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Entonces 1/0.64= 1.56 aos necista la El rendimento sobr elsoa ctviso ROA: return
empresa para hacer una on assets.) es una emdiad de la utilida
rotaiconcmompleta de los activos. por dolar de activos
It is the portion of a compny profit alloated - o tmabien que no tien buenas utlidades.
to each osutanding shre of commo stocl. It
3. Razn de valor de mercado a valor en
serves as an indicator of a compnays
libros:
profitability
Razn a valor de mercado a valor en
Ehrn laculating it is more accurate to use a
libros= valor de mercado x accin/ valor
weighted average numbers of shares
en libros x accin.
outstanding over the reporting them,
because the number of share outstanding -el valor en libros x acion es el capital total( y
can change over time. But to simplify you no solo el capital comn) dividido entre
can use N share of oustanding at the end of numeor de acciones en ciruclaicon
the period.
Ej 88/78.5(2591:equity/33)=1.12 veces
It is considered to be the single most
El valor en libro x accin refleja costos
importantn variable in detemrininig a shars
histricos. Comrpara el valor de mercado
Price. It is also a major component sed to
de las inversiones de la empresa con su
claculate th Price-to.earingins valution ratio
csoto.
Ej: if th ecompnay pays a NI= 25, if the
Si es z1 siginifaria que la empresa no ha
copnay pays out 1 in prferred dividends and
logrado genera valor apra sus aciconiestas.
has 10 shares for half of the year and 15
shares for the other half, the EPS would be 4. Capitaliziacon de mercado.
24/(10+15/2= 12.5, fir the 1 of preferred
divnidnes is deducted from the NI to get 24, La cpaitlaiziaocn de mercado de una
then the weighted avergae is taken to ind empresa que cotiza en bolsa es = preico de
the number of shares mercado x accin X el N de acciones en
outstanding(50%*10+50%*25=12.5) ciruclacion.
2) Spontaneous liabilities: are all the short NOPAT (net operating profit - adjusted taxes)
teerm finantial
NOPAT=EBIT(1-t)
sorucesimpuestos+cts+Accounts
Payable+Other Current Liabilities 2) EBIT=ventas-costo de ventas-depreciacion
3)Financial current liabilities: Short/Current t=T/EBIT: unlevered tax rate
Long Term Debt(CL)
3) %NOWC(K/L)=%CA-%CL operative
4) Working capital: Total Current Assets -
Total Current Liabilities + Cash And Cash (change in necesidaddes ioeprativas de
Equivalents K/L)=cambios en actvios corrientes-
cambios en pasivos oeprativos
5)Working capital requirements(NOF): = corrientes
Financial current liabilities +Working capital
4)CAPEX=%NFA(activos fijos netos)-
=CL+tota current assets-total current depreci(gasto de capital)
liabilities+cas and cash equivalents
VE=VL=D+E
Flujo de caja libre:
1) Pasivos corrientes=PC operativos+PC
It is the cash of free use for creditors and financieros
shareholders it is a profitability
2) EQUITY=Capital social+ utilidades
Luego de costear: retenidas
-Gastos operativa, K/L , Gasto de k de 3) DEBT=pasivos corrientes+ deuda de LP
LP
-PC operativo: son los no negociados y no
Triple identidad + FCL que son recibidos generan interese, osea no hayh necedisda de
par aacionistas para que +mas gente negociar con nadaie, simplemente vendo
demndade acciones por las buenas mas y lo obtengo. Ej: compra de MP, una
utilidad+ el valor de la accin cta x pagar, ir x pagar, remuneracionesx
pagar
-CAPEX: inversiones a LP para crecimiento ROE: NI/equity: NI:flujo, equity: stock
de la empresa.
-Para eso se debe hallar un promeido o el
Anlisis y diagnositico financiero pronostico flujo en la fecha
del futuro
Si el activo aumenta estoy invirtiendo en el
NOWC=C/A-C/Loperativo necesidad
Si apsivo aumenta es una fuente
operativa de K/L
Si pasivo caeuso de fondos
NWC= C/A-C/L necesidad de K/L
contable Ratios de deuda: D/VL, E/VL,D/E
EFN(neceisdade externas de financiameinto) Conversin de cash: desde cuando pagas en
eefectivo hasta que vendes el producto.
EFN=C/Lfinancimeinto+LTD+C/S=NOFa
re all the kinds of fianicila soruces in KL(-): siginifaca quie neceisto menos dienro
short term and long temr apr acubri mis operaciones.
Dinero para poder opera res externo y tien KL(+)significa que se encesita mas dienro
un cosnto :r para operar
Aumento de k tmabien 1) K/L neto operativo : es el dienro extra de
CP que tine in costo financiero y que
-los dividndendo no van porque no generan
necesito conseguir para operar. Ej:
un costo.
prestmao paga interese.Pago inters cada
-si tiens garna poder de negociaicon vez que hay. Es decir al restar los
K/L<0no es nula operativos que son pasivos sin costo me
estara quedadno justo cons los activos
-Si tiens CLoperativa=80, CL fina=20, AC:80,
por curbir que si deben financeiarse con
eres ilquido pero rentable.
cost financiero
- Si tiens CLoperativa=20, CL fina=80,
-K/Lneto oeprativo=C/A-C/L operativo
AC:80, eres ilquido y menos rentable y
aque debes inters financiamiento que no 2) K/L neto financiero: el pasivo corriente
hay en l priemro son csoto que encesito cosneguir
-es mejor ser mas rentable que ilquido K/Lneto oeprativo=C/A-C/L fiananciero
porque pudeo cubrir las gnanacias las
3) K/L neto (NWC)=C/A-C/L=RP-ANoC
deusas de CPlazo
4) CL= C/Loperativo++C/L finaciero
1)cuentas importantrs: ananilissi
vertical NWC=C/A-C/L
2)evolucin de ctas tiempo: anlisis NWC=C/A-(C/Loper+C/L+finaci)
hpriznotal
NOWC=C/A-C/L opera
Para detectar ptrones, si por jemeplo si se
endeuda sistemticamente a CP con letras x NFWC=C/A-C/L financ
pagar. Se esta obteniendo renbtialdiad para 5) NOF: NOWC + NFWC-C/A
cubrirse fondos.
NOF: dinero de CP para operar sin costo
3) elaboraicon del estado de fuentes y
usos: de donde obtengo la palta y K/L total: toda dinero de CP que necesito
donde la estoy invirtiendo. para operar y que puede tener un costo.
Activo Espontaneo: toda inversin que 1=b+d, b: retention ratio, g:% de ventas ,
aumenta con el crimiento de ventas. NI= S1 * M
1200 800 400 180 126 uando una sociedad ampla su capital segn
EFN 1500 1333 .33 1500 1333 .33 1500 1333 .33 193 .60 el primer sistema (a la par), aumenta el nmero
1200 1333 .33 1200 1200 180
de acciones en circulacin, lo que hace que
Hence, the total EFN are: disminuya el valor contable de cada ttulo (la
empresa vale lo mismo pero se divide entre ms
EFN 51 .1 193 .60 142 .6
ttulos). Este hecho se conoce como efecto
dilucin. Para evitar este efecto, es por lo que se
suele exigir una prima de emisin, de manera que
Ampliacin de capital los nuevos accionistas paguen tambin por las
reservas de la empresa, y la valoracin de
Ampliacin de capital es el incremento del capital empresas de nueva creacin, donde son las
socialde una sociedad. Se realiza emitiendo perspectivas de beneficios futuros las claves de
nuevas acciones o aumentando el valor las que tambin, pasan a ser propietarios.
nominal de las ya existentes. El efecto contrario
Valoracin Pre-money y Valoracin
de ampliacin de capital sera la reduccin de
Post-Money
capital. Las acciones nuevas pueden tener iguales o
diferentes derechos econmicos que las antiguas.
Cuando el inversor ha decidido invertir una cantidad
en una empresa, esta cantidad representar un
porcentaje en el capital social, dependiendo de la El inversor asumir la titularidad de 750
valoracin pre-money que hayan acordado y participaciones de la Sociedad, que representarn un
negociado el antiguo accionista y el inversor. La 20% del total de las participaciones sociales en las
valoracin Pre-money es la valoracin que se le ha que estar dividido el capital social, es decir, 3.750
otorgado a la empresa por su actividad en el mercado participaciones.
desde su constitucin, previamente a la recepcin de
la inversin y esta valoracin es independiente al Es aqu donde entra en juego la Prima de emisin, ya
capital social de la empresa. que si cada participacin tiene un valor de UN EURO,
al realizar la ampliacin de capital el inversor slo
La valoracin Post-money es la valoracin que se le estara aportando 750 Euros, faltara aportar los
otorga a la empresa posteriormente a la aportacin 99.250 Euros restantes de la inversin. Esta cantidad
de la inversin. (99.250 Euros) ser aportada por el inversor a la
Sociedad mediante una Prima de emisin que
Por ejemplo si un inversor invierte 100.000 a contablemente figurar en el pasivo de la compaa
cambio del 20% de una empresa, el valor Post-Money como fondos propios, pero no como porcentaje de
ser 500.000 (100.000/20%). El valor Pre-Money capital. Es decir, el inversor pagar por cada nueva
ser de 400.000, es decir 500.000 menos los 100.000 participacin emitida UN EURO ms una prima de
que se invirtieron en la empresa emisin por un valor total de 99.250 Euros,
adquiriendo el inversor la condicin de socio de la
A continuacin realizaremos un simulacro de
empresa con un porcentaje del 20% en el capital
ampliacin de capital siguiendo los conceptos
social de la misma. El asiento contable de la
anteriormente expuestos, Caso Prctico completo
operacin ser: 100.000 Tesorera a Capital 750 y a
para ese mismo supuesto con un capital inicial de
Prima de Emisin 99.250
3.000 en participaciones de 1 y un inversor de
100.000 : A la par
Un equipo emprendedor con una Sociedad Limitada Una sociedad ampla su capital realizando
con capital social de 3.000 Euros, representados en una ampliacin a la par de la siguiente manera:
3.000 participaciones de un (1) Euro de valor nominal
cada una, despus de varias reuniones y a) 1 accin nueva a la par por cada 4 acciones
negociaciones, logra que un Business Angel acceda a antiguas (1x4 a la par).
invertir 100.000 Euros a cambio de un 20% del capital
de su Startup. b) Las acciones de la sociedad tienen un valor
nominal de 3 euros.
Por tanto, la Junta General de Socios deber acordar
la ampliacin del capital social de la empresa, Un accionista antiguo que tenga 20 acciones puede
emitiendo nuevas participaciones que representen el acudir a la ampliacin y suscribir un nmero entero de
20% del total de participaciones existentes una vez ttulos. Para acudir a la ampliacin deber hacer
producida la ampliacin. grupos de 4 acciones antiguas y por cada grupo
recibir una accin nueva. Si posee 20 acciones har
En este caso, el nmero de participaciones a emitir es 5 grupos (20/4 = 5) y tendr derecho a suscribir 5
de 750 nuevas participaciones. acciones nuevas. Por lo tanto el accionista que tenga
750/(750+3.000)=20% 20 acciones antiguas y acuda a la ampliacin tendr
o confirm your intention to participate, please Reply to this
20 ttulos antiguos ms 5 ttulos nuevos que
email with a current copy of your resume and a 5 slide
desembolsar por cada uno de ellos el valor nominal, presentation with the following casebefore Friday 9th of
December 1pm.
en este caso 3 euros, siendo:
Case: A group of foreign investors have decided to diversify
A x N = Nmero de ttulos nuevos adquiridos x Valor their portfolio by investing in Latin American, and are
therefore considering on acquiring part of Cementos
Nominal de cada accin = 5 x 3 = 15 euros. Pacasmayos common stocks. Your job is to create a 5 slide
presentation with a brief introduction of the company, an
outlook and analysis of the industry (including possible risks
Totalmente liberada (liberada 100x100) and mitigants) and your final recommendation.
Note: The presentation must be done in English and there
is no predetermined structure for the presentation.
Una sociedad amplia su capital realizando
una ampliacin totalmente liberada de la siguiente
CAPM PERU y AL
manera:
-Beta de bloomber: entre la accion o
a) 1 accin nueva totalmente gratuita por cada 5 portafolio con el emrcado.
antiguas (1x5 liberada 100x100). Tasa libre de riesgo (RF):retornos de
bonos soberanos del pas en soles o
Un accionista antiguo que tenga 50 acciones puede deolares.
acudir a la ampliacin y suscribir un nmero entero de Sin embarognocmo en el emrcado
ttulos. Para acudir a la ampliacin deber hacer internacional peru tiene califiaicon BBB+ no
grupos de 5 acciones antiguas y por cada grupo corresponde usarla como libre riegso sino
recibir una accin nueva. Si posee 50 acciones har mas bien los bonos del tesoro americano a
10 aos para invesrionistas internacionales,
10 grupos (50/5 = 10) y tendr derecho a suscribir 10
pero esta libre de riesgo no recoge: 2 partes
acciones nuevas. Por lo tanto el accionista que tenga
-prima x riesgo pas=2% en peru
50 acciones antiguas y acuda a la ampliacin tendr
50 ttulos antiguos ms 10 ttulos nuevos sin -prima por riesgos cambiario
desembolso para el suscriptor. Existiendo coreelaicon entre ambas
Solucin: agregar a al rf usa de bonos del +
A x 0 = Nmero de ttulos nuevos adquiridos x 0 = 10
country risk premiun
x 0 = 0 euros
But in practice this assumes that the
Los resultados de la empresas diference between soverieng risk = country
risk prmiun which is not correct.
eubicaronenlneaconnuestrosestimados,dadoque:i)noesperbamosmayorescambiosenlosingresos,debid
ventasadicionalesqueserealizaronenel3T2015paratrabajosdeprevencincontraelFenmenodelNio;y,ii)
SoRF to invest in peru= global soverign
ipamosunamejoraenelmargenEBITDA,debidoalasmayoreseficienciasquegeneralanueva
bonds it contents currency risk and planta
specificde Piura
risk of our market that are not diversified
internationally.
La utilidad neta tuvo un retroceso de 20.9% A/A. A pesar de la mejora en el margen EBITDA (33.2% v
31.8% en el 3T2015), BETa:
tuvieronunmayorimpactoenlacompaaladepreciacinadicionaldelaplantadePiura,ylaausenciadecapital
The principal problem wit emerging market is
ndeintereses, dada la finalizacin de la construccin de la we
is that misma.
dont count with the avlaibale
information for profitability or rate of return
Market Cap vs Enterprise Value | fo the market.
Solution: takes betas from other markets
Same or Different? USA, assuming the tha corraltion with the
market comes from the similar bunises b. Rendimiento de Mercado (Rm)
structure.
cosndier S& 500 are the 500 companies that
The beta <1, indicetae the firm is less list in New yorek sexchange and American
sesnsible with changes in the market, exchange (amex) and nasfdaq
inelastic
this index it is contruct as a with average of
Prima de riesgo del mercado stocks with maket value for each comapny .
Ther is also non rleiable infromation about a it is important take in consideration an
proxy of the market bwecause th invement horizon of long term, because the
ebchamarks of the market are conetraed in current economic rerturns{(market return+
som sectors as mining, real stae rinfratrur. rf) do not affect the costo of capital.
Solution: rmarket risk prmiu of USA. But this As an average return of S& p 500 1928-2010
primes doens take into account riskes
derived from intitituonal differences, laws c. Beta ()
infreastruct lakness, security and many it is the sensitiveness of the security to the
aspectos that afecct the risk uin a emerging non diversifed risk knows as market risk or
country. sistematic risk.
-market risk prime* voalitty local market Betas>1 implies that the security has more
BVL/volatility Usa market(VIX) risk than the average of the market
Some authors propose affects this estimate So securities with larger betas will be
by multiplying for som factors less than 1 like desciount with higer rates as way
0.6. compensated to the investors for asuminr
E(R) = Rf peru+ Bapalcado de usa(marke risk over the market.
prime riskusa)*voaltility peru/voaltilit usa Betas of the sector real state , fianancial
COMPONENTES DEL CAPM Ways to calculate beta:
Inversionistas son personas aversas al 1) With a regression betewnwn the
riesgo. retrurns of the scruty and the reruns of
Se debe de cuidar el balance entre el the market
2) R squered= squeare of crorelacio
retorno esperado y su varianza asociada.
coeffcitne
Existe una tasa libre de riesgo para invertir 3) Covariance and variance
o endeudarse.
d. Country risk primiun
No existe asimetra de informacin.
It is the risk of a investment deut to
Inversionistas son racionales sobre las escpecifc factors and common to a country. It
conclusiones que tomaran acerca de los can be cosndiere as an averages iris of
retornos esperados y la desviacin estndar. invesments mede in a country. Measure the
porltic , economic, public security of a
a. Rendimiento Libre de Riesgo (Rf)1 country.
it is recommeded to use T-bills due to more It assumes that it is relatared to some events
longer terms wont allow to estimate with thath a sovering state could cross in temr of
precision the iflation as los as the interes rate sovering default
movements so in this sitaucion thwre will be
motre riskes. Average of the indicator of Jp morgan
embi+peru (2008-2012)
As an average of the return of 3 months
1928-2010 Estimation of diconte rates in
emergengin markets
Divide in 2:
1)For well diversigie investors(WDI)
2)no well-diversified investors (NWDI)
Model (1993):
Degree of diversification
0 Max
Total Risk Systematic Risk
Risk premiun
2) Model of complete integration
Damodarans Model (2002, 2003)
World CAPM (Solnik, 1974)
The variable of interest is the degree
of investors diversification and the
degree of emerging markets
integration (country risk).
Cul ha sido el mayor reto al que te has Oferta de analista de banca de inversi
enfrentado en tu vida?
Cmo establecera el valor de una compaa de
Tienes alguna pregunta para m?
biotecnologa?
Preguntas tcnicas en una entrevista en banca
de inversin
Oferta de analista de banca de inversin
Qu es un DCF? Explcame como haras
uno.
Imagine un pas sin red mvil que quiera vender
Cules son los diferente mtodos de algunas licencias a operadores de redes. Qu
valoracin?
hara usted para valorar el mercado?
Cul es la diferencia entre un LIFO y un
FIFO? Oferta de analista de gestin de patrimonios
Cundo emitiras deuda y cundo
acciones? Si quiero comprar una casa y tengo el dinero
Private equity y venturare capital son dos ripos de Resumen de la inversin : invertimos en
fondo de capital que se basan en comprar esta compaa?, sustento y riesgos de la
empresas(o parte de ellas) y venedralas mas inverison o compra de laccion punto de vista
caracs. cualitativo/anlisis de la industria.
Valoracin: en estas 2 diapositivas
cunto vale esto y a cuanto creo que podra
valer en el futuro?. Nadie te va a preguntar por
Ventura capital Private equity
qu usaste una beta de 1, o un crecimiento del
2%.
Empiezas con la gente y luego tratas de Empicezas con los nmeros y luego
averiguar que nmeros puedes hacer con tratas de encajar
todo
Si en los nmeros
tienes acceso a compaas
ellos comparables pblicas y transacciones
Es una inversin de menor
privadas, riesgolos
incluye porque
mltiplos.
Es una inverison de mayor riesgo porque se compran empreas o proyectos en
se comrpar en empresas en sus etapas e etapas mas amduras de operacin.
iniciales de operaciones Por ltimo, incluir la cuenta de prdidas y
ganancias, el flujo de caja, y los retornos con
Es el capital financiero en las primeras sensibilidades
Adquiere una empresa respectocon
ya existente a los parmetros
ms sensibles (
etapas de una mepresa con alto potencial productos y FC ya existentes, para
pero de alto riesgo. reestreuc turarla y optimizar sus
rendimeinto financiero
tieneymucho
una vez
ms que
inters analizar que
El fondo de capital riesgo aporta dienro haya emjroado pasara
venderlaside
el nuevo.
plazo medio de cobro cambia de
necesario par ecrer a cmabio de entrar en 150 das a 90 das debido a la legislacin).
el capital de la sociedad.
Cuando funciona Aspectos
bien cualitativos
peudes salvara de la industria :
bsicamente
empreas de la bancarrota crecimiento
y convertirla endel volumen de sta,
La 1era inversin tpica de VC s produce competidores,
empreas rentables de nuevo. cambios de legislacin, cambios
despus de la ronda de financiacin en la tecnologa, etc
semilla y es una ronda para financiar el El rango de ivnerisones es muy grande
crecimiento, se conoce como Serie A y Carry:retorno
aunque no peudes er menorfuturos del fondo.
de 50-100
5 preguntas para ganarte al recruiter en una
suele rondar los 2MM. millones de eruros o dlares en USA y
entrevista de banca
EU. Conlleva el uso de deuda en
Todas estas rondas terminan cuando se operaciones llamadas LBOs
1)pregutna la iuntimo de la entrevista, ks tienes
produce una salida, ya sea una venta
alguna pregunta?
estratgica(es decir una empresa mas
grande la compra) o una salida a la bolsa
Como se siente en banca d einveriso ne le
citibank?
Ambos tipos de gestoras tambin es importante la tarea de captacin de fondos. Es
decir el trbajo de lso socios de stas gestoras es bucas dinero
1. par apoder
Qu utilziarlo para
porcentaje del trabajo de un
invertri analista/asociado (segn la posicin para la
que te ests entrevistando) es pitching y que
nivel de exposicin a la realizacin de modelos
puedo esperar?
La diferencia entre la banca de
inversin/consultora y el capital riesgo radica 2. Le hace poco acerca de una operacin que
en que una vez hecha la inversin, los segundos desarrollo su grupo con la empresa X. Durante
son dueos de la compaa mientras que los esta operacin, quin facilito la financiacin
primeros ya estn trabajando en otro del deal y cun a menudo utiliza su grupo a
proyecto. otros bancos como medio de financiacin?
Some weaknese is insufficient prodcutos so for the first risk it is good to consdiere a cross
diversifcations, are to much focus in cement but currency swaps.
they are trying develop more elaboretd products. It allows you to exchange payment flows in one
On the opporunties side: greater prodctions and currency determined by another flow in a different
sales to attend nortehren demdnas. currency.
Some riks that can affect the value of the company Take advantage of better levels of financing than
are: in the conventional market (eg take a debt in soles
plus a CCS from PEN to USD as an alternative to
obtain
A better rate in dollars than taking a traditional loan) With the CCS, the client receives on each
payment date the amount in dollars necessary to
Advantage: honor his debt (USD 7.50%) in exchange for paying
It allows to set in advance the future exchange of an amount in soles that depends on the agreed
two payment flows in different PEN rate (PEN 10.00%).
Eliminating the uncertainty of future exchange rates In net, the client has converted its debt into dollars
into a debt in soles.
Forwards)
It should be spscific, it is important to note
Possibility of taking advantage of better financing
conditions in a given currency, taking it in a different The results of the company were in line with the
currency and using the cross currency swap to market estimates, becasue: i) no major changes in
exchange the flows of this debt for others in the revenues are expected, because of the additional
desired currency, obtaining better rates of financing sales made in 3Q2015 for prevention work against
than the traditional alternatives the Child Phenomenon, ii) An improvement in the
EBITDA margin is anticipated, due to the greater
No initial cost efficiencies that the new Piura plant will generate.
