which allow you to “put” something to
       someone, or bet that something will decline. Puts
       move in the opposite direction of the underlying
       asset and that’s why they are great for Hedging.
   Options are:
    1. Very Volatile and therefore “fun”.
    2. Tough to buy right, especially getting the time
       period right.
    3. Cheap gambling!!!
    4. Expensive in volatile times. Because they have
       “vol” priced into them. Rats huh.
   Options are:
       Tough to buy right, especially getting the time
        period right.

       There is a balance between term and risk and term
        and price. You Pay for term because of the Time
        Value Of Money.
    Indirect ways to own and diversify...


    A Mutual Fund is nothing more than Big Group of
     equities, bonds, or commodities. They have three nice
     things:
1.    They are a way of diversifying.
2.    They are a great way of indirectly owning risky stuff.
3.    You can own specialty funds at lower risks.
   Indirect ways to own and diversify...

   A Mutual Fund can be Expensive:
    1. Fees can run as high as 2% for basic funds.
    2. Specialty funds have even higher fees, but can be
       worth it.
    3. Their performance relative to the market is not all
       that good!
   Indirect ways to own and diversify...

   Most Mutual Funds are NOT Market Timers.

   So:
     Do expect human expertise for your fees.
     Do expect specialized expertise from a special, or sector
      fund.
     Do not expect your mutual fund manager to get you in
      and out of the markets at the right time.
   Indirect ways to own and diversify...

   A ETF, or Exchange Traded Fund, is a computer run,
    mirror of an index, commodity, or specialty area.
    They have no human expertise behind them.

   The are:
    1. Cheap was of owning indexes and the like.
    2. Easy to trade.
    3. But, just a mirror.
   The one piece of math you need to
    understand investing – The Time Value of
    Money.
   Risky Living...Now behave! I said Risky, not
    Riske.
   Some Examples of all this fun!
Lock up the kids...
                      Hide the grand parents...

                          It be Time for a Little Math!
   Almost all of the analysis of financial
    instruments involves three principles:
     The Time Value of Money.
     Volatility.
     Risk/Reward Profiles.


   And you Need to know them all…
   All of the math that we are going to go though is
    easily handled by Excel, which is part of Microsoft
    Office…
   If you don’t want to add to Mr. Gates fortune, you can
    load Open Office from OpenOffice.org. Its “Calc”
    program is not quite Excel, but it will do the job and it
    be Free.
   One Humongous Tip!!!

   Excel has a hidden add-in called the “Analysts
    Tool Box”! If you go to the Options menu and
    to add-ins you can check it. Then almost all of
    the financial math you will ever need will be
    loaded and it is all free!!! Google it for details.
According to Wikipedia:
 The time value of money is based on the
  premise that an investor prefers to receive a
  payment of a fixed amount of money today,
  rather than an equal amount in the future, all
  else being equal.

                          That’s Greek to me.
   The concept is, that $1,000 in the future is less
    valuable because, if I had it now, I could earn
    interest on it for a while.

   In addition, there is uncertainty about future
    interest rates, inflation etc.! So, we need to
    adjust for that.
   So the math wizards use a technique called
    Discounting, or Present Value.
   What it does is to take a Future Value,
    dividend, or cash flow stream and convert
    them into their value at present (i.e. Today).
   Oh yah and adjust for risk too...
•   The Dreaded Formula:




                      PV=FV/(1+i)n


Where FV=future value, n is the number
of periods and i is the going interest rate.
•   What it means:

•   It boils down to Future Value/Discount.

•   Therefore, value or price, will rise as the stream of
    income rises and fall as interest rates rise.

                     Remember this
•   What it means:

•   A little Aside: There a two kinds of interest
    calculations:
    1. Simple Interest, i.e. a simple percent of face value.
    2. Compound Interest, i.e. taking interest on the
       interest already paid into account. This is the
       (1+i)n calculation that the financial markets use!
•   What it means:

•   Stuff way out in the future is worth way less than stuff
    in your pocket.

•   If the interest rate is 10% each year, I take 10% off its
    value by dividing by (1+10%) each and every year.
•   By year 10 that’s $1000/2.594, or a measly $385.54,
    give or take a shekel.
   The good news is that the PV calculations are built
    into Excel { pv() } and Open Office’s Calc. Or, you
    can buy a cheap calculator to do all the math.
    YEH!!
   Why do I need this?

     Almost all of the valuation calculations in the
      various markets are derived from some sort of
      discounting function.

     It is also the basis for what some call the “miracle”
      of compound interest. Hmm, very unscriptural that.
   Why Do I need this??

   Equity prices are a Present Value of dividends,
    or earnings.
   Bond Prices are a Present Value of coupon
    payments and Future Value.
   Why do I need this?

     We shall go though some examples in Part III of this
      seminar. So hold on…
   Volatility (Vol) is the variability of markets.
   Markets hate volatility like the tax man.
   Valuation has to take Vol, as it is called, into
    account.
   How do I measure it?

   It is like the % change versus say the average %
    change.
    1. So if equities are up 50% and they usually rise 10%
       a year, they are volatile, good but volatile.
    2. If equities, over a period of month, are up and
       down 10%, they are volatile.
   How do I measure it?