And benefits for a participant in such an operation Net income fell 20.9% in the 3Q 2016. Despite the
may include obtaining financing at the lower improvement in the EBITDA margin (33.2% vs.
interest rate than available in the local market, 31.8% in 3Q2015), there was also a greater impact
on the company due to the additional depreciation
Disadvantages: of the Piura plant, and the interres expenses. In
result, it recommends to buy Cementos Pacasmayo
Contractual obligation of future exchange,
stocks because it remains under its fundamental
eliminating the possibility of taking advantage of
value around S / .7.10 (today S / .6.18) and it is
More favorable market exchange rate levels expected to raise.
Notes:
For liquidation you can choose between the The bank sells dollars at a spot exchange rate
following modalities:
Customer receives the dollars
Or Delivery: At each exchange date, the physical
Client pays in loan at doalres at a lower rate
delivery of the amounts of each flow of payments is
made. Bank buys at forward exchange rate
O Non Delivery: At maturity, the delivery is made by Soles credit is canceled
compensation considering the difference between
the amount paid and the amount received by the Allows to fix in advance the future exchange of
customer payments in different currencies, eliminating the
uncertainty of future exchange rates. There is the
The client has a debt in soles with a rate of 7.00% possibility of taking advantage of better financing
PEN that he wants to transfer to dollars. conditions in a given currency, taking it in a
currency and using the cross currency swap to
With CCS, the client receives on each payment
exchange flows
date the amount in soles needed to honor his debt
(PEN 7.00%) in exchange for paying a dollar On the date of exchange the physical delivery of
amount that depends on the USD agreed rate the amounts of each flow of payments is made, the
(USD 6.50%). spot exchange rate against the forward exchange
rate implicit in the contract is compared, and the
In net, the client has converted its debt into soles
differential against is paid by the corresponding
to a debt in dollars.
party.
The customer has a dollar debt with a 10.00%
The forward exchange rate is defined as the
PEN rate that he wants to spend on soles.
exchange rate applied to the amounts of each flow
of payments.
For the second risk should be cosndiered a and to fixed. The commercial paper gives the investor
iflation derevates like swaps iflation.
real LIBOR plus credit spread plus a floating
It is used to mitigate the effect of potencially large inflation rate, which the investor exchanges for a
levels of inflation. In which which a counterparty's fixed rate with a counterparty.
cash flows are linked to a price index(in this case
IPC) and the other counterparty is linked to a For the third problem it can be used a energy
conventional fixed or floating cash flow derivate contract based in an underlying enrgy
asset in this case the carbon price it would be
Many investors prefer inflation protection from feasible or possible a forward or swap contract.
Energy derivatives include exchange-traded contracts
derivatives because unlike inflation-indexed such as futures and options, and over-the-counter
bonds, a significant amount of capital isn't (i.e., privately negotiated) derivatives such as
required and it's more flexible. Inflation forwards, swaps and options. This describes the
process used by corporations to reduce their risk
derivatives require the buyer to provide a small exposures to the movement of carbon prices in this
premium to the swap provider. In most cases the case whichs import from Colombia.t the approieta
contract for the firm would be forward
Consumer Price Index (CPI) is used measure the
differences in annual inflation.
A forward contract is a customized contract
between two parties to buy or sell an asset at a
An inflation swap is a derivative used to
specified price on a future date. A forward
transfer inflation risk from one party to another
contract can be used for hedging or speculation,
through an exchange of cash flows. In an inflation
so its non-standardized nature makes it
swap, one party pays a fixed rate on a notional
particularly apt for hedging.a forward contract
principal amount, while the other party pays a
can be customized to any commodity, amount
floating rate linked to an inflation index, such as
and delivery date. A forward contract settlement
the Consumer Price Index (CPI). The party
can occur on a cash or delivery basis. Forward
paying the floating rate pays the inflation adjusted
contracts do not trade on a centralized exchange
rate multiplied by he notional principal amount.
and are therefore regarded as over-the-counter
For example, one party may pay a fixed rate of
(OTC) instruments. While their OTC nature
3% on a two year inflation swap, and in return
makes it easier to customize terms, the lack of a
receive the actual inflation.
centralized clearinghouse also gives rise to a
higher degree of default risk.
BREAKING DOWN 'Inflation
Swap' a forward contract is a agreement to buy and sell
ans asst in a future day,the price for the asset is
Investors use inflation swaps to hedge inflation fixed at the time the contract is assecuretd. This
risk. A more complicated example of an contract dont trade on an exchange, also are
inflation swap would be an investor purchasing settle at the end of the contract term. Parties who
commercial paper. At the same time, the investor want to hedge th volatility inherent in the
enters into an inflation swap contract, in which he underlying asset use forward contracts. Also are
receives a fixed rate and pays a floating rate highly costumazilble manay corporations use
linked to inflation. By entering into an inflation them to hedge commodities. In this case the firm
swap, the investor effectively turns the inflation uses carbosn as a mateira prima so the firm can
component of the commercial paper from floating enter to a forward contract with a large proveedr
for example to a Colombian firm whom always
been bought the carbon, so the firm buy an
specific qeuinty and price o carbon to be
delivered in a specific date with a cash
settlement, if at the end of the contract the marke
price of carbon in colombia is higher than the
price that was settle then the company gain
profits
Risk free rate: The risk free rate the betas of comparable companies
should theoretically reflect yield to are distorted because of different
maturity of a default-free government
bonds of equivalent maturity to the rates of leverage, we should unlever
duration of each cash flows being
discounted. In practice, lack of liquidity in the betas of these comparable
long term bonds have made the current
companies as such:
yield on 10-year U.S. Treasury bonds as
the preferred proxy for the risk-free rate
for US companies. Unlevered = (Levered) / [1+
Market risk premium: The market (Debt/Equity) (1-T)]
risk premium (rm-rf) represents the
excess returns of investing in stocks
Then, once an average unlevered beta is
over the risk free rate. Practitioners
often use the historical excess returns calculated, relever this beta at the target
method, and compare historical spreads
between S&P 500 returns and the yield on companys capital structure:
10 year treasury bonds.
Beta (): Beta provides a method Levered = (Unlevered) x [1+
to estimate the degree of an assets (Debt/Equity) (1-T)]
systematic (non-diversifiable) risk.
Beta equals the covariance between
expected returns on the asset and on
the stock market, divided by the 6. How do you calculate
variance of expected returns on the
stock market. A company whose equity unlevered free cash flows for
has a beta of 1.0 is as risky as the DCF analysis?
overall stock market and should therefore
be expected to provide returns to investors
that rise and fall as fast as the stock Free cash flows = Operating profit
market. A company with an equity beta of
2.0 should see returns on its equity rise (EBIT) * (1 tax rate) + depreciation
twice as fast or drop twice as fast as the
& amortization changes in net
overall market.
working capital capital
expenditures
5. How would you calculate beta
for a company? Levered cash flows are also known
as equity cash flows, because it values just
Calculating raw betas from historical the equity claim in the business. unlevered
cash flows are also known as firm cash
returns and even projected betas is
flows because it values the entire
an imprecise measurement of future
enterprise.I am more accustomed to referring
beta because of estimation errors (i.e. them as equity or firm cash flows thus I will be
standard errors create a large
referring to them in that format for the 7. What is the appropriate
remainder of the article. numerator for a revenue
multiple?
Equity cash flows are considered as cash
flows after debt payments and after
The answer is enterprise value.
making reinvestments needed for future
growth. The discount rate used for these cash
Equity value = Enterprise value Net
flows when preparing a DCF model is the
Debt (where net debt = gross debt
cost of equity.
Free Cash Flow to Equity = Net Income - and debt equivalents excess
CapEx + Depreciation - Change in Non- cash). For more on this equation see
Cash Working Capital +(New Debt Issues - WSPs article
Debt Payments)
at www.wallstreetprep.com/blog/.
Firm cash flows are prior to any debt
payments but after the firm has EBIT, EBITDA, unlevered cash flow, and
reinvested earnings to grow its assets. revenue multiples all have enterprise
The discount rate used for these cash flows value as the numerator because the
reflects the cost of equity and debt, also known
denominator is an unlevered (pre-
as the weighted average cost of capital
debt) measure of profitability.
(WACC).
Conversely, EPS, after-tax cash flows, and
Free Cash Flow to Firm = EBIT*(1-tax rate)
book value of equity all have equity value
- CapEx +(Depreciation + Amortization) -
as the numerator because the
Change in Non-Cash Working Capital
denominator is levered or post-debt.
In a DCF model the present value of equity
cash flows reflects only the value of equity
8. How would you value a
claims on the firm where as firm cash flows
company with negative historical
reflect the value of all claims on the firm.
cash flow?
How to Convert from Firm to Equity Cash
Flows Given that negative profitability will
make most multiples analyses
This calculation is very simple. To get from firm
meaningless, a DCF valuation
value to equity value simply subtract out the
approach is appropriate here.
market value of all debt and all other non-
equity claims in the firm.
* Describir algunas de sus ventajas y desventajas? Los beneficios del estado eran obtener un nuevo
totalemnte eqeuipo y con mayor segurairad,
renovaicon urbana en elc ecrdao delima, -Is to follow comanies, all typically in the
contrubion a la formalizaion del cemrcio, y la same industry, and provide regurlar
apmliaicond e vacante de reclusos research reports to the firms clients.
-As apart of the process, the anayst wil
typically build models to project the
* Cmo hacer frente a la crtica, en el trabajo y en
frims financial results, as well as speak
la vida personal?
to the comstumers, suppliers,
* Cmo hacer frente con o superar las fallas?
competittors and other soruces.
* Cree usted, hay un lder en ti?
- the ultimate outocem of the analyst
* Qu tanto cree en el trabajo en equipo?
works is a research report that is a set of
* Cul ha sido el mayor fracaso de su vida, hasta
fincnial estimates, a price target and a
hoy?
recommmedntaion as the stocks
* Dnde te ves 5 a 10 aos por delante en su
expected performance.
carrera?
-in practice the job of the analuyst is to
en tres aos haber temrniado e l prgoram del CFA
convince insititucional acoocunts to
y en 5-7 aos haciendo un MBA en una buena
direct their trading thorug the trading
undiversidad de USA, continuar trbajndo en banca
desk of the anayst firm and the job is
d einversion.
aobut marketing. Tryin to be the firt to
* Por qu eligi la banca de inversin como una the client with new and different
opcin de carrera? information.
-insitittuional investor will reward people
Me gusto porque who meet with them
Por qu deberamos contratarte? -it os laike a high price travel agent.
Porque en primeri lugar tengo enormas ganas de -analyst will also create expert networks
aprender sobre finanzas inverisons y mecado d that ehy can rely upon for a constant
ecapitales, adems porque creo que re stream of information
In the case of ADRs. Dividends are paid in US Threatsmdoerate levels of levaerage so future
dollars and are subject to withholding tax in Peru growth depedne on capital contribution
with a rate of 6.8%. High corrleaiton with public an privete investment
The custodian bank of Cementos pacasmayo's Some riks that can affect the value of the company
ADRs is JP Morgan Chase Bank are:
2) now the oultlook and analystis of the industry Exchange rate risk due to debt in us dollars and the
This table shows us how the Peruvian cement a possible solutiocn coulb be acquire financiallt
market is divided in three regions: southern, central isecurities such as cross currency swaps this are
and northern. As you can see the firm has been the contratcs to hedge cash flow in other currencies in
indisputable leader in the northern region and also this case to hedge corproativ bonds in us dolars.
it always has obteined around 20% share of the .in 2015 oss currency sswaps to razonable value
total market. reflects changes in 2015 ha a value of 124 mm
In the industry th egrph illustrates that cemtnos soles and so far this year its value is aorund 82 mm
pacsamayo hast the best ebitda margin compared soles. This securities works as
to its competence. As you can note ebitda margin is So far this year the firm holds cross currency
almost the double of each competitors such as contracts for a nominal vlue of 300mm de doalres
cemex argos mesure in razonble value. Los saldo of this
This outcome can be explained because of its cost cosntracts changes with the level of future
eficent operations and also due to its focuse in the excahange rates.
growth of its core busness cement and cemente In fact the cash flow hedge of the future payments
related products. was considered as very effective, for this concept
the firm was able to anticipate a loss of more than And benefits for a participant in such an operation
42 mm soles may include obtaining financing at the lower
interest rate than available in the local market,
Th razonable value of cross currency swaps are
measured based in market data considering a Disadvantages:
swaps valuation models using resent value. This
Contractual obligation of future exchange,
models take into account different factors,
eliminating the possibility of taking advantage of
includingcredit rating of the counterparts,
currencies, foraward rates, interes rates cruves. More favorable market exchange rate levels
So far this year there has been a moderate Notes:
exchange rate volatility. This effects wre partially
mitigated by the exchange rate hedge for the For liquidation you can choose between the
corporate bonds following modalities:
But the group does na thave other financial Or Delivery: At each exchange date, the physical
intruemnts to hedge the echange rate, interest rate delivery of the amounts of each flow of payments is
ormarket prices volatility sucha s carbon prices in made.
the market O Non Delivery: At maturity, the delivery is made by
so for the first risk it is good to consdiere a cross compensation considering the difference between
currency swaps. the amount paid and the amount received by the
customer
It allows you to exchange payment flows in one
currency determined by another flow in a different The client has a debt in soles with a rate of 7.00%
currency. PEN that he wants to transfer to dollars.
-empresa
Mayor fracaso:
-cargo
3 ambitos: labroal acadmico personal
-tiempo
Si se habla de algo
-funciones
bueno(fortalezas):laboral acadmico
personal
-logro
Si se hablad ealgo
3.bloque:
malo(debilidades):personal acadmico
-responsable laboral
1)
2)
3)
Debilidades:
R+prima de emrcado=estrategia apsiva que trata de
capturar e retorno esperado dado un niveld e riesgo
de portaoflio.(sea consistente con un nivel de rirsgo
del portaoflio). Lo que compres o o que repliques
debe ser consistente con el nivel de riesgo de l
cliente. A acptar con ello replico el portaoflio. Luego
BVL. El Rally la salv de ser hago un reblanzce para modificar los pesoso de los
frontera? 5 de mayo montos invertidos en secuirties que estoy
Pasar de ser una bolsa poco atractiva y al borde de una replicando.Que sea consistente con un veile de
reclasificacin a mercado frontera por parte del MSCI (SE 1483, riesgo del protafolio.
1489, 1490) a ser la segunda bolsa ms rentable del mundo
despus del Bovespa de Brasil en slo dos meses parece un Cuando se habla del aphas e habla de una estrategia
milagro, y efectivamente lo fue. Hasta febrero la gran mayora de activa dada por ganarle al emrcado. Contrayendo
los actores del mercado local se mostraba pesimista frente a
la BVL (SE 1503) ante un panorama desalentador por una
portafolios capcaes de producir retonros que
suma de factores internos y externos: el alza de las tasas de exceden los retonros esprados ajsutados por
la Fed, el fenmeno de El Nio, las elecciones, la reriwsgos.
desaceleracin econmica y los precios deprimidos de los
commodities. No haba ningn catalizador de retorno al alza a la La estrategia pasiva mantiene acciones que hacen
vista. () Oportunidades Hay oportunidades despus del rally?
S, pero los analistas recomiendan ser selectivos y enfocarse en
que el retorno del protafolio haga track del
acciones de demanda interna, dadas las perspectivas ms protafolio becnchmark. Tambin llamado indexing
positivas sobre la economa. "Ahora es ms difcil encontrar no es parte del objetivo genera alpha.
papeles con potencial de apreciacin, pero nos gustan los que
estn ligados al consumo", seal Fernando Iberico, nuestro La estrategia activa es un intento activa es un
Analista Senior de Estrategia y Estudios Econmicos. intento del gestor de superara un benchamark de
acciones ajsutado pro rrisgo:
puesta por el Mila
-ajsutes tcticos:
Renta4 Banco, con sede en Espaa, lanz su fondo MILA, que
concentrar el ... -selecciond eactivos:seccuirty selection
Renta4 Banco, con sede en Espaa, lanz su fondo MILA, que
2) Estrategias de gestin de protafolios de RV
concentrar el 75% de su Inversin en renta variable de los
pases de la Alianza del Pacfico: Per, Chile, Colombia y
Mxico. Con ello la firma espaola avanza en reforzar su
Tracking error: volatilidad del reronro de un
presencia en el bloque, donde ya cuenta con operaciones en protafolio respecto de su ebnchmark
el Per, Chile y Colombia. Para finales de este ao abrir una
oficina en Mxico. El fondo apuesta por las acciones ms lquidas RPT: retorno portafolios en t
de la Alianza del Pacfico, representadas en el ndice S&P
Pacific Alllance Select Index, que ha rendido 10% en lo que va Rit: rentabilidad activo i en t (en portafolio)
del ao. Entre ellas figuran las peruanas Credicorp y Southern
Copper Corp. El fondo MILA ser el primero en su tipo Rbt= retorno de benchmar en t
gestionado por una entidad europea: Renta4 Luxemburgo. Segn
un informe nuestro reciente informe, el MILA se ha visto impulsado Wit: peso activo i en el portafolio
en los ltimos dos meses por una menor aversin al riesgo
ante los mejores resultados de las economas desarrolladas. Para una meustra T obs, la varinza del cambio en el
Las acciones ms negociadas del MILA en febrero fueron tiempo
Enersis (Chile) y Ecopetrol (Colombia).
RPT=Zi=1,N wi Rit
Portaoflio:
%t=Rpt-Rbt
Una estrategia pasiva replcia lo que ya exste y sobre
la abse de lo que ya existe genera una rentbailidad. Para una muestra de T obs, la varinza del %t
Una estrategia activa quiere gnarle al emrcado y
sobrepondera acciones o inlcuyeacciones disitntas Varianza (%)=
con mayor riesgo. Instrumentos derfivados:
1)estrartegia pasiva vs estrategia activa Isntumento cuyo precio deriva del precio de otros
Retorno totoal de portafolio o accion= R+ prima de activos.
mercado+ alpha: retorno extra por encima del 2)forwards
mercado
El principal reisgo es el incumplimiento(default) o Spin out_: te quedas con una psoicon
de contrato minoritaria y vendeas la mayoriataria son
ventas de unida de negocio
Contato t=0 y se reliza en el futuro T=t
Le das la opcin al que comrpa las acciones
En el not delivery no hay entrga del subyacente sol
que intercambia unas acciones con la
Full delivery, te dan el activo subyacente que accines de la empresa que vendekk
vendeinedoleo en ele mrcado de ta gnancias.
Cato mas capital concentrado tenia la
compia menso posibilidad tenia la
compaa.
5 deiciones importantes:
4 pregntas sobre poltica de dividendosa
1)Deiciond einverison de cpaitla:capex
1)deben ser altos o bajos:
2) Gestin de capital de trbajo:admiistra
efectivo inventarios cxc para crear valor 2)estables o irregulares:
-Reparto en acciones: Por cada accin que Is las mepresas tienen mas ebenficios van a
tien un accionesta recibir una fraccin de comrpara acciones, si el rpecio no cmabia y
accin.(acciones liberadas:por cada 4 la mepresa tiene mas ebenficios la empresa
acciones recibe una accin) en acciones esta subvaluada.
-recompra d acciones: puede indicar que la Rarios importantes del pago de diviendos:
accin esta depreciada. Didinden pay put= dididnedos/NI, cuando se
3 frmas de die vesittures: paga ams del 100% de dividndos pay out:
para mantenr el rpeico de la accin.se presta
-stock plit: par aumentar la liquidez de plata para pagar dividendos por que
acciones es una particin accionario, la proemdio pagara dividiendos o cierto monto
cpaitlaizicon burstil no cmabia. de divindos.
100*10=1000 Didinde yield = diiv/pricerd
200*5=1000 Retention ratios: = 1-divi/NI=1-d
-es la venta de una unidad e negocio peude Cada empresa debe deicsdir su polticia de
srr una porcin minoriata o mayoriatariiia. dividndedos particular
I es minoriataria es un equity carve-out:
venders una propocion unitaria de negocio
pero sigues con la psocion mayoriataria Finanzas
Ocho consejos
habilidad y no distraerse innecesariamente, pues de
esta forma evitar perder tiempo, dinero y calidad.
Hemos comentado que un swap puede Periodicidad de pago del tipo fijo: semestral
referenciarse a cualquier tipo de variable (base 30/360). Primer pago el 20 de enero de 2009 y
observable. As los compromisos de cobro y pago ltimo pago el 20 de julio de 2011.
de las dos partes del swap pueden referenciarse
a diferentes variables (por ejemplo, tipos de Tipo variable: Euribor 6 meses.
inters, precio del petrleo, precio de la vivienda,
cotizacin de una accin, etc). Los swaps ms Periodicidad de fijacin del tipo variable: semestral
simples y conocidos en los mercados financieros con primera fijacin en fecha 20 de julio de 2008 y
son los swaps de tipo de inters. En estos swaps ltima fijacin el 20 de enero de 2011.
cada parte est referenciada a diferentes ndices
de tipo de inters.
Periodicidad de pago del tipo variable: semestral
(base 30/360) pagos por periodos vencidos. Fecha
Swaps de tipos de inters de tipo variable del primer pago 20 de enero de 2009 y ltimo pago
vs tipo fijo[editar] 20 de julio de 2011.
Los swaps fijo/variable se pueden definir como el Esto significa que la parte A pagar cada 20 de julio y
compromiso por el que una parte paga/recibe un 20 de enero de 2000 euros a la parte B y que recibir
tipo fijo sobre un nocional prefijado y recibe/paga de la parte B cada 20 de julio y 20 de enero el tipo
un tipo variable sobre un nocional prefijado . euribor 6 meses antes sobre el nocional y dividido por
Normalmente Error al representar (MathML dos ya que el plazo es semestral (el 20 de enero se
con SVG o PNG como alternativa paga el tipo a 6 meses que se fij el 20 de julio
anterior ya que se paga el tipo de inters por
(recomendado para navegadores
vencido).
modernos y herramientas de
accesibilidad): respuesta no vlida Valoracin de un swap a tipo fijo/variable.
(Math extension cannot connect to Descomposicin[editar]
Restbase.) del servidor
/mathoid/local/v1/:): {\displaystyle Para valorar un swap a tipo fijo/variable
N_1=N_2=N} . El nocional es la cantidad sobre descompondremos el swap en sus distintos flujos.
la que se aplicar el tipo de inters (el nocional Estos son los compromisos de pago/cobro de flujos a
tambin se suele llamar nominal). Un ejemplo en tipo fijo y los compromisos cobro/pago a tipo variable.
detalle de cmo se definira un contrato de swap
fijo variable sera como sigue: Valoracin de los compromisos a tipo
Fijo[editar]
Fecha de inicio: 20 de julio de 2008
Vamos a empezar con la valoracin de un
Fecha de finalizacin: 20 de julio de 2011 compromiso a tipo fijo. Si nos fijamos en el
ejemplo cada uno de los compromisos a tipo fijo
suponen el pago de una cantidad cierta de En este caso siempre ser interesante entrar en el
dinero. Descompondremos la cadena de pagos compromiso.
fijos y obtendremos el valor econmico de cada
uno de ellos. De esta forma, cuando sepamos Si alguien estuviera dispuesto a pagar 1950
valorar un nico compromiso "simple", seremos euros para recibir 2000 euros 6 meses
capaces de valorar su conjunto. despus, si los tipos de inters fueran el
3,5%, no nos interesara entrar en el
Cual es el valor econmico del primer pago de compromiso de pago sino al revs. Si alguien
2.000 euros que hay que realizar el 20 de enero est dispuesto a recibir 1950 euros para
de 2009? pagar 2.000 euros 6 meses despus, lo que
nosotros haremos es la operacin contraria,
Para realizar la valoracin usaremos el arbitraje. si podemos, y pagar los 1950 euros. El nico
Esto supone que el valor del compromiso ha de problema es que debemos pagar 1950 euros
ser tal que suponga que no podemos ganar o hoy para recibir 2.000 euros en 6 meses pero
perder dinero comprando o vendiendo el hoy no tenemos los 1950 euros. Muy fcil.
compromiso y simultneamente realizar una Pedimos un prstamo de 1950 euros a 6
operacin financiera que nos permita ganar un meses al 3,5%. Al cabo de 6 meses
beneficio sin riesgo. Vamos a poner un ejemplo. deberemos devolver el prstamo pagando los
Supongamos que estamos en fecha 20 de julio intereses (34,13), lo que supone que
de 2008 y queremos saber el NPV del devolvemos de nuestro prstamo un total de
compromiso de pago de 2.000 euros el 20 de 1984,13. Cmo devolvemos el prstamo?
enero de 2009. Si tenemos que pagar 2.000 el 20 con los 2.000 euros que nos paga nuestra
de enero de 2009 la cantidad que necesitamos contrapartida. Esto supone que obtenemos
tener hoy para poder hacer frente a ese pago, un beneficio en fecha 20 de enero de 2009
suponiendo que el tipo de inters a 6 meses es el de 15,9 euros.
3,5%, es:
Por tanto esto supone que, por arbitraje, el
Error al representar (MathML con SVG o PNG valor econmico del compromiso solo pueden
como alternativa (recomendado para ser los 1965,6, ya que cualquier otro valor
navegadores modernos y herramientas de supone que se puede arbitrar y obtener un
accesibilidad): respuesta no vlida (Math beneficio sin riesgo.
extension cannot connect to Restbase.) del
servidor /mathoid/local/v1/:): {\displaystyle Para poder avanzar ms adelante vamos a
NPV={2 000 \over (1+{3,5% \over 2})}=1965,6} empezar a poner estos conceptos en forma
matemtica y empezaremos a dar forma a
Por qu 1965,6? Si invertimos esta cantidad durante
6 meses, a un inters del 3,5% anual, los intereses nuestra funcin Error al representar
que obtendramos al cabo de los 6 meses son 34,4 (MathML con SVG o PNG como
euros, que sumados a los 1965,6 hacen un total de alternativa (recomendado para
2.000 euros que es exactamente nuestro navegadores modernos y
compromiso. Por tanto el valor econmico de un pago herramientas de accesibilidad):
de 2.000 euros el 20 de enero de 2009 a fecha 20 de
respuesta no vlida (Math extension
julio del 2.008 es de 1965,6. Esta es la cantidad que
deberemos aceptar para entrar en el compromiso de
cannot connect to Restbase.) del
pago de los 2.000 euros para que no suponga servidor /mathoid/local/v1/:):
ninguna perdida ni beneficio para nosotros. \varphi .
El arbitraje supone que cualquier otro valor del Llamaremos factor de descuento a la
compromiso permite hacer un beneficio sin riesgo. funcin que relaciona por arbitraje el valor
econmico de un compromiso futuro de pago
Imaginemos que por entrar en el compromiso de fijo. En nuestro caso Error al representar
pagar los 2.000 euros alguien nos paga 1980 euros. (MathML con SVG o PNG como
Inmediatamente podemos ver que para atender alternativa (recomendado para
nuestro compromiso solo necesitamos 1965,6 euros navegadores modernos y
con lo que realizamos un beneficio directo de 14,4.
herramientas de accesibilidad):
respuesta no vlida (Math extension Convencin para el Factor de descuento[editar
cannot connect to Restbase.) del Hemos de parar aqu un momento para tomar una
servidor /mathoid/local/v1/:): convencin que luego simplificar mucho la carga
{\displaystyle FD_{20/1/2009} = matemtica. Los factores de descuento se calcularn
0,982800983} y por tanto se cumple la con los tipos de inters de la curva cupn cero y con
relacin: tipo compuesto anual en lugar de tipo de inters
simple. (para ms detalles verfactor de descuento ).
Esta convencin supone que la funcin coge la
Con lo que determinamos la forma de la
siguiente forma:
funcin Error al representar
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alternativa (recomendado para
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herramientas de accesibilidad): extension cannot connect to Restbase.) del
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extension cannot connect to FD_t=(1+i_t)^{-t}}
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obtener el valor econmico hoy de un o PNG como alternativa (recomendado para
nico pago cierto a una fecha futura. navegadores modernos y herramientas de
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futuros a tipo fijo la expresin genrica
ser: extension cannot connect to Restbase.)
del servidor /mathoid/local/v1/:):
Que en nuestro ejemplo concreto quedara {\displaystyle i_t} es el tipo de inters cupn cero
como: que hay en el mercado financiero para un periodo que
Podemos ampliar la frmula desarrollando el va desde hoy hasta el momento t (expresado en
trmino , que es el flujo en el momento t, aos).
incorporando todas las variables que
describen el swap obteniendo una frmula En nuestro ejemplo, el tipo cupn cero equivalente al
genrica: 3,5% a 6 meses (llamado tambin tipo nominal) ser
Donde N es el nominal sobre el que se aplica el que satisface la ecuacin . Siendo Error al
el tipo fijo (C) y p=1,2,...,12 para indicar el representar (MathML con SVG o PNG como
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etc). En nuestro ejemplo N=100.000, C=4% y
respuesta no vlida (Math extension
p=2.
cannot connect to Restbase.) del servidor
Ahora ya hemos hallado el valor econmico de la /mathoid/local/v1/:): {\displaystyle
pata fija del swap. Nos queda hallar el valor i_t=3,5%}
econmico de la pata flotante para encontrar el valor
de todo el swap en su conjunto. (Para ms Valoracin de los compromisos a tipo
informacin vase tambin VAN) Variable[editar]
Negoci
acin
de un
swap[e
ditar]
Los
swaps
se
negocia
n OTC e
ntre dos
contrapa
Conce En un
pto swap, el
concept
de coti o
zacin de cober
o tura se
Pricin le suele
g aplicar
desde
y cober
dos
tura o mbitos:
Hedg
e de Pen
un san
swap[e do
en
ditar] que
el
Por coti swa
zacin p es
de un un
swap instr
entende ume
remos el nto
acto de de
calcular cob
y ofrecer ertur
a de
un
otro
precio
s
para instr
contrata ume
r un ntos
swap. fina
En los ncie
mercado ros.
s
financier Pen
os las san
contrapa do
rtidas en
que se com
dedican o
perman cubr
entemen ir el
te a ries
cotizar go
swaps de
tipo
se
de
llaman c
inter
readore s
s de que
mercad nos
o o "ma prov
rket oca
makers entr
". ar
en ries
un go
swa de
p. crd
Este ito
ries exist
go e
se por
suel la
e posi
cubr bilid
ir ad
con de
otro que
s nue
instr stra
ume cont
ntos rapa
fina rtida
ncie no
ros pag
(futu ue
ros, sus
dep com
sit pro
os, mis
etc) os.
o En
con este
otro cas
s o, el
swa ries
ps. go
de
Otras
crd
consid ito
eracion no
es es
del
sobre nom
un inal,
swap[e sino
ditar] del
NPV
del
Los swa
swa p en
ps cad
est a
n mo
suje men
tos to
a que
ries quer
go emo
de s
crd med
ito. ir el
El mis
mo. era
Exis cont
ten rapa
mec rtes
anis disp
mos uest
, as a
com entr
o ar
las en
gara la
nta oper
s en aci
form n de
a de swa
cola p
teral que
, quer
para emo
miti s lo
gar que
el impli
ries ca
go que
de tene
crd mos
ito. un
ries
Los go
swa de
ps liqui
est dez.
n En
suje este
tos cas
al o
ries podr
go a
de ser
liqui posi
dez. ble
En no
dete enc
rmin ontr
ada ar a
s nadi
situ e
acio para
nes pod
de er
mer reali
cad zar
o la
podr oper
a aci
ser n de
que cob
no ertur
hubi ao
esp n
ecul falla
aci n.
n Es
que muy
des imp
eam orta
os. nte
Es tene
perti rlo
nent en
e cue
men nta
cion para
ar su c
que ober
el tura
swa oh
p edg
man e y
tien cotiz
e un aci
may n.
or
Otros
ries
go a swaps
com de tipo
para de
cin
de
inters
otro [editar]
s
instr En
ume general
ntos cualquie
fina r
ncie combina
ros cin de
deri compro
vad
misos
os.
de
Si la
liqui cobro/pa
dez go de
del flujos de
mer tipo de
cad inters
o constitu
des ye un
apar swap.
ece Las
ento combina
nce ciones
s los son
mod pues
elos
muy
de
numeros
valo
raci as (por
ejemplo pata
tipos para
fijos que
crecient tenga
es en el algn
tiempo, inters
nominal el swap.
es
variable Asset
s en el Swap[e
tiempo, ditar]
etc). A
continua Los
cin se pagos/c
expone obros de
una una pata
relacin replican
de los los
ms cobros/p
usuales agos de
en los un
mercado activo
s mientras
financier que la
os. otra
pata se
Swap paga a
Fijo vs un tipo
Fijo o de
Variable inters
vs variable.
Variable Sirve
[editar] para
convertir
Los los flujos
pagos y de un
cobros activo
estn que
referenci tengamo
ados a s (por
ndices ejemplo
fijos o un bono
variable que
s en las paga un
dos tipo fijo)
partes. a otros
Los que nos
ndices convien
deben en ms.
ser para
diferente
s
periodici
dades
en cada
Call de swap
Money en el
Swap[e que una
ditar] de las
patas
Tipo est
especial referenci
de swap ado a un
muy tipo
utilizado variable
en el a corto
mercado plazoEu
interban ribor (inf
cario. erior a
Suelen 12
tener meses)
vencimi y la otra
entos est
desde referenci
un mes ada a un
a un tipo
ao. superior
Una de a 12
las meses
patas es (por
a tipo ejemplo,
fijo el tipo
mientras swap a
que la 10
otra esta aos).
indexad Se suele
a a un cotizar
tipo en % del
variable tipo
diario referenci
(normal ado al
mente el ndice
tipo Eoni superior
a). Se a 12
suele meses.
realizar
una sola Swaps
liquidaci de tipo
n a
de
vencimi
ento. inters
en
Constan diferen
t tes
Maturity divisas
Swap[e [editar]
ditar]
Un caso
Tipo especial
especial de todos
los para
swaps incorpor
de tipo ar este
de hecho.
inters
es el
caso en
Eje
el que mpl
una de
las
os
patas de
est
referenci
otro
ada a s
una
divisa y
tipos
el otro a de
otra
divisa.
swa
Por ps[edi
ejemplo tar]
la pata
fija Swap
podra de
estar divisas
expresa [editar]
da en
Artculo
tipos de
principal:
inters
Swap de
en dlar
divisas
es y la
otra
Suelen
en euros
confundi
. (No
rse con
debe
los
confundi
swaps
rse con
de tipos
la
de
operaci
inters,
n de
donde
swap de
cada
divisas)
pata
Las
est
frmulas
referenci
expresa
ada a
das para
una
el swap
divisa
simple
diferente
fijo vs
. La
variable
confusi
son
n puede
diferente
provenir
s en
por la
este
utilizaci
caso
n del
trmino Equity
swap Swap[
ingls,
editar]
que
significa
intercam En un
bio. Equity
swap
una de
Un swap
las
de
patas
divisas e
est
s una
referenci
operaci
ada a
n que
tipo de
incluye
inters y
una
la otra
comprav
referenci
enta de
ada a
divisas a
renta
fecha de
variable
hoy y
(accione
una
s o w:en
operaci
:Equity
n de
Equity)
sentido
. La
contrario
referenci
a fecha
a a la
futura a
renta
un
variable
precio
puede
prefijado
ser de
hoy. Por
muchos
ejemplo,
tipos
una
(variaci
compra
n sobre
de
un
dlares
ndice,
contra
sobre un
euros
portafoli
hoy a un
o de
precio
accione
de 1.40
s,
y venta
rentabili
de euros
dad en
contra
un
dlares
periodo,
dentro
etc)
de un
mes a
un
precio
de
1.3970.
Total muy
Return similar a
lo que
Swap[ es el
editar] forward.
En este
tipo de
swap se 1 Resea histrica
intercam
bia un 2 SWAP
tipo de
inters 3 Caractersticas de las operaciones SWAP
flotante
por 4 Tipos de SWAPS
todos
los flujos 5 Tipos de riesgo
de un
activo 6 Conclusiones y recomendaciones
financier
o por INTRODUCCIN
variados
y Dentro de nuestro marco social, cultural, poltico y econmico
complej se han creado y desarrollado innovaciones para beneficio y
crecimiento del hombre. Gracias a ellas se han aprovechado
os que
oportunidades que permiten la evolucin social y econmica
sean. de nuestro entorno, por eso es importante acoger
Usualm la tecnologa y los nuevos proyectos, como una alternativa de
ente si crecimiento y expansin profesional.
el
vencimi Dentro del desarrollo del presente trabajo, se da a conocer una
ento de de las ms importantes operaciones, que
este las empresas pueden desarrollar para hacer crecer
su capital con mayor rendimiento y efectividad, de tal forma
swap es
que si no tiene liquidez inmediata se puede hacer un canje o
inferior transaccin para as aprovechar oportunidades y hacer crecer
al del su actividad econmica.
activo
financier Esta oportunidad que nos ofrece el mercado para desarrollo y
o suele sostenimiento empresarial, son las operaciones SWAP, la
haber cuales en forma general, representan una reestructuracin del
portafolio de inversiones, a travs de una transaccin de
un
ttulos valores con determinadas caractersticas por otra otras
intercam que puede afectar en forma positiva los portafolios
bio, de inversin.
entre las
partes,
RESEA HISTRICA
del
activo al
Aunque esta operacin vino a existir slo en aos muy
inicio y recientes, puede ser relacionado a los aos 1800s y la Ley de
vencimi Ventaja Comparativa de Ricardo. En esencia, esta ley
ento del examinaba dos pases los cuales ambos producan tela y vino.
contrato
de swap Si el pas A puede producir tela ms eficientemente que el pas
a un B, entonces tiene una ventaja absoluta en tela sobre el pas B.
precio Sin embargo, de acuerdo a la Ley de Ricardo, an si A tiene
una ventaja absoluta en tela y vino sobre B, no hay razn para
prefijado
que los dos no puedan negociar.
.Es un
contrato
El pas A debe concentrarse en producir el producto en el cual Utilidad de un swap
tenga la ms grande ventaja comparativa, dejando
la produccin del otro producto para B. Los dos pueden Bsicamente podemos hablar de dos utilidades o motivos por
entonces intercambiar sus abastecimientos en exceso uno con el que tendremos inters en entrar en un swap:
otro, permitiendo a ambos completar sus requerimientos para
el producto que no producen- con el resultado neto de que
a) Cambiar nuestros bienes
ambos se beneficiaran.
o recursos futuros: Puede interesarnos para nuestro negocio
intercambiar durante un tiempo bienes o recursos que
Swap generaremos por otros bienes o recursos necesarios para
nuestra actividad o bienestar.
1. Conceptos
b) Especulacin: Al igual que la especulacin en otros activos,
entraremos en un swap si nuestra visin es que los bienes que
Un swap, o permuta financiera, es un contrato por el cual dos
recibiremos a futuro van a suponer para nosotros mayor valor
partes se comprometen a intercambiar una serie de cantidades
que los bienes que entregaremos a futuro.
de dinero en fechas futuras. Normalmente los intercambios de
dinero futuros estn referenciados a tipos de inters,
llamndose IRS (Interest Rate Swap) aunque de forma mas CUL ES SU FINALIDA
genrica se puede considerar un swap cualquier intercambio
futuro de bienes o servicios (entre ellos el dinero) referenciado Mitigar las oscilaciones de las monedas Y de los tipos
a cualquier variable observable. Un swap se considera un de inters
instrumento derivado.
Reducir el riesgo del crdito
Partes de un swap
Reestructuracin de portafolios, en donde se logra
Dado que es un compromiso de intercambio de dinero a futuro aportar un valor agregado para el usuario
un swap tiene dos partes para cada uno de los contratantes: el
compromiso de cobro de dinero a futuro y el compromiso de
Disminuir los riesgos de liquidez
pago de dinero a futuro. Cada una de estas dos partes se les
suele llamar "pata" proveniente del termino ingls "leg" (pata o
pierna). EN QU SE FUNDAMENTAN?
3
Ejemplo: un Swap a tres aos sobre petrleo; esta transaccin Swaps indexados a hipoteca y de obligacin
es un intercambio de dinero basado en el precio hipotecaria colateral: Clase especial de swap que estipula la
del petrleo (A no entrega a B petrleo en ningn momento), amortizacin de los principales de una manera consistente con
por lo tanto el Swap se encarga de compensar cualquier la amortizacin de una hipoteca.
diferencia existente entre el precio variable de mercado y el
precio fijo establecido mediante el Swap. Es decir, si el precio Swaps base: tambin llamados de variables-por
del petrleo baja por debajo del precio establecido, B paga a A -variable (flotante-por-flotante), son swaps en los que ambas
la diferencia, y si sube, A paga a B la diferencia. ramas son variables, pero estn vinculados a dos diferentes
ndices. Por ejemplo, un lado puede estar vinculado a la tasa
Swaps de ndices burstiles: El mercado de los Swaps sobre LIBOR, mientras que la otra lo est a 3 meses LIBOR.
ndices burstiles permite intercambiar el rendimiento del
mercado de dinero por el rendimiento de un mercado burstil, Swaps de curva de rendimiento: estos son swaps
este rendimiento se refiere a la suma de dividendos recibidos, en los que ambas ramas son flotantes, pero a diferencia de los
ganancias y/o prdidas de capital. swaps base, los lados flotantes pueden estar vinculada a la
tasa de largo plazo. Por ejemplo, una rama puede estar
vinculada a la tasa de subasta sobre los bonos del Tesoro a 30
aos, y la otra puede estarlo a la tasa de la subasta relativa a
pagars del Tesoro a 10 aos..
TASAS DE INTERES SWAPS
Swaps cupn cero: Estos son swaps de fija-por-
Tipos: variable en los que la tasa fija es la de un bono cupn cero.
Esto es, no se hace ningn pago en la rama de la tasa fija del
Cupon Swap: Se intercambian tasas fijas por tasas variables swap hasta el vencimiento. Al trmino de ste, se fija la tasa y
o viceversa. se hace un pago simple.
Basis Swap: Se intercambian tasas variables por tasas Swaps forward: tambin llamados swaps diferidos,
variables. son aquellos en los que el cupn se fija en la fecha de la
transaccin, pero el swap no comienza hasta una fecha
posterior. Esto podra ser 60 das, 1 ano despus, etctera.
Cross Currency Rate Swap: Se intercambian tasas fijas en
una divisa por tasas variables en otras.
Swaps de fijacin retrasada de tasa: Tambin
llamados swaps de fijacin diferida de tasa. Estos son swaps
Otros tipos de swaps que comienzan inmediatamente, pero su cupn no se fija sino
en una fecha posterior. El tiempo de fijacin de la tasa se deja,
Equity Swap : En un Equity swap una de las tasas con lmites contractuales, a la discrecin del usuario final.
esta referenciada a tipo de inters y la otra referenciada a Cuando se fija la tasa, se hace de acuerdo con una frmula
renta variable (acciones o "Equity"). La referencia a la renta previamente acordada.
variable puede ser de muchos tipos (variacin sobre un ndice,
sobre una cesta de acciones, rentabilidad en un periodo, etc) Swaps pagadero a la demanda colocable y
ampliado o swaps con opcin: Estos son swaps en lo que
Total Return Swap: En este tipo de swap se una parte tiene el derecho, no la obligacin, de extender o
intercambia un tipo de inters flotante por todos los flujos de acortar la duracin del mismo. En un swap pagadero a la
un activo financiero por variados y complejos que sean. demanda, el que paga la tasa fija tiene el derecho a terminar
Usualmente si el vencimiento de este swap es inferior al del antes el swap. En el swap colocable, el que paga la tasa
activo financiero suele haber un intercambio, entre las partes, variable tiene el derecho de extender la duracin del swap ms
del activo al inicio y vencimiento del contrato de swap a un all de la fecha programada de terminacin.
precio prefijado.
Swap de tasa lmite: Estas son swaps en los que la
Tipos o variables de Swaps de inters: tasa variable tiene lmites. Estos pueden obtenerse mediante
la incorporacin de dichos lmites directamente en los trminos
del swap, o conseguirse por separado o travs de un agente
Swaps amortizables y acumulables: Los swaps especfico.
amortizables son swaps cuyo principal est reducido o
concentrado en uno o ms puntos en el tiempo, previos al
vencimiento del swap. Los swaps acumulables son aquellos en Swaps reversibles: estos son swaps en los que el
los que el principal es incrementado en uno o ms puntos del que paga la tasa fija y el que paga la tasa flotante invierten sus
tiempo previo al vencimiento del mismo. Ambos tipos de swaps papeles una o ms veces durante la vida del mismo. Esto es,
requieren un calendario separado estipulando el que paga la tasa variable se convierte en el que paga la tasa
la amortizacin o acumulacin de todas principales. fija, a su vez, el que paga la tasa fija se convierte en el que
paga la tasa variable.
Swaps roller coaster: tipo "montaa rusa", estos
swaps estipulan un periodo de acumulacin seguido de un Swaps estacionales: este swap se define en forma
periodo de amortizacin de principales. amplia como cualquier swap diseado con el fin de
desestacionalizar los flujos de efectivo de una empresa. Existe
un buen nmero de estructuras que pueden hacer esto. Una
es con el swap de fija por fija con fechas de pago no CONCLUSIONES Y RECOMENDACIONES
concordantes.
A swap is an agreement between two parties to Plain Vanilla Interest Rate Swap
exchange sequences of cash flows for a set
The most common and simplest swap is a "plain
period of time. Usually, at the time the contract is
vanilla" interest rate swap. In this swap, Party A
initiated, at least one of these series of cash
agrees to pay Party B a predetermined, fixed rate
flows is determined by a random or uncertain
of interest on a notional principal on specific
variable, such as an interest rate,
dates for a specified period of time. Concurrently,
foreignexchange rate, equity price or commodity
Party B agrees to make payments based on
price. Conceptually, one may view a swap as
a floating interest rate to Party A on that same
either a portfolio of forward contracts, or as
notional principal on the same specified dates for
a long position in one bond coupled with a short
the same specified time period. In a plain vanilla
position in another bond. This article will discuss
swap, the two cash flows are paid in the same
the two most common and most basic types of
currency. The specified payment dates are
swaps: the plain vanilla interest rate and currency
called settlement dates, and the time between
swaps.
are called settlement periods. Because swaps
are customized contracts, interest payments may
The Swaps Market be made annually, quarterly, monthly, or at any
Unlike most other interval determined by the parties.
standardized options and futures contracts,
swaps are not exchange-traded instruments. SEE: How do companies benefit from interest
Instead, swaps are customized contracts that are rate and currency swaps?
traded in the over-the-counter (OTC) market
between private parties. Firms and financial For example, on Dec. 31, 2006, Company A and
institutions dominate the swaps market, with few Company B enter into a five-year swap with the
(if any) individuals ever participating. Because following terms:
Company A pays Company B an amount Figure 1: Cash flows for a plain vanilla interest
equal to 6% per annum on a notional rate swap
principal of $20 million.