   Most people use what is call Standard Deviation,
    or SD. It too is in Excel.
   Options Markets use the log of the price change,
    to price vol. That too is easy to do in Excel.
   Equity markets have thing call the VIX that
    purports to measure it.
   Why do I care???

    1. Almost all prices include some idea of volatility.
       So high Vol can seriously lower the value of a
       security.
    2. Options include Vol in their price. So high Vol
       means a high price, i.e.. An expensive option.
   Risky Living...Now behave! I said Risky, not Riske.
   Most People do not understand risk. As a
    result, the are blinded by the big return
    potential of something like a Futures Contract,
    not taking into account its Unlimited Risk.

   Risk can be managed, at a cost, but that is way
    beyond today’s workshop….
   Risk is a Fact of life and even a Truth.
   Markets HATE Risk.
   Risk does affect prices/values of investments.
   You need to understand where to be as risk
    makes like NASA rocket.
   Risk can stem from all sorts of things, but there
    are four main area we need to Understand.

    1.   Event Risk and Political unrest.
    2.   Economic Risk – Business cycles and the like.
    3.   Sector risk – like autos versus smart phones.
    4.   Asset risk – like Futures, vs. Equities vs. Bonds and
         the like.
   Risk can stem from all sorts of things...

     Event Risk and Political unrest.

   This is almost impossible to predict and “see”
    coming. We just have to live with it...
   Risk can stem from all sorts of things...

     Economic Risk

 It really is the economy stupid, as they say.
 All markets are influenced by economic risk.
 The effect that recessions and booms have on
  earnings, inflation and demand for stuff is
  IMPORTANT STUFF!!!!!
   Risk can stem from all sorts of things...
     Economic Risk

   Equities boom in booms and bust in busts, because
    earnings do the same.
   Bond Prices rise in bad times and sink in good
    because interest rates tend to do the opposite.
   Even Gold goes up in mayhem. Weird people gold
    bugs.
   Risk can stem from all sorts of things...

     Sector Risk

 Different Stuff reacts to business cycles in
  different ways.
 Each area has it own “special” issues.

 Expertise is Valuable here!!!
   Risk can stem from all sorts of things...

     Asset Risk – Two Levels...

   First is how asset classes behave risk wise.
   Risk can stem from all sorts of things...

     Asset Risk – Asset Classes...

     In recessions/panics and general mayhem
      and other fun stuff, equities and
      commodities are the most risky. Gold and
      Bonds and especially Money Markets can
      be places to hide!
   Risk can stem from all sorts of things...

     Asset Risk – Asset Classes...

     In recoveries/booms, equities and
      commodities can be the place to be while
      Gold and Bonds, well you know. Oh and
      money markets...Boring, but safe!
   Risk can stem from all sorts of things...

     Asset Risk – Specific Asset Risk

 Here we are dealing with the specific equity,
  bond, commodity, whatever.
 GM has a different balance sheet than Honda!
 Corporate bonds are different than
  Governments.
   So Let’s take some of that math (ooops he used
    that four-letter word again) and see how to
    make use of it!
   Just what is an equity share worth??? Glad I
    asked...

     Some say it is discounted (i.e. PV) of dividends...
     Some say it is a PV of earnings, etc.
     Some say Aliens make up the price (only on
      Halloween).
   What are earnings?? They come in flavours...

    1. Earnings are after, or pre-tax profits.
          There is a sub category Called EBITA, which in
           English is Earnings Before Interest Taxes and
           Adjustments, oh those adjustments. Analysts
           love these.
    2. Cash flows are retained earnings plus depreciation.
   What is an Equity Share worth???



   It is one of the Present Value of:
      1. Dividends (The Dividend Discount Model).
      2. EBITA (The Earnings Model).
      3. Cash Flows (The Cash Flow Model).
   What is an Equity Share worth???

   So Equity Value:
      Rises as earning, cash flow, or the dreaded EBITA rises.
      Falls as interest rates and risk rise, because they are in
       the “discounting rate”.
   What is Money Market Stuff worth???

   They a sold at a discount to their Face Value.
   So:
     Their Price is simply the PV of the Face Value.
     Their Price will rise and fall in THE OPPOSITE DIRECTION
      of interest rates.
     They have low, very low volatility/risk thanks to their
      short maturities.
   What is Bond worth???



   It is simply the Present Value of the coupon
    payments (um remember no “q”) and the Face
    Value.
   What is Bond worth???

   So a bond’s Price goes:
     In the OPPOSITE DIRECTION to interest rates.
     Down as risk rises.
     Down as inflation rises as inflation boosts interest
      rates.
   What is Bond worth???

   So a bond’s Price is:
     Higher the Higher the risk class (i.e. Governments vs.
      GM).
     Mostly lower the longer the term. It mirrors the
      shape of the yield curve.
                         Normal      Inverted
12


10


 8


 6


 4


 2


 0
     0   2   4   6   8       10   12      14    16   18   20   22

                              TERM
   What is Bond worth???

   Remember the Strip Bond (how could you
    forget). They are pure Present Value vehicles.
   They:
     Offer compound interest, which normal bonds do
      not.
     Are very volatile because the are pure PV vehicles.
   We will leave the valuations of Options and
    Futures to Grad School.

   I will tackle Forex valuations in the next lecture.
    Talk about rocket science.
Thanks for Coming Out...

				
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