Plain Vanilla Foreign Currency
Company B pays Company A an amount
equal to one-year LIBOR + 1% per annum
Swap
on a notional principal of $20 million. The plain vanilla currency swap involves
exchanging principal and fixed interest payments
LIBOR, or London Interbank Offer Rate, is the on a loan in one currency for principal and fixed
interest rate offered by London banks on deposits interest payments on a similar loan in another
made by other banks in the eurodollar markets. currency. Unlike an interest rate swap, the parties
The market for interest rate swaps frequently (but to a currency swap will exchange principal
not always) uses LIBOR as the base for the amounts at the beginning and end of the swap.
floating rate. For simplicity, let's assume the two The two specified principal amounts are set so as
parties exchange payments annually on to be approximately equal to one another, given
December 31, beginning in 2007 and concluding the exchange rate at the time the swap is
in 2011. initiated.
At the end of 2007, Company A will pay For example, Company C, a U.S. firm, and
Company B $20,000,000 * 6% = $1,200,000. On Company D, a European firm, enter into a five-
Dec. 31, 2006, one-year LIBOR was 5.33%; year currency swap for $50 million. Let's assume
therefore, Company B will pay Company A the exchange rate at the time is $1.25
$20,000,000 * (5.33% + 1%) = $1,266,000. In a per euro (e.g. the dollar is worth 0.80 euro). First,
plain vanilla interest rate swap, the floating rate is the firms will exchange principals. So, Company
usually determined at the beginning of C pays $50 million, and Company D pays 40
the settlement period. Normally, swap contracts million euros. This satisfies each company's need
allow for payments to be netted against each for funds denominated in another currency (which
other to avoid unnecessary payments. Here, is the reason for the swap).
Company B pays $66,000, and Company A pays
nothing. At no point does the principal change
hands, which is why it is referred to as a
"notional" amount. Figure 1 shows the cash flows
between the parties, which occur annually (in this
example).
Figure 2: Cash flows for a plain vanilla
SEE: Corporate Use Of Derivatives For Hedging currency swap, Step 1.
Figure 3: Cash flows for a plain vanilla For example, consider a well-known U.S. firm
currency swap, Step 2 that wants to expand its operations into Europe,
Finally, at the end of the swap (usually also the where it is less known. It will likely receive more
date of the final interest payment), the parties re- favorable financing terms in the U.S. By then
exchange the original principal amounts. These using a currency swap, the firm ends with the
principal payments are unaffected by exchange euros it needs to fund its expansion.
Float to Float interest by trading with the other than they would
if they chose a more traditional financing route.
Companies sometimes enter into a swap to
change the type or tenor of the floating rate index
that they pay; this is known as a basis swap. A
BREAKING DOWN 'Liability
company can swap from three-month LIBOR to Swap'
six-month LIBOR, for example, either because For example, XYZ may swap a six-month LIBOR
the rate is more attractive or it matches other interest rate for ABC's six-month fixed rate of 5%
payment flows. A company can also switch to a on a notional principal of $10 million dollars. Due
different index, such as the federal funds rate, to the split, XYZ will pay a fixed interest payment
commercial paper or the Treasury bill rate. of 5%, instead of the floating rate.
Asset Swap
A swap will have an initial value of zero because
the initial cash flows are the same. Over time,
however, this will change as interest rates change
An asset swap is similar in structure to a plain and the swap will have either a positive or
vanilla swap, the key difference is the underlying negative value for each contract holder. In certain
of the swap contract. Rather than regular fixed cases, the swap can be marked-to-market
and floating loan interest rates being swapped, periodically to clear out the unrealized gains and
fixed and floating investments are being losses by making any payments due.
exchanged.
Currency Swap
Exchange of Principal
In a currency swap, the parties agree in advance
whether or not they will exchange the principal
A currency swap, sometimes referred to as a amounts of the two currencies at the beginning of
cross-currency swap, involves the exchange of the transaction. The two principal amounts create
interest and sometimes of principal in one an implied exchange rate. For example, if a swap
currency for the same in another currency. involves exchanging 10 million vs $12.5 million,
Interest payments are exchanged at fixed dates that creates an implied EUR/USD exchange rate
through the life of the contract. It is considered to of 1.25. At maturity, the same two principal
be a foreign exchange transaction and is not amounts must be exchanged, which creates
required by law to be shown on a company's exchange rate risk as the market may have
balance sheet. moved far from 1.25 in the intervening years.
Pricing is usually expressed as LIBOR plus or Interest rate payments are usually calculated
minus a certain number of points, based on quarterly and exchanged semi-annually, although
interest rate curves at inception and the credit swaps can be structured as needed. Interest
risk of the two parties. payments are generally not netted because they
are in different currencies.
Currency Swap
Swap Rate
There are three different types of interest rate
exchanges for a currency swap: (1) the fixed rate
of one currency for a fixed rate of the second; (2)
the fixed rate of one currency to a floating rate of
A swap rate is the rate of the fixed leg of
the second; and (3) the floating rate of one to a
a swap as determined by its particular market. In
floating rate of the second. Within each of those
an interest rate swap, it is the fixed interest
three variations, there are two additional
rate exchanged for a benchmark rate such
variations: the swap can include or exclude a full
as LIBOR plus or minus a spread. It is also
exchange of the principal amount of currency at
the exchange rate associated with the fixed
both the beginning and the end of the swap. The
portion of acurrency swap.
interest rate payments are not netted because
they are calculated and paid in different
BREAKING DOWN 'Swap Rate'
currencies.
An interest rate swap is the exchange of a
floating rate for a fixed rate; a currency swap is Regardless of whether the principal is
the exchange of interest payments in one exchanged, a swap rate for the conversion of the
currency for those in another. In both types of principal must be set. If there is no exchange,
transaction, the fixed element is referred to as the then this is used simply for the calculation of the
swap rate. two notional principal currency amounts on which
the interest rate payments are based. If there is
Interest Rate Swap an exchange, where the swap rate is set can
Parties are referred to with respect to the fixed have a large profit or loss impact between the
rate leg of the swap; they are start and end dates of the swap
either payer or receivers of fixed. The cash flow
of the fixed rate leg of the swap is set when the
trade is done. The cash flow for the floating rate
leg is set periodically on the rate reset dates,
Estos son los elementos claves para evaluar una
which are determined by the reset period of the
floating rate leg. The most common index for the
floating rate leg is the three-month U.S. dollar firma de asset management
LIBOR. This can either be paid quarterly, so
31 OCTUBRE 2016 0 COMENTARIOS
every three months, or compounded and paid
semi-annually. The spread above or below
Una clara filosofa de inversin, un equipo
LIBOR reflects both the yield curve and
calificado y una visin a largo plazo son
any credit spread to be charged. Interest rate
algunos factores a considerar antes de entregar
payments between the fixed and the floating rate
un mandato de inversin.
legs are netted at the end of each payment
period, and only the difference is exchanged.
Detrs de una eficiente gestin de activos hay diversos gestores globales del 2006 al 2015. De
mucho ms que comprar barato y vender caro. los que estuvieron en el cuartil superior
Un buen asset manager es coherente con la durante el perodo 2006-2010, apenas el 35%
estrategia de inversin que defiende y entiende se mantuvo en dicho cuartil en el quinquenio
cules son los objetivos del cliente y los riesgos sucesivo (2011-2015). Otros estudios arrojan
que est dispuesto a tomar. Qu aspectos similares resultados: la performance es rara vez
deben evaluarse antes de entregar un mandato persistente. En promedio, un gestor con un
de inversin? buen desempeo pasado no aumenta sus
Una buena gestin de inversiones probabilidades de repetirse en el futuro.
requiere disciplina y orden: seguir una ARTCULO RELACIONADOPor qu las
secuencia lgica. En primer lugar, el gestor personas no suelen ahorrar?
debe conocer cul es el mandato de inversin Roberto Melzi, CIO de SURA Investment
que se est tomando por encargo. Un mandato Management, seala que la clave est
refleja regulacin, apetito por riesgo y en entender la filosofa de inversin
objetivos, y depende del perfil del cliente o del del managery el trabajo de su equipo. Qu
diseo de la poltica de inversin del asset haces en el da a da para honrar esa filosofa?
manager. Luego, debe quedar claro qu Qu haces cuando tu filosofa est en estrs y
riesgos pueden asumirse y qu vehculos se enfrentas una situacin en la que pierdes
utilizarn para alcanzar los objetivos. dinero o te encuentras debajo del benchmark?
Un aspecto clave antes de encargarle la gestin Cumples con el mandato que fijaste desde un
de los propios fondos a un asset manager es principio, asegura el ejecutivo. La evidencia
la evaluacin de su trabajo y visin. Sin demuestra que los gestores ms eficientes en el
embargo, esta tarea se pasa muchas veces por largo plazo son aquellos que siempre han hecho
alto y, cuando se realiza, la aproximacin ms lo que dijeron que iban a hacer. En momentos
comn es la cuantitativa. Es decir, se evala la de estrs, son los primeros en defender la tesis
data histrica de cada gestor para entender qu por la que sus clientes confiaron en ellos en
tanto alpha (retorno por encima primer lugar.
del benchmark) ha producido en el tiempo, Sin la filosofa correcta, que se sostiene en la
cun estables son sus rendimientos y cul es la disciplina y el coraje para llevarla a cabo, la
relacin entre los retornos generados y los gestin de fondos no tiene sentido, resalta en
riesgos asumidos. un reciente artculo Schroders, una empresa
Sin embargo, el anlisis de los resultados britnica de asset management con ms de
histricos resulta muchas veces 343,800 millones en activos administrados.
insuficiente. Wilshire Advisors una Una firma de gestin de fondos debe adems
consultora de inversiones con sede en Santa preocuparse de planificar una slida sucesin
Mnica, California evalu el desempeo de de ejecutivos si desea permanecer en la
industria por 200 aos o ms y generar Premio Nobel de Economa: cmo
rendimientos a largo plazo, subraya Schroders, todos pueden beneficiarse?
fundada nada menos que en 1804.
En la misma lnea, la multinacional Oliver Hart y Bengt Holmstrm ganaron
financiera Barclays recomienda evaluar cmo el Premio Nobel de Economa 2016 por
se toman las decisiones de inversin en una disear mecanismos que permiten que todas
empresa gestora antes de otorgarle un las partes ganen tras la firma de un contrato
Revenue - Cash
Selling, General
inflows or other
and Administrative
enhancements of assets
expenses (SG&A or
(including accounts
SGA) - consist of the
receivable) of an entity
combined payroll
during a period from
costs. SGA is usually
delivering or producing
understood as a major
goods, rendering services,
portion of non-
or other activities that
production related
constitute the entity's
costs, in contrast to
ongoing major operations.
production costs such
It is usually presented as
as direct labour.
sales - sales discounts,
returns, and allowances.
Every time a business sells Selling
a product or performs a expenses -
service, it obtains revenue. represent
This often is referred to as expenses needed
gross revenue or sales to sell products
revenue.[5] (e.g., salaries of
sales people,
commissions and
Expenses - Cash
travel expenses,
outflows or other using-up
advertising, freight,
of assets or incurrence of
shipping,
depreciation of (IAS 1.99) If an entity
sales store categorises by function, then
buildings and additional information on the
equipment, etc.). nature of expenses, at least,
depreciation, amortisation and
General employee benefits expense
and Administrative must be disclosed. (IAS 1.104)
(G&A) expenses -
represent The major exclusive of costs
expenses to of goods sold, are classified
manage the as operating expenses. These
business (salaries represent the resources
of officers / expended, except for
executives, legal inventory purchases, in
and professional generating the revenue for the
fees, utilities, period. Expenses often are
insurance, divided into two broad sub
depreciation of classicifications selling
office building and expenses and administrative
equipment, office expenses.[5]
rents, office
supplies, etc.). Non-operating
Depreciation / A
section[edit]
mortization - the
charge with respect Other revenues or
to fixed gains - revenues and gains
assets / intangible from other than primary
assets that have been business activities
capitalised on (e.g., rent, income from
the balance sheet for a patents, goodwill). It also
specific (accounting) includes unusual gains that
period. It is a are either unusual or
systematic and infrequent, but not both
rational allocation of (e.g., gain from sale of
cost rather than the securities or gain from
recognition of market disposal of fixed assets)
value decrement.
Other expenses or
Research & losses - expenses or
Development (R&D) losses not related to
expenses - represent primary business
expenses included in operations, (e.g., foreign
research and exchange loss).
development.
Finance costs - costs
Expenses recognised in the of borrowing from various
income statement should be creditors (e.g., interest
analysed either by nature (raw expenses, bank charges).
materials, transport costs,
staffing costs, depreciation, Income tax expense -
employee benefit etc.) or sum of the amount
by function (cost of sales, of tax payable to tax
selling, administrative, etc.).
authorities in the current requires prospective changes.
reporting period (current tax (IAS 8)
liabilities/ tax payable) and
the amount of deferred No items may be presented in
tax liabilities (or assets). the income statement
as extraordinary items under
Irregular items[edit] IFRS regulations, but are
permissible under US GAAP.
They are reported separately (IAS 1.87)
because this way users can
better predict future cash
Extraordinary items are both
flows - irregular items most
unusual (abnormal) and
likely will not recur. These are
infrequent, for example,
reported net of taxes.
unexpected natural disaster,
expropriation, prohibitions
Discontinued under new regulations.
operations is the most
common type of irregular Additional items may be needed
items. Shifting business to fairly present the entity's
location(s), stopping results of operations. (IAS 1.85)
production temporarily, or
changes due to
technological improvement Disclosures[edit]
do not qualify as
discontinued operations. Certain items must be
Discontinued disclosed separately in the
operations must be shown notes (or the statement of
separately. comprehensive income), if
material, including:[4] (IAS 1.98)
Cumulative effect of changes
in accounting policies Write-downs
(principles) is the difference of inventories to net
between the book value of the realisable value or
affected assets (or liabilities) of property, plant and
under the old policy (principle) equipment to recoverable
and what the book value amount, as well
would have been if the new as reversals of such write-
principle had been applied in downs
the prior periods. For example,
valuation of inventories Restructurings of the
using LIFO instead activities of an entity
of weighted average method. and reversals of any
The changes should be provisions for the costs of
applied retrospectively and restructuring
shown as adjustments to
the beginning balance of Disposals of items of
affected components property, plant and
in Equity. All comparative equipment
financial statements should be
restated. (IAS 8)
Disposals of
investments
However, changes in
estimates (e.g., estimated
useful life of a fixed asset) only Discontinued
operations called bottom line. It is
important to investors as it
Litigation settlements represents the profit for the
year attributable to the
Other reversals of shareholders.
provisions
After revision to IAS 1 in 2003,
Earnings per share[edit] the Standard is now
using profit or loss for the
Because of its year rather than net profit or
importance, earnings per loss or net income as the
share (EPS) are required to be descriptive term for the bottom
disclosed on the face of the line of the income statement.
income statement. A company
which reports any of the Requirements of
irregular items must also IFRS[edit]
report EPS for these items
either in the statement or in
On 6 September 2007,
the notes.
the International Accounting
Standards Board issued a
There are two forms of EPS revised IAS 1: Presentation of
reported: Financial Statements, which is
effective for annual periods
Basic: in this case beginning on or after 1
weighted average of January 2009.
shares outstanding
includes only actual A business entity adopting IFRS
stocks outstanding. must include:
therrefore, cash is not the same as net in accounts receivable on the balance sheet
income, which on the income statement and from one accounting period to the next must
balance sheet, includes cash sales and sales also be reflected in cash flow. If accounts
made on credi receivable decreases, this implies that more
cash has entered the company from
Cash flow is determined by looking at three customers paying off their credit accounts
components by which cash enters and leaves - the amount by which AR has decreased
a company: core operations, investing and is then added to net sales.
financing,
An increase in inventory, on the other hand,
Operations signals that a company has spent more
the cash inflows and outflows caused by core money to purchase more raw materials. If the
business operations, the operations inventory was paid with cash, the increase in
component of cash flow reflects how much the value of inventory is deducted from net
cash is generated from a company's products sales. A decrease in inventory would be
or services. Generally, changes made in added to net sales. If inventory was purchased
cash, accounts on credit, an increase in accounts payable
receivable, depreciation, inventory and accoun would occur on the balance sheet, and the
ts payable are reflected in cash from amount of the increase from one year to the
operations. other would be added to net sales.
The same logic holds true for taxes payable,
CF is calated by making certain adjustments salaries payable and prepaid insurance. If
to net income by adding or subtracting something has been paid off, then the
differences in revenue, expenses and difference in the value owed from one year to
credit transactions (appearing on the the next has to be subtracted from net income.
balance sheet and income statement) If there is an amount that is still owed, then
resulting from transactions that occur from one any differences will have to be added to net
period to the nex. These adjustments are earnings
made because non-cash items are
calculated into net income (income Investing
statement) and Changes in equipment, assets, or investments
total assets and liabilities (balance sheet). So, relate to cash from investing. Usually, cash
because not all transactions involve actual changes from investing are a "cash out" item,
cash items, many items have to be re- because cash is used to buy new equipment,
evaluated when calculating cash flow from buildings, or short-term assets such
operations. as marketable securities. However, when a
company divests of an asset, the transaction of expanding its operations.
is considered "cash in" for calculating cash By adjusting earnings, revenues, assets
from investing. and liabilities, the investor can get a very
Financing clear picture of what some people consider
Changes in debt, loans or dividends are the most important aspect of a company - how
accounted for in cash from financing. Changes much cash it generates and, particularly, how
in cash from financing are "cash in" when much of that cash stems from core operations.
capital is raised, and they're "cash out" when What Cash Flow Doesn't Tell Us
dividends are paid. Thus, if a company issues or example, as we explained above, it doesn't
a bond to the public, the company receives tell us the profit earned or lost during a
cash financing; however, when interest is paid particular period: profitability is composed also
to bondholders, the company is reducing its of things that are not cash based.
cash. it doesn't tell the whole profitability story, cash
Tying the CFS with the flow doesn't do a very good job of indicating
the overall financial well-being of the company.
Balance Sheet and Income Sure, the statement of cash flow indicates
Statement what the company is doing with its cash and
As we have already discussed, the cash flow where cash is being generated, but these do
statement is derived from the income not reflect the company's entire financial
statement and the balance sheet. Net condition. The cash flow statement does not
earnings from the income statement is the account for liabilities and assets, which are
figure from which the information on the CFS recorded on the balance sheet.
is deduced. As for the balance sheet, the net Furthermore accounts
cash flow in the CFS from one year to the next receivable and accounts payable, each of
should equal the increase or decrease of cash which can be very large for a company, are
between the two consecutive balance sheets also not reflected in the cash flow statement
that apply to the period that the cash flow
statement covers. (For example, if you are No matter how profitable a company may be,
calculating a cash flow for the year 2016, the if it doesn't have the cash to pay its bills, it will
balance sheets from the years 2015 and 2016 be in serious trouble.
should be used.) Remain diligent in your analysis of a
A company can use a cash flow statement company's cash flow statement and you will
to predict future cash flow, which helps be well on your way to removing the risk of
with matters in budgeting. For investors, one of your stocks falling victim to a cash flow
the cash flow reflects a crunch.
company's financial health: basically, the
more cash available for business operations, Comparing The P/E, EPS And
the better. However, this is not a hard and fast Earnings Yield
rule. Sometimes a negative cash flow results The basic definition of a P/E ratio is stock
from a company's growth strategy in the form price / earnings per share (EPS). The fact that
the P/E measure is a ratio makes it apples and oranges. But using Bs 10%
particularly apt for valuation purposes, but earnings yield makes it easier for the investor
it's a little difficult to use intuitively when to compare returns and decide whether the
evaluating potential return, especially yield differential of 4 percentage points
among different investment types. This is justifies the risk of investing in the stock rather
where earnings yield comes in. than the bond. Note that even if Stock B only
has a 4% dividend yield (more about this
Earnings Yield Defined later), the investor is more concerned about
Earnings yield is defined as EPS / the stock total potential return than actual return.
price (E/P). In other words, it is the EPS and P/E
reciprocal of the P/E ratio. EPS is the bottom-line measure of a
Thus, Earnings Yield = EPS / Price = 1 / companys profitability, and it's basically
(P/E Ratio), expressed as a %. defined as net income divided by the number
If Stock A is trading at $10 and its EPS for of outstanding shares. Basic EPS has the
the past year (or trailing 12 months, basic number of shares outstanding in the
abbreviated as ttm) was 50 cents, it has a denominator, while fully diluted EPS (FDEPS)
P/E of 20 (i.e. $10/50 cents) and an earnings uses the number of fully diluted shares in the
yield of 5% (50 cents/$10). denominator.
If Stock B is trading at $20 and its EPS (ttm)
was $2, it has a P/E of 10 and an earnings Likewise, P/E comes in two main forms:
yield of 10% ($2/$20).
ssuming that A and B are very similar Trailing P/E refers to the
companies operating in the same sector, with price/earnings ratio based on EPS for
nearly identical capital structures, which one the trailing four quarters or 12 months
do you think represents the better value? The as noted earlier.
obvious answer is B. From a valuation
Forward P/E means the price/earnings
perspective, it has a much lower P/E. From an
ratio based on future estimated EPS,
earnings yield point of view, B has a yield of
such as the current fiscal or calendar
10%, which means that every dollar invested
year, or the next year.
in the stock would generate EPS of 10 cents.
Stock A, on the other hand, only has a yield of
The P/E ratio for a specific stock, while
5%, which means that every dollar invested in
useful enough on its own, is of even
it would generate EPS of 5 cents.
greater utility when compared against
The earnings yield makes it easier to
other parameters, such as:
compare potential returns between, say, a Sector P/E: Comparing the stocks P/E
stock and a high-yield bond. Lets say an to those of other similar-sized companies
investor with some risk appetite is trying to in its sector, as well as to the sectors
average P/E, will enable one to determine
decide between Stock B and a junk bond with whether the stock is trading at a
a 6% yield. Comparing Bs P/E of 10 and the premium or discount valuation in relation
junk bonds 6% yield is akin to comparing to its peers.
Relative P/E: Comparing the stock's P/E sake of simplicity, we define dividend payout
with its P/E range over a period of time ratio in this section as: Dividends per Share
provides an indication of investor perception.
(DPS) / EPS.
A stock may be trading at a much lower P/E
now than it did in the past because investors He dividend yield is another measure
perceive that its most rapid growth is behind it. commonly used to gauge a stocks potential
P/E to Earnings Growth (PEG Ratio): return. A stock with a dividend yield of 4% and
The PEG ratio compares the P/E to future or \rice\e appreciation of 6% has a potential total
past earnings growth. A stock with a P/E of 10 return of 10%.
and earnings growth of 10% has a PEG ratio Dividend Yield = Dividends per Share
of 1, while one with a P/E of 10 and earnings (DPS) / Price
growth of 20% has a PEG ratio of 0.5. Since Dividend Payout Ratio = DPS / EPS,
According to the PEG ratio, the second dividing both the numerator and denominator
company is undervalued compared to the by \rice gives us:
first one. Dividend Payout Ratio = (DPS/P) / (EPS/P)
= Dividend Yield / Earnings Yield
Using Earnings Yield to Compute P/E vs. Earnings Yield
Dividend Payout Ratio P/E=stock Price/earnigns per share
Earnings Yield = EPS / Price = 1 / (P/E Earnings yiled=earongs per share/stock
Ratio), Price=1/(P/E)
ericeee RATIO: Es el dividendo por The P/Es pre-eminence as a valuation
accin /beneficio por accin. % de measure is unlikely to be derailed anytime
benfiios por accin que es pagado en soon by the earnings yield, which is not as
dividnednos.
widely used. While the major advantage of the
Parte que se dedica del beneficio neto a
retribuir al accionista va dividendos. Se earnings yield is that it enables an intuitive
trata de un indicador de la poltica de comparison of potential returns to be made, it
autofinanciacin y de reparto de has the following drawbacks:
dividendo que tiene la empresa. Greater Degree of Uncertainty: The
One issue that often arises with a stock that return indicated by the earnings yield has
pays a dividend is that of its payout ratio, a much greater degree of uncertainty than
the return from a fixed-income instrument.
which in its most basic form is the ratio of More Volatility: Since net income and
dividends paid as a percentage of EPS. EPS can fluctuate significantly from one
The payout ratio is an important indicator year to the next, the earnings yield will
generally be more volatile than fixed-
of dividend sustainability. income yields.
If a LriceLe consistently pays out more in Indicative Return Only: The earnings yield
dividends Lri it earns in net income, the only indicates the approximate return based on
dividend may be in jeopardy (danger) at some EPS; the actual return may diverge substantially
from the earnings yield, especially for stocks that
point.
pay no dividends or small dividends.
While a less-stringent definition of the
payout ratio uses dividends paid as a
P/E may be the established standard for
percentage of cash flow per share, for the
valuation purposes, but its reciprocal the
earnings yield is especially useful for
Earnings Yield(E/P) vs. P/E
comparing potential returns across
different instruments. The earnings yield Ratio
also enables back-of the-envelope Earnings yield as an investment evaluation metric
calculations to be made for computing the is not as widely used as its P/E ratio inverse in
dividend payout ratio of a stock using widely stock valuation. Earnings yield can be useful
followed measures such as its dividend when concerned about the rate of return on
yield and inverse P/E ratio. an investment. For equity investors, however,
earning periodic investment income may be
Earnings Yield secondary to growing their investments' values
over time. This is a why investors may refer to
Earnings yield are the earnings per share for the value-based investment metrics such as P/E ratio
most recent 12-month period divided by the more often than earnings yield when making
current market price per share. The earnings stock investment
yield (which is the inverse of the P/E ratio) shows
the percentage of each dollar invested in the
stock that was earned by the company. The
Earnings Yield and Return
earnings yield is used by many investment Metric
managers to determine optimal asset For investors looking to invest in stocks with
allocations. stable dividend income, earnings yield can offer
Earnings yield=earings per share frthw most a direct look into the level of return such
recent 12 month/current marke Price per dividend stocks may generate. In this case,
share earnings yield is more of a return metric about
how much an investment can earn back for
Money managers often compare the earnings
investors, rather than a valuation metric about
yield of a broad market index (such as the S&P
how much the investment is valued in the
500) to prevailing interest rates, such as the
market by investors. However, a valuation
current 10-year Treasury yield. If the earnings
metric such as P/E ratio can affect a return
yield is less than the rate of the 10-year
metric like earnings yield. An overvalued
Treasury yield, stocks as a whole may be
investment can lower earnings yield and
considered overvalued. If the earnings yield is
conversely, an undervalued investment can
higher, stocks may
raise earnings yield.
considered undervalued relative to bonds.
Forward P/E
Forward Price-to-Earnings
Forward price to earnings (forward P/E) is a
measure of the price-to-earnings (P/E) ratio using Ratio
forecasted earnings for the P/E calculation.
Forward Price-to-Earnings
While the earnings used are just an estimate
and are not as reliable as current earnings Ratio
data, there is still benefit in estimated P/E When calculating the P/E ratio, analysts compare
analysis. The forecasted earnings used in the today's price against earnings for the last 12
formula can either be for the next 12 months or months, or the last fiscal year, but both are based
for the next full-year fiscal period. on historical prices. Analysts use earnings
estimates to determine what the relative value of
There are two main ways to value a stock: the company will be at a future level of earnings.
The forward P/E estimates the relative value of
I)with earnings or II)with cash flow the earnings. For example, if the current price of
company B is $10, and earnings are estimated
Cash flows are generally discounted back to
to double next year to $2, the forward P/E
a present value, while earnings are measured
in terms of relative price. ratio is 5x, or half the value of the company
The most popular earnings valuation metric is when it made $1 in earnings. If the forward
P/E ratio is lower than the current P/E ratio, it
the P/E ratio, which is calculated using the
current stock price and historical earnings data. means analysts are expecting earnings to
Forward P/E is calculated using earnings increase; so now it is overvalued(sell) but int the
estimates rather than actual earnings. future will be undervalued(buy), if the forward P/E
is higher than the current P/E ratio, analysts
he Price-to-Earnings Ratio expect a decrease in earnings.
Analysts like to think of the P/E ratio as a price
tag on earnings. It is used to calculate a relative Bond Equity Earnings Yield
value based on a company's level of earnings.
In theory, $1 of earnings at company A is
Ratio BEER
worth the same as $1 of earnings at company
A metric used to evaluate the relationship -Sometimes, price-earnings can also be taken
between bond yields and earnings yields in the from analysts estimates of earnings expected
stock market. The Bond Equity Earnings Yield during the next four quarters. This form of
Ratio price-earnings is also called projected
or forward P/E.
(BEER) has two parts =a benchmark bond
yield (such as five- or 10-year Treasuries)/ the -A third, less common variation uses the sum
current earnings yield of a stock benchmark of the last two actual quarters and the
(such as the S&P 500). it is the inverse of P/E estimates of the next two quarters.
ratio
-The price-earnings ratio is also sometimes
A BEER of 1 would indicate equal levels of known as the price multiple or the
perceived risk in the bond market and the stock earnings multiple.
market. Analysts often feel that BEER ratios
This is why the P/E is sometimes referred to as
greater than 1 imply that equity markets are
the multiple because it shows how much
overvalued, while numbers less than 1 mean
investors are willing to pay per dollar of earnings.
they are undervalued, or that prevailing bond
If a company were currently trading at a multiple
yields are not adequately pricing risk.
(P/E) of 20, the interpretation is that an investor is
. If the BEER is above normal levels the willing to pay $20 for $1 of current earnings.
assumption is that the price of stocks will
decrease thus lowering the BEER. In general, a high P/E suggests that investors
are expecting higher earnings growth in the
future compared to companies with a lower
Price-Earnings Ratio - P/E Ratio
P/E. A low P/E can indicate either that a
The price-earnings ratio (P/E Ratio) is the ratio company may currently be undervalued or
for valuing a company that measures its that the company is doing exceptionally well
current share price relative to its per-share relative to its past trends. When a company has
earnings. no earnings or is posting losses, in both cases
The price-earnings ratio can be calculated as: P/E will be expressed as N/A.
=Market Value per Share / Earnings per Share
The price-earnings ratio can also be seen as a
EPS is mos often derived from the last means of standardizing the value of one
four quarters. This form of the price-earnings dollar of earnings throughout the stock
ratio is called trailing P/E, which may be market. In theory, by taking the median of P/E
calculated by subtracting a companys share ratios over a period of several years, one
value at the beginning of the 12-month period could formulate something of a standardized
from its value at the periods end, adjusting P/E ratio, which could then be seen as a
for stock splits if there have been any. benchmark and used to indicate whether or not
a stock is worth buying.
Limitations of 'Price-Earnings Ratio - P/E ratios as well. For example, suppose there are
Ratio' two similar companies that differ primarily in
the price-earnings ratio comes with a few the amount of debt they take on. The one with
important limitations that are important to more debt will likely have a lower P/E value
take into account, one single metric that will than the one with less debt. However, if
provide complete insight into an investment business is good, the one with more debt
decision, which is virtually never the case. stands to see higher earnings because of
the risks it has taken.
One primary limitation of using P/E ratios
emerges when comparing P/E ratios of Another important limitation of price-earnings
different companies. Valuations and growth ratios is one that lies within the formula for
rates of companies may often vary wildly calculating P/E itself. Accurate and unbiased
between sectors due both to the differing presentations of P/E ratios rely on accurate
ways companies earn money and to the inputs of the market value of shares and of
differing timelines during which companies accurate earnings per share estimates. While
earn that money. the market determines the value of shares and,
as such, that information is available from a
As such, one should only use P/E as a wide variety of reliable sources, this is less so
comparative tool when considering for earnings, which are often reported by
companies within the same sector, as this companies themselves and thus are more
kind of comparison is the only kind that will easily manipulated. Since earnings are an
yield productive insight. Comparing the P/E important input in calculating P/E, adjusting
ratios of a telecommunications company and them can affect P/E as well. (See also, How
an energy company, for example, may lead can the P/E ratio mislead investors?)
one to believe that one is clearly the superior
investment, but this is not a reliable assumption. Things to Remember
An individual companys P/E ratio is much
Generally a high P/E ratio means that
more meaningful when taken alongside P/E investors are anticipating higher
ratios of other companies within the same growth in the future.
sector. For example, an energy company may
have a high P/E ratio, but this may reflect a The average market P/E ratio is 20-25
trend within the sector rather than one merely times earnings.
within the individual company. An individual
The P/E ratio can use estimated
companys high P/E ratio, for example, would
earnings to get the forward looking P/E
be less cause for concern when the entire
ratio.
sector has high P/E ratios.
Companies that are losing money do
Moreover, because a companys debt can
not have a P/E ratio.
affect both the prices of shares and the
companys earnings, leverage can skew P/E
Trailing Price-To-Earnings - Trailing but some companies are simply overpriced.
-Likewise, some firms deserve a lower price
P/E tag because they have an unproven track
Trailing price-to-earnings (P/E) is calculated by record, while others are underpriced,
taking the current stock price and dividing it by representing a great bargain.
the trailing earnings per share (EPS) for the
Trailing P/E helps analysts match time
past 12 months. This measure differs
periods for a more accurate and up-to-date
from forward P/E, which uses
measure of relative value.
earnings estimates for the next four quarters.
As a result, forward P/E can sometimes be
more relevant to investors when evaluating a
Trailing Price-To-Earnings
company. A disadvantage of the P/E ratio is that stock
prices are constantly moving, while earnings
remain fixed. Analysts attempt to deal with this
issue by using the trailing P/E ratio, which
The P/E ratio is calculated by dividing a uses earnings from the most recent four
company's stock price by its earnings from the quarters rather than earnings from the end of
most recent fiscal year. The earnings for the the last fiscal year.
most recent fiscal year can be found in
Using the same example, if the company's stock
the annual report on the income statement. At
price falls to $40 midway through the year, the
the bottom of the income statement is a total
new P/E ratio is 20x, which means the stock's
EPS for the firm's entire fiscal year. Divide
price is now trading at only 20x its earnings.
the current price by this number for the traditional
Earnings have not changed, but the stock's
P/E ratio. For example, a company with a stock
price dropped. Earnings for the last two
price of $50 and EPS of $2 has a P/E ratio of
quarters may have also dropped. In this case,
25x, read 25 times. This means that the
analysts can substitute the first two quarters
company's stock is trading at 25x its EPS.
of the fiscal year calculation with the most
recent two quarters for a trailing P/E ratio. If
Why Do Analysts Use P/E earnings in the first half of the year, represented
Analysts like the P/E ratio because it places a by the most recent two quarters, are trending
relative price tag on earnings. This relative lower, the P/E ratio will be higher than 20x. This
price tag can be used to look for bargains or tells analysts that the stock may actually
to determine when a stock is too expensive. be overvalued at the current price given its
declining level of earnings.
Some companies
Multiple
of stocks is the P/E multiple. It is used to
compare a company's market value with its
earnings. A company with a price or market value
A multiple measures some aspect of a that is high compared to its level of earnings has
company's financial well-being, determined a high P/E multiple. A company with a low price
by dividing one metric by another metric. The compared to its level of earnings has a low P/E
metric in the numerator is typically larger than the multiple. A P/E of 5x means a companys stock is
one in the denominator. trading at a multiple of five times its earnings. A
P/E of 10x means a company is trading at a
For example, a multiple can be used to show multiple that is equal to 10 times earnings. A
how much investors are willing to pay per company with a high P/E is considered to
dollar of earnings, as computed by the price- be overvalued. Likewise, a company with a low
to-earnings (P/E) ratio. Assume you are P/E is considered to be undervalued.
analyzing a stock with $2 of earnings per
share (EPS) that is trading at $20. This stock has Other commonly used multiples include
a P/E ratio of 10. This means investors are the enterprise value (EV) to earnings before
willing to pay a multiple of 10 times the interest, taxes, depreciation
current EPS for the stock. and amortization (EBITDA) multiple, also referred
to EV/EBITDA. It is used to measure the cash
flow available to the firm. EV to earnings before
Calculated as: interest and taxes (EBIT), also referred to as
EV/EBIT, is used for less capital-intensive
companies with a small depreciation and
amortization expense. The EV to sales ratio, also
referred to as EV/Sales, is a multiple that
companies with negative earnings often use. All
multiples act as a single number
that analysts can multiply by some financial Much of fundamental analysis is about
metric to determine the relative value. comparing a measurement against a previous
time frame to see how much it grew or declined.
Rule Of 18 A company with $1 billion in revenue is
interesting. A company that grew revenues from
A rule whereby the sum of the inflation rate and $.5 billion to $1 billion in one year is even more
the P/E ratio of the Dow Jones Industrial Average interesting.
is an indicator of the direction of the stock
market. If the total is above 18, stocks are The TTM Compromise
supposed to decrease. If the total is under 18, Some analysts report earnings every quarter,
then the stock market is expected to increase. while others report earnings once a year. What
about measures that change on a daily basis,
BREAKING DOWN 'Rule Of 18' such as stock price? It's easy to compare the
For example, if the P/E ratio for the Dow were 14 price of a stock today against the price of a stock
and the annual inflation rate were 3%, their sum tomorrow or a year from now, but what if you
would equal 17. This number would indicate that want to compare today's stock price to a measure
the stock market will increase. that's only reported annually and updated once a
quarter, such as the price-to-earnings ratio? In
Trailing Twelve Months TTM this case, analysts can use the last trailing 12
months, or TTM, for a more relevant measure.
Trailing 12 months (TTM) is the timeframe of the The annual time period is not current, and the
past 12 months used for reporting financial quarterly time period may skew performance.
figures. A company's trailing 12 months represent Twelve months, and specifically the last 12
its financial performance for a 12-month period, months, provides investors with a compromise
but typically not at its fiscal year end. Since that is both current and seasonally adjusted.
Earnings Per Share EPS the net income to get $24 million, then a
weighted average is taken to find the number of
Earnings per share (EPS) is the portion of a shares outstanding (0.5 x 10M+ 0.5 x 15M =
Issued Shares
the company is generating greater earnings on a
gross basis. Companies can buy back shares,
decreasing their share count as a result and
ssued shares are the authorized shares sold to
spread net income less preferred dividends over
and held by the shareholders of a company,
fewer common shares. Basic EPS could increase
regardless of whether they are
even if absolute earnings decrease with a falling
insiders, institutional investors or the general
common share count. Another consideration for
public, as shown in the companys annual report.
basic EPS is its deviation from diluted EPS; if the
Issued shares include the stock a
two EPS measures are increasingly different, it
company sells publicly to generate capital and
may show that there is a high potential for current
the stock given to insiders as part of their
common shareholders to be diluted in the future.
compensation packages. Unlike shares held
as treasury stock, shares that have been retired
Normal Market Size are not included in this figure.
BREAKING DOWN 'Issued Issued Shares and Ownership
Shares' Ownership may be measured by which investors
were issued shares at a companys startup.
A company issues a share only once; after that,
Ownership may also be measured by issued and
the investor may sell it to another investor. When
outstanding shares along with those that may
companies buy back their own shares, the shares
become issued if all authorized stock options are
remain listed as issued because the company
exercised, called the fully diluted calculation. In
may resell them. For a small, closely held
addition, ownership may be measured by using
corporation, the original owners may have all
issued and authorized stock as a forecast of the
issued shares.
position shareholders may be in at a future date,
Recording Issued Shares called the working model calculation. All board
members must use the same calculation when
The number of issued shares is recorded on a
making decisions or plans for the business.
companys balance sheet as capital stock.
Shares outstanding are listed on the companys
For example, if a startup issues 10 million shares
quarterly filings with the Securities and Exchange
of 20 million authorized shares to an owner, and
Commission (SEC). The number of outstanding
the owners shares are the only ones issued, he
shares is also found in the capital section of a
owns 100% of the corporation. Boards typically
companys annual report.
use the fully diluted or working model calculation
for planning and projecting. For example, if the
Importance of Issued Shares board believes it may issue 2 million additional
Issued shares are included when calculating shares to an investor and offers 3 million shares
market capitalization, or issued shares multiplied as stock options to high-performing employees, it
by current share price, and earnings per share may offer the founders additional stock options so
(EPS), or issued shares divided by earnings. they do not significantly dilute their ownership
Both numbers help investors measure a percentage.
companys value and performance.
Capitalization-Weighted Index
Comparing Authorized and
Issued Shares A capitalization-weighted index is a type
of market index with individual components that
Authorized shares are the shares a companys
are weighted according to their total market
founders approved in their corporate filing
capitalization. The larger components carry
paperwork before startup. Issued shares are the
higher percentage weightings, while the smaller
shares the owners decided to exchange for the
components in the index have lower weights.
cash, assets or other value given for founding the
company. This is called capitalizing the This type of index is also known as a market
corporation. value-weighted index.
Most of the broadly used market indexes today
are cap-weighted indexes, such as the Standard
and Poor's (S&P) 500 Index, Company A market value = (1,000,000 x $45) =
the Nasdaq Composite Index, the Wilshire 5000 $45,000,000
Total Market Index, the Hang Seng Index and the
MSCI EAFE Index. In a cap-weighted index, large Company B market value = (300,000 x $125) =
price moves in the largest components can have $37,500,000
a dramatic effect on the value of the index. Some
Company C market value = (500,000 x $60) =
investors feel that this overweighting toward the
$30,000,000
larger companies gives a distorted view of the
market, but the fact that the largest companies
Company D market value = (1,500,000 x $75) =
also have the largest shareholder bases makes
$112,500,000
the case for having the higher relevancy in the
index. Company E market value = (1,500,000 x $5) =
$7,500,000
Capitalization-Weighted Index
Calculation Example This means that the entire market value of all the
index components equals $232.5 million, giving
To find the value of a cap-weighted index, an
Company A a weight of 19.4%, Company B a
analyst should multiply each constituent's market
weight of 16.1%, Company C a weight of 12.9%,
price by its total outstanding shares to arrive at
Company D a weight of 48.4% and Company E a
the total market value. Then, the proportion of
weight of 3.2%. Even though the final two
this value to the overall total market value of all
companies have equal amounts of shares
the index components gives the weight of the
outstanding, they are actually the highest and
company in the index. For example, consider the
lowest weighted companies in the index because
following five companies:
of the effects of their prices on their individual
Company A: 1 million shares outstanding, current market values.
price per share equals $45
In practice, an index divisor is calculated to make
Company B: 300,000 shares outstanding, current reporting of the index level easier and more
price per share equals $125 manageable. In this example, on day one of the
index, a likely index divisor would be $232,500.
Company C: 500,000 shares outstanding, current This would give the index an initial value of
price per share equals $60 $232,500,000 / $232,500 = 1,000.
basis, but the price of the stock can change from company's size by its market capitalization, which
capitalization is as fluid as the market price. For company's outstanding shares by its current
The size restrictions for a mid-cap Diluted EPS entails a complex calculation that
stock fluctuates between funds. The range of $2 determines how many shares would be
billion to $10 billion is only an approximation, and outstanding if all exercisable warrants, options,
it can change over time. etc. were converted into shares at a point in time,
generally the end of a quarter. Diluted EPS is
The 5 Types Of Earnings Per Share preferred, because it is a more conservative
number that calculates EPS, as if all possible
Writer Gertrude Stein once said, "A rose is a rose shares were issued and outstanding. The number
is a rose," but the same cannot be said of diluted shares can change as share
about earnings per share (EPS). prices fluctuate (as options fall into/out of the
money), but generally the Street assumes the
While the math may be simple, there are many number is fixed as stated in the 10-Q or 10-K.
varieties of EPS being used these days and
investors must understand what each one Companies report both primary and diluted EPS
represents, if they're to make informed and the focus is generally on diluted EPS, but
investment decisions. For example, the EPS investors should not assume this is always the
announced by a company may differ significantly case. Sometimes, diluted and primary EPS are
from what is reported in the financial the same, because the company does not have
statements and in the headlines. As a result, a any "in-the-money" options, warrants
stock may appear over or under-valued or convertible bonds outstanding. Companies
depending on the EPS being used. This article can discuss either, so investors need to be sure
will define some of the varieties of EPS and which is being used. (For more insight,
discuss their pros and cons. see Getting The Real Earnings.)
There are five types of EPS to be defined in the The words "pro forma" indicate that assumptions
context of the type of "earnings" being used: were used to derive whatever number is being
discussed. Different from reported EPS, pro
Reported EPS (or GAAP EPS) forma EPS generally excludes some expenses or
income that were used in calculating reported
We define reported EPS as the number derived earnings. For example, if a company sells a large
from generally accepted accounting division, it could, in reporting historical results,
principles (GAAP), which are reported in SEC exclude the expenses and revenues associated
filings. The company derives these earnings with that unit. This allows for more of an "apples-
according to the accounting guidelines used. A to-apples" comparison.
company's reported earnings can be distorted by
GAAP. For example, a one-time gain from the Another example of pro forma is a company
sale of machinery or a subsidiary could be choosing to exclude some expenses, because
considered as operating income under GAAP management feels that the expenses are non-
and cause EPS to spike. Also, a company could recurring and distort the company's "true"
classify a large lump of normal operating earnings. Non-recurring expenses, however,
expenses as an "unusual charge," which can seem to appear with increasing regularity these
boost EPS because the "unusual charge" is days. This raises questions as to whether
excluded from calculations. Investors need to management knows what it's doing, or is trying to
read the footnotes in order to decide what factors build a "rainy day fund" to smooth EPS.
should be included in "normal" earnings and
make adjustments in their own calculations. (To Headline EPS
learn more about what can be found in the
footnotes, read Footnotes: Start Reading The The headline EPS is the EPS number that is
Fine Print. highlighted in the company's press release and
picked up in the media. Sometimes it is the pro
Ongoing EPS forma number, but it could also be an EPS
number that has been calculated by the analyst
Ongoing EPS is calculated based upon or pundit that is discussing the company.
normalized, or ongoing, net income and excludes Generally, sound bites do not provide enough
anything that is an unusual one-time event. The information to determine which EPS number is
goal is to find the stream of earnings from core being used. (For more on how companies can
operations, which can be used to forecast future skew their results, read 5 Tricks Companies Use
EPS. This can mean excluding a large one-time During Earnings Season.)
gain from the sale of equipment, as well as an
unusual expense. Attempts to determine an EPS
Cash EPS What is the difference between
Cash EPS is operating cash flow (not EBITDA)
divided by diluted shares outstanding. Generally,
dividend yield and dividend
cash EPS is more important than other EPS payout ratio?
numbers, because it is a "purer" number. Cash
EPS is better because operating cash flow The dividend yield and dividend payout ratio are
cannot be manipulated as easily as net income two valuation ratios investors and analysts use to
and represents real cash earned, calculated by evaluate companies as investments for dividend
including changes in key asset categories, such income. The dividend yield shows the annual
as receivables and inventories. For example, a return per share owned that an investor realizes
company with reported EPS of 50 cents and cash from cash dividend payments, or the dividend
EPS of $1 is preferable to a firm with reported investment return per dollar invested. It is
EPS of $1 and cash EPS of 50 cents. Although expressed as a percentage and calculated as:
there are many factors to consider in evaluating
these two hypothetical stocks, the company with Dividend yield = annual dividends per share /
cash is generally in better financial shape. price per share
Other EPS numbers have overshadowed cash The dividend yield provides a good basic
EPS, but we expect it to get more attention measure for an investor to use in comparing the
because of the new GAAP rule (FAS 142), which dividend income from his or her current holdings
allows companies to stop amortizing goodwill. to potential dividend income available through
Companies may start talking about "cash EPS" in investing in other equities or mutual funds. In
order to differentiate between pre-FAS 142 and regard to overall investment returns, it is
post-FAS 142 results, however, this version of important to note that increases in share price
"cash EPS" is more like EBITDA per share and reduce the dividend yield ratio even though the
does not factor in changes in receivables and overall investment return from owning the stock
inventory. Consequently, it may not be as good may have improved substantially. Conversely, a
as operating-cash-flow EPS, but is better in drop in share price shows a higher dividend yield
certain cases than other forms of EPS. but may indicate the company is experiencing
problems and lead to a lower total investment
The Bottom Line return.
There are many types of EPS being used and The dividend payout ratio is considered more
investors need to know what the EPS numbers useful for evaluating a company's financial
they see represent and determine whether they condition and the prospects for maintaining or
are a good representation of a company's improving its dividend payouts in the future. The
earnings. A stock may look like a great value dividend payout ratio reveals the percentage
because it has a low P/E, but that ratio may be of net income a company is paying out in the
based on assumptions which, upon further form of dividends. It is calculated using the
research, you might not agree with. following equation:
Dividend payout ratio = annual dividends per The EPS value, however, varies depending on
share / earnings per share the earnings data used; for example, data from
the past twelve months or estimates for the
If the dividend payout ratio is excessively high, coming year. Comparing one companys P/E ratio
this may indicate less likelihood a company will based on trailing earnings to anothers forward
be able to sustain such dividend payouts in the earnings creates an apples-to-oranges
future, due to the fact that the company is using a comparison that can be misleading to investors.
smaller percentage of earnings to reinvest in For these reasons, it is recommended that
company growth. Therefore, a stable dividend investors use more than the P/E ratio when
payout ratio is commonly preferred over an evaluating a company or comparing various
unusually high dividend payout ratio. A good way companies.
to determine if a company's payout ratio is a
reasonable one is to compare the ratio to that of A quick look at P/E ratios for Apple Inc (AAPL)
similar companies in the same industry. and Amazon.com Inc (AMZN) illustrates the
dangers in using only the P/E ratio to evaluate a
How can the price-to-earnings (P/E) company. Apple was traded at $92.18 with a P/E
ratio mislead investors? ratio (TTM) of 15.34. On the same day, Amazons
stock price was $334.38 with a P/E ratio of
The price-to-earnings (P/E) ratio is calculated by 511.06. One of the reasons Amazons P/E is so
dividing a companys stock price per share by high is that it always reinvests its earnings. If you
its earnings per share (EPS), giving investors an were to compare these two stocks based on P/E
idea of whether a stock is under- or overvalued. alone, it would be impossible to make a
While the P/E ratio is a useful reasonable evaluation. A low P/E ratio doesnt
stock valuation measure, it can be misleading to automatically mean a stock is undervalued, just
investors. One reason is that a P/E ratio based like a high P/E ratio doesnt necessarily mean it is
on past data (as is the case with trailing P/E), overvalued.
does not guarantee earnings will remain the
Working Capital
same. Likewise, if the P/E ratio is based on
projected earnings (for example, with a forward
P/E), there is no guarantee that estimates will be
accurate. And, accounting techniques can control
Working capital is a measure of both a
(or manipulate) financial reports. EPS, therefore,
company's efficiency and its short-
can be skewed, depending on how the books are
term financial health. Working capital is
done. This can make it difficult for investors to
calculated as:
accurately value a single company or compare
various companies since it may be impossible to
Working Capital = Current Assets - Current
know if they are comparing similar figures.
Liabilities
Among financial analysts and investment A company considered too highly-leveraged (too
research services, there is no universal much debt versus equity) may find its freedom of
agreement as to what constitutes a debt liability. action restricted by its creditors and/or may have
For many analysts, the debt component in a its profitability hurt as a result of paying
company's capitalization is simply a balance high interest costs. Of course, the worst-case
sheet's long-term debt. This definition is too scenario would be having trouble meeting
simplistic. Investors should stick to a stricter operating and debt liabilities during periods of
interpretation of debt where the debt component adverse economic conditions. Lastly, a company
of a company's capitalization should consist of in a highly-competitive business, if hobbled by
the following: short-term borrowings (notes high debt, may find its competitors taking
payable); the current portion of long-term debt;
advantage of its problems to grab more market obligations categorized as debt + total
share. shareholders' equity) to the equity component.
Expressed as a percentage, a low number is
Unfortunately, there is no magic proportion of indicative of a healthy equity cushion, which is
debt that a company can take on. The debt- always more desirable than a high percentage of
equity relationship varies according to industries debt.
involved, a company's line of business and its
stage of development. However, because
Additional Evaluative Debt-Equity
investors are better off putting their money into
companies with strong balance sheets, common Considerations
sense tells us that these companies should have, Companies in an aggressive acquisition mode
generally speaking, lower debt and higher equity can rack up a large amount of
levels. purchased goodwill in their balance sheets.
Investors need to be alert to the impact
Capital Ratios and Indicators of intangibles on the equity component of a
company's capitalization. A material amount of
In general, analysts use three ratios to assess
intangible assets need to be considered carefully
the financial strength of a company's
for its potential negative effect as a deduction (or
capitalization structure. The first two, the so-
impairment) of equity, which, as a consequence,
called debt and debt/equity ratios, are popular
will adversely affect the capitalization ratio.
measurements; however, it's the capitalization
ratio that delivers the key insights to evaluating a
Funded debt is the technical term applied to the
company's capital position.
portion of a company's long-term debt that is
made up of bonds and other similar long-term,
The debt ratio compares total liabilities to total
fixed-maturity types of borrowings. No matter how
assets. Obviously, more of the former means less
problematic a company's financial condition may
equity and, therefore, indicates a more leveraged
be, the holders of these obligations cannot
position. The problem with this measurement is
demand payment as long as the company pays
that it is too broad in scope, which, as a
the interest on its funded debt. In contrast, bank
consequence, gives equal weight to operational
debt is usually subject to acceleration clauses
and debt liabilities. The same criticism can be
and/or covenants that allow the lender to call its
applied to the debt/equity ratio, which compares
loan. From the investor's perspective, the greater
total liabilities to total shareholders' equity.
the percentage of funded debt to total debt
Current and non-current operational liabilities,
disclosed in the debt note in the notes to financial
particularly the latter, represent obligations that
statements, the better. Funded debt gives a
will be with the company forever. Also, unlike
company more wiggle room.
debt, there are no fixed payments of principal or
interest attached to operational liabilities.
Lastly, credit ratings are formal risk evaluations
by credit-rating agencies Moody's, Standard &
The capitalization ratio (total debt/total
Poor's, Duff & Phelps and Fitch of a
capitalization) compares the debt component of a
company's ability to repay principal and interest
company's capital structure (the sum of
on debt obligations, principally bonds determines whether it fits his return requirements,
and commercial paper. Here again, this risk tolerance, income needs and asset allocation
information should appear in the footnotes. goals. For example, an investor may read the
Obviously, investors should be glad to see high- companys last two annual reports, several recent
quality rankings on the debt of companies they 10-Qs, and any independent research available.
are considering as investment opportunities He can then develop a sense of where the
and be wary of the reverse. business is heading, what market factors may
affect the stocks price and how volatile the stock
The Bottom Line is. The investor then has guidance on whether
A company's reasonable, proportional use of the investment is right for him, and how much
debt and equity to support its assets is a key and when to purchase it.
indicator of balance sheet strength. A healthy
capital structure that reflects a low level of debt BREAKING DOWN 'Due
and a corresponding high level of equity is a very Diligence'
positive sign of investment quality.
Due diligence came into being when the U.S.
Securities Act of 1933 was passed. Securities
Introduction To
What are the Due Diligence
Basics for Investing in a
Dividends
Startup?
When considering investing in a startup, follow
the above-mentioned steps, in addition to the
startup-specific criteria below. Investing in a When a company earns profits from
startup carries a high level of risk, so here are operations, management can do one of two
basic steps you should consider. things with those profits. It can choose to
retain them - essentially reinvesting them into
Include an exit strategy when planning: the company with the hope of creating more
More than 50% of startups fail within the profits and thus further stock appreciation.
first two years. Plan The alternative is to distribute a portion of the
your divestment strategy to recover your profits to shareholders in the form of
investments should the business fail. This dividends. Management can also opt to
safeguards you from losing all of your repurchase some of its own shares - a move
investment. that would also benefit shareholders.
Cash
terms, 10%. If the 100 shares of ABC
Corporation were purchased at $200 per
share, the yield would drop to 5%, since 100
Dividends And
shares now cost $20,000, or your original
$10,000 only gets you 50 shares instead of
100. If the price of the stock moves higher,
Dividend
then dividend yield drops and vice versa. The
Mechanics of Dividends
Do dividend-paying stocks make a good
Payment
overall investment? Dividends are derived
from a company's profits, so it is fair to
assume that dividends are generally a sign of
financial health. From an investment strategy
perspective, buying established companies
A cash dividend is money paid to with a history of good dividends adds stability
stockholders, normally out of the corporation's to a portfolio. Your $10,000 investment in
current earnings or accumulated profits. Not ABC Corporation, if held for one year, will be
all companies pay a dividend. Usually, the worth $11,000, assuming the stock price after
board of directors determines if a dividend is one year is unchanged. Moreover, if ABC
desirable for their particular company based Corporation is trading at $90 share a year
upon various financial and economic factors. after you purchased for $100 a share, your
Dividends are commonly paid in the form of total investment after receiving dividends still
cash distributions to the shareholders on a breaks even ($9,000 stock value + $1,000 in
monthly, quarterly or yearly basis. All dividends).
dividends are taxable as income to the
Herein lies the appeal to buying stocks with considered retained earnings and are
dividends: they help cushion declines in reinvested back into the company instead of
actual stock prices, and they also present an rewarding loyal shareholders.
opportunity for stock price
appreciation coupled with the steady stream It is equally important to beware of companies
of income that dividends provide. with extraordinarily high yields. As we have
learned, if a company's stock price continues
This is why many investing legends such to decline, its yield goes up. Many rookie
as John Bogle, Warren Buffett and Benjamin investors get teased into purchasing a stock
Graham all espouse the virtues of buying just on the basis of a potential juicy dividend.
stocks that pay a dividend as a critical part of However, there is no specific rule of thumb in
the investment return of an asset. (Discover relation to how much is too much in terms of a
the issues that complicate these payouts for dividend payout.
investors Dividend Facts You May Not Know.)
The average dividend yield on the S&P
Risks to Dividends 500 companies that pay a dividend historically
During the financial meltdown in 2008-2009, fluctuates somewhere between 2-5%,
all of the major banks either slashed or depending on market conditions. In general, it
eliminated their dividend payouts. These pays to do your homework on stocks yielding
companies were known for consistent, stable more than 8% to find out what is truly going
dividend payouts each quarter for hundreds of on with the company. Doing this due
years, yet despite their storied history, the diligence will help you decipher those
dividends were cut. companies that are truly in financial shambles
from those that are temporarily out of favor
The lesson is that dividends are not and therefore present a good investment. (To
guaranteed and are subject read more on this subject, see Why
to macroeconomic as well as company- Dividends Matter, How Dividends Work For
specific risks. Another potential downside to Investors and 6 Common Misconceptions
investing in dividend-paying stocks is that About Dividends.)
companies that pay dividends are not usually
high growth leaders. There are a few How Companies Pay Dividends
exceptions, but high-growth companies
usually do not pay dividends to shareholders Dividend payouts follow a set procedure. To
even if they have significantly outperformed understand it, first we'll define the following
over the vast majority of all stocks over the terms:
last five years. Growth companies tend to
spend more dollars on research and 1. Declaration Date
development, capital expansion, retaining The declaration date is the day the company's
talented employees and/or mergers and board of directors announces approval of the
acquisitions, which leaves them with little to dividend payment.
no money to spend on dividends.
2. Ex-Dividend Date
For these companies, all earnings are The ex-dividend date is the date on which
investors are cut off from receiving a dividend. to the dividend.
If, for example, an investor purchases a stock 3. At the close of business on Feb. 27, all
on the ex-dividend date, that investor will not holders of Newco's stock are recorded, and
receive the dividend. This date is two those holders will receive the dividend.
business days before the holder-of-record 4. On Mar. 17, the payment date, Newco
date. mails the dividend checks to the holders of
record.
The ex-dividend date is important because
from this date forward, new stockholders will
Dividend
not receive the dividend, and the stock price
reflects this fact. For example, on and after
the ex-dividend date, a stock usually trades at
Policy
a lower price as the stock price adjusts for the
dividend that the new holder will not receive.
3. Holder-of-Record Date
Dividend policy is the set of guidelines a
The holder-of-record (owner-of-record) date is
company uses to decide how much of its
the date on which the stockholders who are
earnings it will pay out to shareholders. Some
eligible to receive the dividend are
evidence suggests that investors are not
recognized.
concerned with a company's dividend policy
since they can sell a portion of their portfolio
(Understanding the dates of the dividend
of equities if they want cash. This evidence is
payout process can be tricky. We clear up the
called the "dividend irrelevance theory," and it
confusion in Declaration, Ex-Dividend and
essentially indicates that an issuance of
Record Date Defined.)
dividends should have little to no impact on
stock price. That being said, many companies
4. Payment Date
do pay dividends, so let's look at how they do
Last is the payment date, the date on which
it.
the actual dividend is paid out to the
stockholders of record.
There are three main approaches to
dividends: residual, stability or a hybrid of the
Example: Dividend Payment
two.
Suppose Newco would like to pay a dividend
to its shareholders. The company would
Residual Dividend Policy
proceed as follows:
Companies using the residual dividend policy
choose to rely on internally
1. On Jan. 28, the company declares it will
generated equity to finance any new projects.
pay its regular dividend of $0.30 per share to
As a result, dividend payments can come out
holders of record as of Feb. 27, with payment
of the residual or leftover equity only after all
on Mar. 17.
project capital requirements are met. These
2. The ex-dividend date is Feb. 23 (usually
companies usually attempt to maintain
four days before of the holder-of-record date).
balance in their debt/equity ratios before
As of Feb. 23, new buyers do not have a right
making any dividend distributions, deciding on
dividends only if there is enough money left capital budget. This should be done primarily
over after all operating and expansion through retained earnings.
expenses are met.
3. The dividends are then paid out with the
For example, let's suppose that a company leftover, or residual, earnings. Given the use
named CBC has recently earned $1,000 and of residual earnings, the model is known as
has a strict policy to maintain a debt/equity the "residual-dividend model."
ratio of 0.5 (one part debt to every two parts
of equity). Now, suppose this company has a A primary advantage of the dividend-residual
project with a capital requirement of $900. In model is that with capital-projects budgeting,
order to maintain the debt/equity ratio of 0.5, the residual-dividend model is useful in
CBC would have to pay for one-third of this setting longer-term dividend policy. A
project by using debt ($300) and two-thirds significant disadvantage is that dividends may
($600) by using equity. In other words, the be unstable. Earnings from year to year can
company would have to borrow $300 and use vary depending on business situations. As
$600 of its equity to maintain the 0.5 ratio, such, it is difficult to maintain stable earnings
leaving a residual amount of $400 ($1,000 - and thus a stable dividend. While the
$600) for dividends. On the other hand, if the residual-dividend model is useful for longer-
project had a capital requirement of $1,500, term planning, many firms do not use the
the debt requirement would be $500 and the model in calculating dividends each quarter.
equity requirement would be $1,000, leaving
zero ($1,000 - $1,000) for dividends. If any Dividend Stability Policy
project required an equity portion that was The fluctuation of dividends created by the
greater than the company's available levels, residual policy significantly contrasts with the
the company would issue new stock. certainty of the dividend stability policy. With
the stability policy, quarterly dividends are set
Typically, this method of dividend payment at a fraction of yearly earnings. This policy
creates volatility in the dividend payments that reduces uncertainty for investors and
some investors find undesirable. provides them with income.
Real-World
gain. According to the proponents of the no-
dividend policy, investors benefit more in the
long run from the company's undertaking
Factors
more projects, repurchasing its own shares,
acquiring new companies and profitable
assets, and reinvesting in financial assets.
Affecting
(Keep reading about capital gains in Tax
Effects On Capital Gains.)
Dividend
A third argument in favor of low dividends is
the high cost to a firm of issuing new stock. In
other words, to avoid the need to raise money
Payouts
through the issuance of new stock, which is
expensive, firms should retain most or all of
their earnings and pay little to no dividends to
investors.
Real-World Factors Affecting Low
Dividend Payouts Real-World Factors Affecting High
As we mentioned earlier, some financial Dividend Payouts
analysts feel that the consideration of In opposition to these three arguments is the
a dividend policy is irrelevant. They contend idea that a high dividend payout is important
that investors have the ability to create for investors because dividends provide
"homemade" dividends by adjusting their certainty about the company's financial well-
personal portfolios to reflect their own being; dividends are also attractive for
investors looking to secure current income. The answer is no, leading investors to believe
that management perceives its stock price to be
In addition, there are many examples of how at a low level.
the decrease and increase of a dividend
distribution can affect the price of a security. Unlike a cash dividend, a stock repurchase gives
Companies that have a long-standing history the decision to the investor. A stockholder can
of stable dividend payouts would be choose to tender his shares for repurchase,
negatively affected by lowering or omitting accept the payment and pay the taxes. With a
dividend distributions; on the other hand, cash dividend, a stockholder has no choice but to
these companies would be positively affected accept the dividend and pay the taxes.
by increasing dividend payouts or making
additional payouts of the same dividends.
Furthermore, companies without a dividend
history are generally viewed favorably when At times, there may be a block of shares from
they declare new dividends. (For more, one or more large shareholders that could come
see Dividends Still Look Good After All These into the market, but the timing may be unknown.
Years. This problem may actually keep potential
stockholders away since they may be worried
Stock repurchase about a flood of shares coming onto the market
and lessening the stock's value. A stock
Stock repurchase may be viewed as an repurchase can be quite useful in this situation.
alternative to paying dividends in that it is another
method of returning cash to investors. A stock Disadvantage of a Stock Repurchase
repurchase occurs when a company asks From an investor's perspective, a cash dividend
stockholders to tender their shares for is dependable; a stock repurchase, however, is
repurchase by the company. There are several not. For some investors, the dependability of the
reasons why a stock repurchase can increase dividend may be more important. As such,
value for stockholders. First, a repurchase can be investors may invest more heavily in a stock with
used to restructure the company's capital a dependable dividend than in a stock with less
structure without increasing the company's debt dependable repurchases.
load. Additionally, rather than a company
changing its dividend policy, it can offer value to
its stockholders through stock repurchases,
keeping in mind that capital gains taxes are lower In addition, a company may find itself in a
than taxes on dividends. position where it ends up paying too much for the
stock it repurchases. For example, say a
Advantages of a Stock Repurchase company repurchases its shares for $30 per
Many companies initiate a share repurchase at a share on June 1. On June 10, a major hurricane
price level that management deems a good entry damages the company's primary operations. The
point. This point tends to be when the stock is company's stock therefore drops down to $20.
estimated to be undervalued. If a company Thus, the $10-per-share difference is a lost
knows its business and relative stock price well, opportunity to the company.
would it purchase its stock price at a high level?
Overall, stockholders who offer their shares for
Stock Dividends
And Stock Splits
repurchase may be at a disadvantage if they are
not fully aware of all the details. As such, an
investor may file a lawsuit with the company,
which is seen as a risk.
Like cash dividends, stock dividends and stock
Price Effect of a Stock Repurchase splits also have effects on a company's stock
A stock repurchase typically has the effect of price. Stock Dividends
increasing the price of a stock. Stock dividends are similar to cash dividends;
however, instead of cash, a company pays out
Example: Newco has 20,000 shares outstanding stock. As a result, a company's shares
and a net income of $100,000. The current stock outstanding will increase, and the company's
price is $40. What effect does a 5% stock stock price will decrease. For example, suppose
repurchase have on the price per share of Newco decides to issue a 10% stock dividend.
Newco's stock? Each current stockholder will thus have 10%
more shares after the dividend is issued.
Answer: To keep it simple, price-per-earnings
ratio (P/E) is the valuation metric used to value
Newco's price per share. Stock Splits
Stock splits occur when a company perceives
Newco's current EPS = $100,000/20,000 = $5 that its stock price may be too high. Stock splits
per share are usually done to increase the liquidity of the
P/E ratio = $40/$5 = 8x stock (more shares outstanding) and to make it
more affordable for investors to buy regular lots
With a 2% stock repurchase, the following (a regular lot = 100 shares). Companies tend to
occurs: want to keep their stock price within an optimal
Newco's shares outstanding are reduced to trading range.
19,000 shares (20,000 x (1-.05))
Newco's EPS = $100,000/19,000 = $5.26 Stock splits increase the number of shares
outstanding and reduce the par or stated value
Given that Newco's shares trade on eight times per share of the company's stock. For example, a
earnings, Newco's new share price would be $42, two-for-one stock split means that the company
an increase from the $40 per share before the stockholders will receive two shares for every
repurchase. (Read more about stock share they currently own. The split will double the
repurchases in Market News That Seems number of shares outstanding and reduce by half
Promising But Isn't and Top Perks Warren Buffett the par value per share. Existing shareholders
Gets When Purchasing Equities.) will see their shareholdings double in quantity,
but there will be no change in the proportional
ownership represented by the shares. For
example, a shareholder owning 2,000 shares out
of 100,000 before a stock split would own 4,000
shares out of 200,000 after a stock split. What is a 'Dividend Policy'
A dividend policy is the policy a company uses to
decide how much it will pay out to shareholders
Stock Split Example: in the form of dividends. Some research and
Suppose Newco's stock reaches $60 per share. economic logic suggests that dividend policy may
The company's management believes this is too be irrelevant (in theory), but many investors rely
high and that some investors may not invest in on dividends as a vital source of income.
the company as a result of the initial price
required to buy the stock. As such, the company BREAKING DOWN 'Dividend
decides to split the stock to make the entry point
of the shares more accessible. Policy'
Because dividends represent a form of income
For simplicity, suppose Newco initiates a 2-for-1 for investors, a company's dividend policy is an
stock split. For each share they own, all holders important consideration for some investors. As
of Newco stock will receive two Newco shares such, it is an important consideration for
priced at $30 each, and the company's shares company leadership, especially because
outstanding will double. Keep in mind that the company leaders are often the largest
company's overall equity value remains the
shareholders and have the most to gain from a
same. Say there are one million shares
generous dividend policy. Most companies view a
outstanding and the company's initial equity value
dividend policy as an integral part of the
is $60 million ($60 per share x 1 million shares
corporate strategy. Management must decide on
outstanding). The equity value after the split is
still $60 million ($30 per share x 2 million shares the dividend amount, timing and various other
outstanding). factors that influence dividend payments over
time. There are three types of dividend policies: a
While stock prices will most likely rise after a split stable dividend policy, a constant dividend policy
or dividend (remember price increases are and a residual dividend policy.
caused by positive signals a company generates
with respect to future earnings), if positive news Stable Dividend Policy
does not follow, the company's stock price will The stable dividend policy is the easiest and
generally fall back to its original level. Some most commonly used policy. The goal of the
investors think that stock splits and stock policy is to aim for steady and predictable
dividends are unnecessary and do little more dividend payouts every year, which is what most
than create more stocks. (For further reading on
investors are seeking. When earnings are up,
stock splits, see Berkshire's Stock Splits: Good
investors receive a dividend. When earnings are
Buy or Goodbye? and Top Stock Target Price
down, investors receive a dividend. The goal is to
Misfires.)
align the dividend policy with the long-term
growth of the company rather than with quarterly
Residual Dividend Policy Mutual fund and ETF shareholders are often
A residual dividend policy is also highly volatile, entitled to receive accrued dividends as
but for some investors, it is the only acceptable well. Mutual funds pay out interest and dividend
dividend policy that a company should have. In a income received from their portfolio holdings as
residual dividend policy the company pays out dividends to fund shareholders. In addition,
what's left after it pays for capital expenditures realized capital gains from the portfolio's trading
and working capital needs. This approach is activities are generally paid out (capital gains
volatile, but it makes the most sense in terms of distribution) as a year-end dividend.
business operations. Investors don't want to
The dividend discount model, or Gordon growth
invest in a company that justifies its increased
model, relies on anticipated future dividend
debt with the need to pay dividends.
streams to value shares.
Forward
expected dividend payments from an investment,
fund or portfolio expressed on an annualized
basis plus any additional non-recurring dividends
Residual Dividend
cash and/or stock.
Dividend
opposed to only its price movements.
How candid and accurate are The typical auditor's report is almost always
management's comments? broken into three paragraphs and written in
the following fashion:
Does management discuss significant
Independent Auditor\'s Report
policies of the business that the company discussed when a company announces
feels that you should be aware of. This is its results - numbers such
as revenue, earnings and earnings per share.
especially important if a company has changed
Basically, the income statement shows how
accounting policies. It may be that a firm is
much money the company generated
practicing "cookie jar accounting" and is
(revenue), how much it spent (expenses) and
changing policies only to take advantage of
the difference between the two (profit) over a
current conditions in order to hide poor
certain time period.
performance.
could not be put in the financial statements. well the company's business is performing -
or, basically, whether or not the company is
To maintain this cleanliness, other calculations
are left for the footnotes. For example, details of making money.. Those companies with low
long-term debt - such as maturity dates and expenses relative to revenue - or high profits
the interest rates at which debt was issued - relative to revenue - signal strong
can give you a better idea of how borrowing fundamentals to investors.
costs are laid out. Other areas of disclosure
include everything from pension plan liabilities Revenue as an investor signal
for existing employees to details about Revenue, also commonly known as sales, is
ominous legal proceedings involving the generally the most straightforward part of the
Finally, there are financial costs, notably Net income generally represents the
taxes and interest payments, which need to company's profit after all expenses, including
be considered. financial expenses, have been paid. This
number is often called the "bottom line" and is
Profits = Revenue - Expenses generally the figure people refer to when they
use the word "profit" or "earnings". assets), and how much it owes (its liabilities).
The difference between what it owns and what
When a company has a high profit margin, it it owes is its equity, also commonly called
usually means that it also has one or more "net assets" or "shareholders equity".
advantages over its competition. Companies
with high net profit margins have a bigger The balance sheet tells investors a lot about a
cushion to protect themselves during the hard company's fundamentals:
times. Companies with low profit margins can
get wiped out in a downturn. And companies -how much debt the company has,
with profit margins reflecting a competitive
advantage are able to improve their market -how much it needs to collect from customers
share during the hard times - leaving them (and how fast it does so),
even better positioned when things improve
- how much cash and equivalents it possesses
again.
and
Conclusion
-what kinds of funds the company has
You can gain valuable insights about a
generated over time.
company by examining its income statement.
Increasing sales offers the first sign of strong 2. The Balance Sheet's Main Three
fundamentals. Rising margins indicate
increasing efficiency and profitability. It's also Assets, liability and equity are the three main
a good idea to determine whether the company components of the balance sheet.
is performing in line with industry peers and
competitors. Look for significant changes in Assets
revenues, costs of goods sold and SG&A to There are two main types of assets: current
get a sense of the company's profit assets and non-current assets. Current assets
fundamentals. are likely to be used up or converted into cash
within one business cycle - usually treated as
1. Fundamental Analysis: The Balance twelve months. Three very important current
Sheet asset items found on the balance sheet
Investors often overlook the balance sheet. are: cash, inventories and accounts
Assets and liabilities aren't nearly as sexy receivables.
as revenue and earnings. While earnings are
important, they don't tell the whole story. Investors normally are attracted to companies
The balance sheet highlights the financial with plenty of cash on their balance sheets.
condition of a company and is an integral part After all, cash offers protection against tough
of the financial statements. times, and it also gives companies more
options for future growth. Growing cash
The Snapshot of Health reserves often signal strong company
It tells you how much a company owns (its performance. Indeed, it shows that cash is
accumulating so quickly that management salaries, merchandise, equipment, loans, and
doesn't have time to figure out how to make best of all, dividends and growth
use of it. A dwindling cash pile could be a sign opportunities.
of trouble. That said, if loads of cash are more
or less a permanent feature of the company's Non-current assets are This includes items
balance sheet, investors need to ask why the that are fixed assets, such as property, plant
money is not being put to use. Cash could be and equipment (PP&E). Unless the company
there because management has run out of is in financial distress and
investment opportunities or is too short- is liquidating assets, investors need not pay
sighted to know what to do with the money. too much attention to fixed assets. Since
companies are often unable to sell their fixed
Inventories are finished products that haven't assets within any reasonable amount of time
yet sold. As an investor, you want to know if a they are carried on the balance sheet at cost
company has too much money tied up in its regardless of their actual value. As a result,
inventory. Companies have limited funds it's is possible for companies to grossly
available to invest in inventory. To generate inflate this number, leaving investors with
the cash to pay bills and return a profit, they questionable and hard-to-compare asset
must sell the merchandise they have figures.
purchased from suppliers. Inventory
turnover (cost of goods sold divided by Liabilities
average inventory) measures how quickly the There are current liabilities and non-current
company is moving merchandise through the liabilities. Current liabilities are obligations
warehouse to customers. If inventory grows the firm must pay within a year, such as
faster than sales, it is almost always a sign of payments owing to suppliers. Non-current
deteriorating fundamentals. liabilities, meanwhile, represent what the
company owes in a year or more time.
Receivables are outstanding (uncollected Typically, non-current liabilities represent bank
bills). Analyzing the speed at which a company and bondholder debt.
collects what it's owed can tell you a lot about
its financial efficiency. If a company's You usually want to see a manageable amount
collection period is growing longer, it could of debt. When debt levels are falling, that's a
mean problems ahead. The company may be good sign. Generally speaking, if a company
letting customers stretch their credit in order has more assets than liabilities, then it is in
to recognize greater top-line sales and that can decent condition. By contrast, a company with
spell trouble later on, especially if customers a large amount of liabilities relative to assets
face a cash crunch. Getting money right away ought to be examined with more diligence.
is preferable to waiting for it - since some of Having too much debt relative to cash flows
what is owed may never get paid. The quicker required to pay for interest and debt
a company gets its customers to make repayments is one way a company can
payments, the sooner it has cash to pay for go bankrupt.
business methodologies), goodwill and brand
Look at the quick ratio. Subtract inventory recognition are all common assets in today's
from current assets and then divide by marketplace. But they are not listed on
current liabilities. If the ratio is 1 or higher, it company's balance sheets.
says that the company has enough cash and
There is also off-balance sheet debt to be
liquid assets to cover its short-term debt
aware of. This is form of financing in which
obligations.
large capital expenditures are kept off of a
company's balance sheet through various
Current Assets - Inventories
classification methods. Companies will often use
Quick Ratio = off-balance-sheet financing to keep the debt
Current Liabilities levels low.
Equity = Total Assets Total Liabilities What distinguishes the two is accrual
accounting, which is found on the income
The two important equity items are paid-in
statement. Accrual accounting requires
capital and retained earnings. Paid-in capital
companies to
is the amount of money shareholders paid for
ecord revenues and expenses when
their shares when the stock was first
transactions occur, not when cash is
offered to the public. It basically represents
exchanged. At the same time, the income
how much money the firm received when it
statement, on the other hand, often includes
sold its shares. In other words, retained
non-cash revenues or expenses, which the
earnings are a tally of the money the company
statement of cash flows does not include.
has chosen to reinvest in the business rather
than pay to shareholders. Investors should look
Whereas when the bottom of the cash flow
closely at how a company puts retained
statement reads $10 net cash inflow, that's
capital to use and how a company generates
exactly what it means. The company has $10
a return on it.
more in cash than at the end of the last
Most of the information about debt can be found financial period. You may want to think of net
on the balance sheet - but some assets and cash from operations as the company's "true"
debt obligations are not disclosed there. For cash profit.
starters, companies often possess hard-to-
measure intangible assets. Corporate Because it shows how much actual cash a
intellectual property (items such company has generated, the statement of
as patents, trademarks, copyrights and cash flows is critical to understanding a
company's fundamentals. It shows how the cash flow, the company may be speeding or
company is able to pay for its operations and slowing its booking of income or costs.
future growth.
Cash Flows from Investing Activities
Indeed, one of the most important features This section largely reflects the amount of cash
you should look for in a potential investment is the company has spent on capital
the company's ability to produce cash. Just expenditures, such as new equipment or
because a company shows a profit on the anything else that needed to keep the
income statement doesn't mean it cannot get business going. It also includes acquisitions
into trouble later because of insufficient cash of other businesses and monetary
flows. A close examination of the cash flow investments such as money market funds.
statement can give investors a better sense of
how the company will fare. You want to see a company re-invest capital in
its business by at least the rate
Three Sections of the Cash Flow Statement of depreciation expenses each year. If it
Companies produce and consume cash in doesn't re-invest, it might show artificially
different ways, so the cash flow statement is high cash inflows in the current year which
divided into three sections: cash flows from may not be sustainable.
operations, financing and investing. Basically,
the sections on operations and financing show Cash Flow From Financing Activities
how the company gets its cash, while the This section describes the goings-on of cash
investing section shows how the company associated with outside financing activities.
spends its cash. Typical sources of cash inflow would be cash
Cash Flows from Operating Activities raised by selling stock and bonds or by bank
This section shows how much cash comes borrowings. Likewise, paying back a bank loan
from sales of the company's goods and would show up as a use of cash flow, as
services, less the amount of cash needed to would dividend payments and common stock
make and sell those goods and services. repurchases.
Investors tend to prefer companies that
produce a net positive cash flow from Cash Flow Statement Considerations:
operating activities. High growth companies, Savvy investors are attracted to companies
such as technology firms, tend to show negative that produce plenty of free cash flow (FCF).
cash flow from operations in their formative Free cash flow signals a company's ability to
years. At the same time, changes in cash flow pay debt, pay dividends, buy back stock and
from operations typically offer a preview of facilitate the growth of business. Free cash
changes in net future income. Normally it's a flow, which is essentially the excess cash
good sign when it goes up. Watch out for a produced by the company, can be returned to
widening gap between a company's reported shareholders or invested in new growth
earnings and its cash flow from operating opportunities without hurting the existing
activities. If net income is much higher than
operations. The most common method of the discounted cash flow realm of valuation,
calculating free cash flow is: essentially differing on what type of cash flow
is used in the analysis.
Ratio Valuation
Financial ratios are mathematical calculations
using figures mainly from the financial
statements, and they are used to gain an idea
of a company's valuation and financial
For simplicity's sake, if we know that a company performance. Some of the most well-known
will generate $1 per share in cash flow for valuation ratios are price-to-
shareholders every year into the future; we can earnings and price-to-book. Each valuation
calculate what this type of cash flow is worth ratio uses different measures in its calculations.
today. This value is then compared to the current For example, price-to-book compares the price
value of the company to determine whether per share to the company's book value.
the company is a good investment, based on
it being undervalued or overvalued. The calculations produced by the valuation ratios
are used to gain some understanding of the
There are several different techniques within company's value. The ratios are compared on
an absolute basis, in which there are For a company, the top line is revenue
threshold values. For example, in price-to- while the bottom line is net income.
book, companies trading below '1' are
considered undervalued. Valuation ratios are The income statement takes into account
some non-cash items, such as
also compared to the historical values of the
depreciation.
ratio for the company, along with
comparisons to competitors and the overall The cash flow statement strips away all
market itself. non-cash items and tells you how
much actual money the company
One of the most important areas for any generated.
investor to look at when researching a
company is the financial statements. It is The cash flow statement is divided into
essential to understand the purpose of each part three parts: cash from
of these statements and how to interpret them. operations, financing and investing.
Valuation
analysis (MD&A) gives investors a better
understanding of what the company
does and usually points out some key
areas where it performed well.
What is a 'Valuation'
Audited financial reports have much Valuation is the process of determining the
more credibility than unaudited ones. current worth of an asset or a company; there
are many techniques used to determine value.
The balance sheet lists the assets,
An analyst placing a value on a company looks at
liabilities and shareholders' equity.
:
For all balance
-the company's management,
sheets: Assets = Liabilities + Shareholder
s' Equity. The two sides must always
- the composition of its capital structure,
equal each other (or balance each other).
-the prospect of future earnings
The income statement includes figures
such
- market value of assets.
as revenue, expenses, earnings and earni
ngs per share.
BREAKING DOWN 'Valuation' options strike price. If the current market
value is $65 per share, the intrinsic value is $65
The market value of a security is determined
- $50, or $15 per share.
by what a buyer is willing to pay a seller,
assuming both parties enter the transaction
willingly. When a security trades on an
Examples of Discounted Cash
exchange, buyers and sellers determine the Flows
market value of a stock or bond. Analysts also place a value on an asset or
investment using the cash inflows and
The concept of intrinsic value, however, refers
outflows generated by the asset. These cash
to the perceived value of a security based on
flows are discounted into a current value using
future earnings or some other company
a discount rate, which is an assumption about
attribute unrelated to the market price of a
interest rates or a minimum rate of
security.
return assumed by the investor. If a company
is buying a piece of machinery, the firm analyzes
How Earnings Impact Valuation the cash outflow for the purchase and the
The earnings per share (EPS) formula is stated additional cash inflows generated by the new
as earnings available to common asset. All of the cash flows are discounted to
shareholders divided by number of common a present value, and the business determines
stock shares outstanding. EPS is an indicator of the net present value (NPV). If the NPV is a
company profit because the more earnings a positive number, the company should make the
company can generate per share, the more investment and buy the asset.
valuable each share is to investors
generated by using the equipment over current asset value per share."
future free cash flows, then discount that value to of value for the stock price or the firm's value.
and reviewing the fundamentals may lead to lead to improper valuations and thus improper
investment decisions, because the Fundamental and technical analysis do not
information is for the most part backward- have to be contrary or held within bounds. At
looking. Financial statement times there may be a single indicator that
analysis, 10Q and 10K commentaries and provides information for both the technician
macroeconomic environments focus on what and fundamentalist. For example, price
already happened. volatility is an important technical indicator of
risk - the greater the volatility, the greater the
Investors use this information to model expected risk. This may be a leading indicator that the
future results. The problem is that forecasting fundamentals are changing. As a result, both
is very subjective, relies on the company would agree on the buy/sell decision.
management teams expectations and
disclosures, and can be in some ways a self- The Bottom Line
fulfilling prophecy. "Garbage in, garbage out"
is a term often used in conjunction with the Sometimes investors like to pigeon-hole
modeling associated with fundamental analysis' themselves into one type of investment style,
intrinsic value determination. but being open to combining styles may
provide the best opportunity to make the
On the other hand, critics of technical analysis most profit. Technical and fundamental analyses
think that chart patterns work until they fail, and do not have to be used alone, but can be used
the failure of the pattern may not always be together to draw a complete investment
predictable from following the past pattern, picture. Fundamentals may be used to identify
especially if there is an unforeseen shock. One appropriate targets, while technicals can be
way to curtail the shortcomings of the two used to make the trading decisions. Together,
methods is to use them together to capture these methods can generate a confluence of
the best aspects of both. Fundamental information that should provide a better
analysis should be used to determine which investment opportunity than either used alone.
stocks or sectors are most likely to perform
well based on a strong macroeconomic
environment and company or sector-specific A company's financial statements - balance
operations. Technical analysis can then be sheet, income and cash flow statements - are a
used to decide when to buy or sell by giving key source of data for analyzing the investment
entry and exit points based on moving value of its stock. Stock investors, both the do-it-
averages, volume and price trends. By yourselfers and those who follow the guidance
employing both strategies together, positions of an investment professional, don't need to
can be taken in fundamentally strong be analytical experts to perform a financial
companies while avoiding buying into stocks statement analysis. However, if you're going to
that have already run up and are overvalued. become a serious stock investor, a basic
Technical analysis can help you avoid buying understanding of the fundamentals of
high or selling low, a phenomenon which financial statement usage is a must. In this
often occurs when psychology starts to rule article, we help you to become more familiar with
trading. the overall structure of the balance sheet.
Breaking Down The Balance Sheet company. While it may be an overly simplistic
view of the fundamental accounting equation,
The Structure of a Balance Sheet investors should view a much bigger equity
A company's balance sheet is comprised value compared to liabilities as a measure of
of assets, liabilities and equity. Assets represent positive investment quality, because
things of value that a company owns and has possessing high levels of debt can increase
in its possession, or something that will be the likelihood that a business will face
received and can be measured objectively. financial troubles.
Liabilities are what a company owes to others
- creditors, suppliers, tax authorities, Balance Sheet Formats
employees, etc. They are obligations that Standard accounting conventions present the
must be paid under certain conditions and balance sheet in one of two formats: the
time frames. A company's equity account form (horizontal presentation) and the
represents retained earnings and funds report form (vertical presentation). Most
contributed by its shareholders, who accept companies favor the vertical report form, which
the uncertainty that comes with ownership risk doesn't conform to the typical explanation in
in exchange for what they hope will be a investment literature of the balance sheet as
good return on their investment. having "two sides" that balance out.
The relationship of these items is expressed in Whether the format is up-down or side-by-
the fundamental balance sheet equation: side, all balance sheets conform to a
presentation that positions the various account
Assets = Liabilities + Equity entries into five sections:
Bond Valuation
history of dividend payments, it cannot easily
suspend or eliminate them without causing
shareholders some real pain. Even
dividend payout reductions, while less
What is 'Bond Valuation' lower price. This interest rate, also called
a coupon, is usually paid semiannually. As
Bond valuation is a technique for determining
interest rates go up, bond prices go down.
the fair value of a particular
Discount bonds are similar to zero-coupon
bond. Bond valuation includes calculating
bonds, which are also sold at a discount, but the
the present value of the bond's future interest
difference is that they don't pay interest. Common
payments, also known as its cash flow, and
examples of discount bonds are U.S. Treasury
the bond's value upon maturity=face
bills and U.S. savings bonds.
value or par value. Because a bond's par
value and interest payments are fixed, an A deep-discount bond is sold at a significantly
investor uses bond valuation to determine lower price than par value, usually 20% or
what rate of return is required for an
more.
investment in a particular bond to be
worthwhile. BREAKING DOWN 'Discount Bond'
Discount bonds can be bought and sold by
BREAKING DOWN 'Bond both businesses and individuals. Businesses
Valuation' have strict regulations for the selling and
purchasing of discount bonds; they must keep
Bond valuation is only one of the factors
detailed expense records of the discount bonds
investors consider in determining whether to
bought and sold on a balance sheet.
invest in a particular bond.
Effective
dollar value of coupon payments. Par value for
a bond is typically $1,000 or $100. Shares
usually have no par value or very low par
Interest Method
value, such as 1 cent per share. The market
price of a bond may be above or below par,
depending on factors such as the level of
interest rates and the bonds credit status. In
The effective interest rate is a method used by
the case of equity, par value has very little
a bond buyer to account for accretion of a
relation to the shares' market price.
bond discount as the balance is moved into
interest income, and to amortize a bond
Also known as nominal value or face value.
premium into an interest expense. The
effective interest rate uses the book value, or
the carrying amount of the bond, to calculate
interest income, and the difference between carrying amount so the new carrying amount of
interest income and the bonds interest $384,817 is used to calculate bond accretion for
payment is the amount of the accretion or year two. At the end of the 10-year life of the
amortization posted each year. bond, the carrying amount is adjusted up to the
$500,000 par amount.
BREAKING DOWN 'Effective
Interest Method' Factoring in Bond Amortization
A bond purchased at a premium generates a
Bonds are normally issued at a par, or face,
larger cost of debt for the bond buyer,
value, of $1,000 and sold in multiples of $1,000.
because the premium paid is amortized into bond
If a bond is purchased at less than par, the
expense. Assume, in this case, a 4.5%, $100,000
amount below the par value is the bond
par value bond is purchased for $104,100,
discount, and since the bond returns the par
which includes a $4,100 premium. The annual
amount to the purchaser at maturity, the
interest payment for the bond is $4,500, but the
discount is additional bond income to the
interest income earned in year one is less than
buyer. In a similar way, a bond purchased at a
$4,500 because the bond was purchased at a
price above par includes a bond premium,
market rate of only 4%. The actual interest
and the premium is an additional expense to
income is 4% multiplied by the $104,100 carrying
the bond buyer because the buyer only
amount, or $4,164, and the premium amortization
receives the par amount at maturity.
for year one is $4,500 less $4,164, which equals
How Accretion Works $336. The amortization of $336 is posted to bond
expense, and the amount also reduces the
Assume an investor buys bonds with a $500,000
carrying amount of the bond.
par value and a coupon rate of 6%; the bonds are
purchased for $377,107, which includes a bond
discount from par of $122,893. The bonds
interest income is calculated as the carrying Current Yield
amount multiplied by the at the market interest
rate, which is the total return earned on the bond Current yield is an investment's annual income
given the discount paid and the interest earned. (interest or dividends) divided by the current
In this case, assume the market interest rate is price of the security. This measure looks at
10%, which is multiplied by the $377,107 carrying the current price of a bond instead of its face
amount to calculate $37,710 in interest income. value. Current yield represents the return an
investor would expect if the owner purchased
The bond pays annual interest of 6% on a
the bond and held it for a year, but current yield
$500,000 par amount, or $30,000, and the
is not the actual return an investor receives if he
difference between the interest paid and interest
holds a bond until maturity.
income, or $7,710, is the amount of the bond
discount accretion for year one. The bond
accretion for the year is moved into bond income,
and the accretion amount is also added to the
BREAKING DOWN 'Current matures in the 10 years. To calculate YTM, an
investor needs to make an assumption about
Yield' a discount rate, so that the future principal
Current yield is most often applied to bond and interest payments are discounted to present
investments, which are securities that are value.
issued to investor at a par value (face
amount) of $1,000. A bond carries In this example, the investor receives $60 in
a coupon amount of interest that is stated on annual interest payments for 10 years. At
the face of the bond certificate, and bonds are maturity in 10 years, the owner receives the par
traded between investors. Since the market value of $1,000, and the investor recognizes a
price of a bond changes, an investor may $100 capital gain. The present value of the
purchase a bond at a discount (less than par interest payments and the capital gain are added
value) or at a premium (more than par value), to compute the bond's YTM. If the bond is
and the purchase price of a bond affects the purchased at a premium, the YTM calculation
current yield. includes a capital loss when the bond matures
at par value.
How Current Yield Is Calculated
Below Par
If an investor buys a 6% coupon rate bond for a
discount of $900, the investor earns annual
interest income of ($1,000 X 6%), or $60. The
current yield is ($60) / ($900), or 6.67%. The $60
A term describing a bond whose price is below
in annual interest is fixed, regardless of the price
the face value or principal value, usually $1,000.
paid for the bond. If, on the other hand, an
As bond prices are quoted as a percentage of
investor purchases a bond at a premium of
face value, a price below par would typically
$1,100, the current yield is ($60) / ($1,100), or
be anything less than 100.
5.45%. The investor paid more for the premium
bond that pays the same dollar amount of
interest, so the current yield is lower.
BREAKING DOWN 'Below Par'
A bond trading below par is the same as a bond
Current yield can also be calculated for stocks trading at a discount. When a bond trades
by taking the dividends received for a stock below par, its current yield is higher than its
and dividing the amount by the stocks fixed coupon rate.
current market price.
Bonds may trade below par when interest
Factoring in Yield to Maturity rates have risen since it was issued, its credit
Yield to maturity (YTM) is the total return rating has declined, there are concerns about
earned on a bond, assuming that the bond a default, or there is an excess supply. A
owner holds the bond until maturity date. bond's discount may narrow as it approaches
Assume, for example, that the 6% coupon rate maturity or its first call date, when investors
bond purchased for a discount of $900 will receive par value.
Bond Quote
The difference between the bid and the ask
price is referred to as the spread. In a full
quote, bonds with high levels of liquidity, such
as Treasuries, generally have spreads of a
A bond quote is the last price at which a bond few pennies between the bid and the ask
traded, expressed as a percentage of par value price. The spreads on corporate bonds with
and converted to a point scale. Par value is lower levels of liquidity, on the other hand,
generally set at 100, representing 100% of a can exceed $1. For example, a full quote on an
bond's face value of $1,000. For example, a illiquid corporate bond could list a last trade
corporate bond quoted at 99 is trading at 99% of $98, with a bid of $97 and an ask price of
of face value, meaning the cost of buying each $99.
bond is $990.
Spreads are calculated metrics that often tatic or Z-spread calculations are
frequently used in mortgage-backed
requires that a trader manually determine the
securities and other bonds with
difference between bid and ask prices. For
embedded options valuation.
traders trying to capture small fluctuations in the
spread, determining the spread requires handling . In other words, each cash flow is discounted at
quotes with a large number following the decimal. the appropriate Treasury spot rate + the Z-
As a result, the spread indicator fluctuates over a spread. The Z-spread is also known as a static
very narrow range. spread.
Yield Spread
treasuries or a combination of both.
Alternatively, the Treasury curve can be
calculated by using Treasury coupon strips.
A yield curve is a line that plots the interest
BREAKING DOWN 'Spot Rate rates, at a set point in time, of bonds having
equal credit quality but differing maturity
Treasury Curve'
dates. The most frequently reported yield
Because many bonds typically have multiple
curve compares the three-month, two-year,
cash flows (coupon payments) at different
five-year and 30-year U.S. Treasury debt. This
points in the bonds' lives, it is not
yield curve is used as a benchmark for other
theoretically correct to use just one interest
debt in the market, such as mortgage rates or
rate to discount all of the cash flow. Therefore,
bank lending rates, and it is also used to
in order to make a sound bond valuation, it is
predict changes in economic output and growth.
good practice to match up and discount each
coupon payment with the corresponding
Treasury spot rate for pricing the present
value of each price.
all the cash flows will be $103.36. future interest rate changes and economic
activity. There are three main types of yield
However, $103.36 is not necessarily the price curve shapes: normal, inverted and flat (or
at which the corporate bond will ultimately be humped). A normal yield curve is one in which
sold. Because the spot rates used to price longer maturity bonds have a higher yield
bonds reflect rates that are from default-free compared to shorter-term bonds due to the
Treasuries, the corporate bond's price will risks associated with time. An inverted yield
curve is one in which the shorter-term yields
are higher than the longer-term yields, which Flat Yield Curve
can be a sign of upcoming recession. In a flat
A flat yield curve may arise from normal or
or humped yield curve, the shorter- and longer-
inverted yield curve, depending on changing
term yields are very close to each other,
economic conditions. When the economy is
which is also a predictor of an economic
transitioning from expansion to slower
transition.
development and even recession, yields on
Normal Yield Curve longer-maturity bonds tend to fall and yields on
shorter-term securities likely rise, inverting a
A normal or up-sloped yield curve indicates
normal yield curve into a flat yield curve. When
yields on longer-term bonds may continue to
the economy is transitioning from recession to
rise, responding to periods of economic
recovery and potentially expansion, yields on
expansion. When investors expect longer-
longer-maturity bonds are set to rise and yields
maturity bond yields to become even higher
on shorter-maturity securities are sure to fall,
in the future, many would temporarily park
tilting an inverted yield curve toward a flat yield
their funds in shorter-term securities in hopes
curve.
of purchasing longer-term bonds later for
higher yields. In a rising interest rate A par curve is the most commonly referred to
environment, it is risky to have investments curve by media and market watchers. The Spot
curve is more often user to calculate the fair
tied up in longer-term bonds when their value value of a particular bond.
has yet to decline as a result of higher yields
over time. The increasing temporary demand for When people quote the par curve they give you
the yields of various maturity bonds. Each of
shorter-term securities pushes their yields even the referred to bonds will usually have
lower, setting in motion a steeper up-sloped different yields and pay semi-annual interest
payments and a bullet or single payment
normal yield curve. maturity. Since each par bond is a collection of
payments the yield quoted on each bond is
Inverted Yield Curve really the average return for several different
term investments. Said another way, a 2yr
An inverted or down-sloped yield curve maturity par bond will make interest payments in
months 6,12,18,24 and a maturity payment in month
suggests yields on longer-term bonds may
24. The quoted yield for the bond is IRR for the
continue to fall, corresponding to periods of whole series of payments. (In essence a
economic recession. When investors expect weighted average return for the whole period.)
longer-maturity bond yields to become even A spot curve is more pure in that each node or
lower in the future, many would purchase maturity is quoted as a zero coupon (only one
longer-maturity bonds to lock in yields before cash flow at maturity) bond so the yield quoted
is for the period from settlement date to maturity
they decrease further. The increasing onset of with no interference from intervening cash flows.
demand for longer-maturity bonds and the lack
You can solve from par to spot curves or vice versa
of demand for shorter-term securities lead to
since the par bonds have so much overlap.
higher prices but lower yields on longer-
maturity bonds, and lower prices but higher For example, if we look now at a 3yr bond, it also pays
interest payments in months 6,12,18,24, and has two
yields on shorter-term securities, further more payment dates in months 30, and 36. Valuing
inverting a down-sloped yield curve. the 3yr bond in comparison to the 2y bond should
really only involve determining the discount rate for Treasury. For example, a 10-
the last two payments because both bonds contain the
same exposures for the first 4 payments.
year planned amortization class bond
might trade at a nominal yield spread
The spot curve is derived from the par curve. to the on-the-run 10-year Treasury, or
a Z-bond might trade at a nominal yield
Then, the forward curve is derived from the spot
curve.
spread to the on-the-run 30-year
Treasury. Because MBS have
sically, the par curve contains all the securities in a embedded call options (borrowers have
portfolio. the free option of prepaying their
The spot curve contains a single payment (usually mortgages), they are frequently evaluated
zero or strip). Some traders use the spot curve to using an OAS.
derive the Z-spread.
Asset-Backed Securities: ABS
Types of Bonds and Their frequently trade at a nominal yield
spread at their weighted average life to
Benchmark and Spread the swap curve.
Calculation
Agencies: Agencies frequently trade at
a nominal yield spread to a specific
High-Yield Bonds: High-yield bonds are usually
Treasury, such as the on-the-run 10-
priced at a nominal yield spread to a specific
year Treasury. Callable agencies are
on-the-run U.S. Treasury bond. However,
sometime evaluated based on an OAS
sometimes when the credit rating and outlook of
where the spot rate curve(s) are derived
a high-yield bond deteriorates, the bond will
from the yields on non-callable agencies.
start to trade at an actual dollar price. For
example, such a bond trades at $75.875 as
Municipal Bonds: Because of the tax
opposed to 500 basis points over the 10-year
advantages of municipal bonds (usually
Treasury.
not taxable), their yields are not as highly
correlated with U.S. Treasury yields as
Corporate Bonds: A corporate bond is
other bonds. Therefore, munis frequently
usually priced at a nominal yield
trade on an outright yield to maturity or
spread to a specific on-the-run U.S.
even a dollar price. However, a muni's
Treasury bond that matches its maturity.
yield as a ratio to a
For example, 10-year corporate bonds
benchmark Treasury yield is
are priced to the 10-year Treasury.
sometimes used as a relative value
Mortgage-Backed Securities: There are measure.
many different types of MBS. Many of
Collateralized Debt Obligations: Like the
them trade at a nominal yield spread at
MBS and ABS that frequently back CDOs,
their weighted average life to the U.S.
there are many different pricing
Treasury I-curve. Some adjustable-
benchmarks and yield measures used
rate MBS trade at a DM, others trade at
to price CDOs. The eurodollar curve is
a Z-spread. Some CMOs trade at a
sometimes used as a benchmark.
nominal yield spread to a specific
Discount margins are used on floating
rate tranches. OAS calculations are any more debt until the bank loan is completely
made for relative value analysis. paid off; they can't participate in any share
offerings until the bank loan is paid off; they can't
The Bottom Line acquire any companies until the bank loan is paid
Bond pricing is really just a matter of off, and so on. Relatively speaking, these are
identifying a pricing benchmark, determining a straightforward, unrestrictive covenants that may
spread and understanding the difference be placed on corporate borrowing. However, debt
between two basic yield calculations: yield to covenants are often much more convoluted and
maturity and spot rates. With that knowledge, carefully tailored to fit the borrower's business
understanding how various types of bonds are risks. Some of the more restrictive covenants
priced shouldn't be intimidating. may state that the interest rate on the debt
increases substantially should the chief executive
Corporate finance guide complee officer (CEO) quit or if earnings per share drop in
a given time period. Covenants are a way for
banks to mitigate the risk of holding debt, but for
Introduction To Bonds
borrowing companies they are seen as an
Companies may issue bonds to finance increased risk.
operations. Most companies can borrow from
banks, but view direct borrowing from a bank as Simply put, banks place greater restrictions on
more restrictive and expensive than selling debt what a company can do with a loan and are more
on the open market through a bond issue. concerned about debt repayment than
bondholders. Bond markets tend to be more
The costs involved in borrowing money directly forgiving than banks and are often seen as being
from a bank are prohibitive to a number of easier to deal with. As a result, companies are
companies. In the world of corporate finance, more likely to finance operations by issuing
many chief financial officers (CFOs) view banks bonds than by borrowing from a bank.
as lenders of last resort because of the restrictive
What Is a Corporate Bond?
debt covenants that banks place on direct
Similar to a mortgage with a bank, bonds are an
corporate loans. Covenants are rules placed on
issue by a borrower to a lender. When you buy a
debt that are designed to stabilize corporate
corporate bond, you are loaning your money to a
performance and reduce the risk to which a bank
corporation for a predetermined period of time
is exposed when it gives a large loan to a
(known as the maturity). In most cases, the
company. In other words, restrictive covenants
bond's par value is $1,000. This is the face value
protect the bank's interests; they're written by
of the bond and the amount the company (the
securities lawyers and are based on what
borrower) will repay the lender (you) once the
analysts have determined to be risks to that
bond matures.
company's performance.
A term bond is the opposite of a serial bond, If a company is near bankruptcy and requires
which has various maturity schedules at regular protection from creditors (Chapter 11), it is likely
intervals until the issue is retired. unable to make payments on its debt obligations.
If this is the case, the company will be liquidated,
Amortized Bonds and the company's value will be spread among
An amortized bond is a financial certificate that its creditors. However, creditors will generally
has been reduced in value for records on only receive a fraction of their original loans to
accounting statements. An amortized bond is the company. Creditors and the company will
treated as an asset, with the discount amount work together to recapitalize debt obligations so
being amortized to interest expense over the life that the company is able to meet its obligations
of the bond. If a bond is issued at a discount - and continue operations, thus increasing the
that is, offered for sale below its par (face value) - value that creditors will receive.
the discount must either be treated as an
expense or amortized as an asset. Junk Bonds
A junk bond, also known as a "high-yield bond" or
As we discussed in Section 4, amortization is an "speculative bond," is a bond rated "BB" or lower
accounting method that gradually and because of its high default risk. Junk bonds
systematically reduces the cost value of a limited typically offer interest rates three to four
life, intangible asset. Treating a bond as an percentage points higher than safer government
amortized asset is an accounting method in the issues.
handling of bonds. Amortizing allows bond
issuers to treat the bond discount as an asset Angel Bonds
until the bond's maturity. (To learn more about Angel bonds are investment-grade bonds that
bond premium amortization, read Premium pay a lower interest rate because of the issuing
Bonds: Problems And Opportunities.) company's high credit rating. Angel bonds are the
opposite of fallen angels, which are bonds that
Adjustment Bonds have been given a "junk" rating and are therefore
Issued by a corporation during a restructuring much more risky.
phase, an adjustment bond is given to the
bondholders of an outstanding bond issue prior An investment-grade bond is rated at minimum
to the restructuring. The debt obligation is "BBB" by S&P and Fitch, and "Baa" by Moody's.
consolidated and transferred from the If the company's ability to pay back the bond's
outstanding bond issue to the adjustment bond. principal is reduced, the bond rating may fall
This process is effectively a recapitalization of the below investment-grade minimums and become
company's outstanding debt obligations, which is a fallen angel.
accomplished by adjusting the terms (such as
interest rates and lengths to maturity) to increase
the likelihood that the company will be able to Bond Valuation
The fundamental principle of bond valuation is interest rate used to calculate the present value.
that the bond's value is equal to the present value To figure out the value, the PV of each individual
of its expected (future) cash flows. The valuation cash flow must be found. Then, just add the
process involves the following three steps: figures together to determine the bond's price.
Rating agencies regularly review bond ratings The bond market is where debt securities are
every six to 12 months. However, a bond may be issued and traded. The bond market primarily
reviewed at any time the agency deems includes government-issued securities and
necessary for reasons including missed or corporate debt securities, and it facilitates the
delayed payments to investors, issuance of new transfer of capital from savers to the issuers or
bonds, changes to an issuer's underlying organizations that requires capital for government
financial fundamentals, or other broad economic projects, business expansions and ongoing
developments. (For more on this subject, operations. The bond market is alternatively
read The Debt Ratings Debate.) referred to as the debt, credit or fixed-income
market. Although the bond market appears
Institutional and individual investors rely on bond complex, it is really driven by the same risk and
rating agencies and their in-depth research to return tradeoffs as the stock market. Most trading
in the bond market occurs over the counter there are more risks associated with this type of
through organized electronic trading networks debt.
and is composed of the primary market (through
which debt securities are issued and sold by The final players in the bond market are those
borrowers to lenders) and the secondary market who buy the debt. Buyers basically include every
(through which investors buy and sell previously group mentioned as well as any other type of
issued debt securities among themselves). investor, including the individual. Governments
Although the stock market often commands more play one of the largest roles in the market
media attention, the bond market is actually many because they borrow and lend money to other
times bigger and is vital to the ongoing operation governments and banks. Furthermore,
of the public and private sectors. governments often purchase debt from other
countries if they have excess reserves of that
The bond market can essentially be broken down country's money as a result of trade between
into three main groups: issuers, underwriters and countries. For example, Japan is a major holder
purchasers. of U.S. government debt.
The issuers sell bonds or other debt instruments Getting bond quotes and general information
in the bond market to fund the operations of their about a bond issue is considerably more difficult
organizations. This area of the market is mostly than researching a stock or a mutual fund. There
made up of governments, banks and is not a lot of individual investor demand for the
corporations. The biggest of these issuers is the information; most bond information is available
government, which uses the bond market to help only through higher level tools that are not
fund a country's operations. Banks are also key accessible to the average investor.
issuers in the bond market, and they can range
from local banks up to supranational banks such In most cases, if you have a brokerage account,
as the European Investment Bank. The final you will have access to that firm's research tools,
major issuer is the corporate bond market, which which may include bond quotes and other
issues debt to finance corporate operations. information. Your brokerage is therefore the first
place that you should look for bond information.
The underwriting segment of the bond market is However, there are also free tools available
traditionally made up of investment banks and online that provide some basic information such
other financial institutions that help the issuer to as the bond's current price, coupon rate, yield to
sell the bonds in the market. In general, selling maturity (YTM), bond rating and other pertinent
debt is not as easy as just taking it to the market. information. Online services can be limited,
In most cases, millions if not billions of dollars are however, if they do not give you the volume of
transacted in one offering. As a result, a lot of bonds that trade hands or a bid-ask spread,
work needs to be done to prepare for the offering, making it difficult to measure the true price of the
such as creating a prospectus and other legal bond.
documents. In general, the need for underwriters
is greatest for the corporate debt market because
will demand for assuming that risk.
How Inflation And Interest
Rates Affect Bonds In this section, we'll focus on interest-rate risk.
(To learn about credit risk, read Corporate
Ownership of a bond is the ownership of a Bonds: An Introduction To Credit Risk.)
stream of future cash payments. Those cash
payments are usually made in the form of Calculation of a Bond's Yield and Price
periodic interest payments and the return To understand how interest rates affect a bond's
of principal when the bond matures. In the price, you must understand the concept of yield.
absence of credit risk (the risk of default), the While there are several different types of yield
value of that stream of future cash payments is calculations, for the purposes of this article we
simply a function of your required return based will use the yield-to-maturity (YTM) calculation. A
on your inflation expectations. In this section we'll bond's YTM is simply the discount rate that can
break down bond pricing, define the term be used to make the present value of all of a
"bond yield" and demonstrate how inflation bond's cash flows equal to its price. In other
expectations and interest rates determine the words, a bond's price is the sum of the present
value of a bond. value of each cash flow where the present value
of each cash flow is calculated using the same
Measures of Risk discount factor. This discount factor is the yield.
There are two primary risks that must be When a bond's yield rises, by definition, its price
assessed when investing in bonds: interest rate falls, and when a bond's yield falls, by definition,
risk and credit risk. Though our focus is on its price increases. (To learn more on this
how interest rates affect bond pricing, otherwise concept, be sure to read Get Acquainted With
known as interest rate risk, it's also important that Bond Price/Yield Duo.)
a bond investor be aware of credit risk.
(Read Managing Interest Rate Risk to learn more A Bond's Relative Yield
about the risk that comes with changing rates.) The maturity or term of a bond largely affects its
yield. To understand this statement, you must
Interest rate risk is the risk of changes in a bond's understand what is known as the yield curve. The
price due to changes in prevailing interest rates. yield curve represents the YTM of a class of
Changes in short-term versus long-term interest bonds (in this case U.S. Treasury bonds). In most
rates can affect various bonds in different ways, interest rate environments, the longer the term to
which we'll soon discuss. maturity, the higher the yield will be. This should
make intuitive sense because the longer the
Credit risk, meanwhile, is the risk that the bond's period of time before a cash flow is received, the
issuer will not make scheduled interest and/or more chance there is that the required discount
principal payments. The probability of a negative rate (or yield) will move higher. (Be sure to
credit event or default affects a bond's price. The read Bond Yield Curve Holds Predictive
higher the risk of a negative credit event Powers to learn more about this measure of
occurring, the higher the interest rate investors economic activity, inflation levels and interest rate
expectations.) - the yield curve gets steeper. If the market
believes that the FOMC has set the fed funds
Inflation Expectations Determine Investors' rate too high, the opposite happens, and long-
Yield Requirements term interest rates decrease relative to short-term
Inflation is a bond's worst enemy. Inflation erodes interest rates, flattening the yield curve.
the purchasing power of a bond's future cash (Whenever you hear the latest inflation update on
flows. Put simply, the higher the current rate of the news, chances are that interest rates are
inflation and the higher the (expected) future mentioned in the same breath. Read the Inflation
rates of inflation, the higher the yields will rise And Interest Rates section of our Inflation
across the yield curve, as investors will demand Tutorial to learn more about their relationship.)
this higher yield to compensate for inflation risk.
The Timing of a Bond's Cash Flows and
Short-Term and Long-Term Interest Rates, and Interest Rates
Inflation Expectations The timing of a bond's cash flows is important.
Inflation - and expectations of future inflation - are This includes the bond's term to maturity. If
a function of the dynamics between short-term market participants believe that there is higher
and long-term interest rates. Worldwide, short- inflation on the horizon, interest rates and bond
term interest rates are administered by nations' yields will rise (and prices will decrease) to
central banks. In the United States, the Federal compensate for the loss of the purchasing power
Reserve Board's Open Market of future cash flows. Those bonds with the
Committee (FOMC) sets the federal funds rate. longest cash flows will see their yields rise and
Historically, other dollar-denominated short-term prices fall the most. This should be intuitive if you
interest rates such as LIBOR are highly think about a present value calculation - when
correlated with the fed funds rate. The FOMC you change the discount rate used on a stream of
administers the fed funds rate to fulfill its dual future cash flows, the longer until a cash flow is
mandate of promoting economic growth while received, the more its present value is affected.
maintaining price stability. This is not an easy The bond market has a measure of price change
task for the FOMC; there is always much debate relative to interest rate changes; this important
about the appropriate fed funds level, and the bond metric is known as duration. (To learn more
market forms its own opinions on how well the about duration, be sure to check out
FOMC is doing. the Duration section of our Advanced Bond
Concepts Tutorial.)
Central banks do not control long-term interest
rates. Market forces (supply and demand) Summing It Up
determine equilibrium pricing for long-term Interest rates, bond yields (prices) and inflation
bonds, which set long-term interest rates. If the expectations have a correlation to each other.
bond market believes that the FOMC has set the Movements in short-term interest rates, as
fed funds rate too low, expectations of future dictated by a nation's central bank, will affect
inflation increase, which means long-term interest different bonds with different terms to maturity
rates increase relative to short-term interest rates differently depending on the market's
expectations of future levels of inflation. The bigger the duration number, the greater
the interest-rate risk or reward for bond
For example, a change in short-term interest prices.
rates that does not affect long-term interest rates
will have little effect on a long-term bond's price It is a common misconception among non-
and yield. However, a change (or no change professional investors that bonds and bond
when the market perceives that one is needed) in funds are risk-free. They are not. As you
short-term interest rates that affects long-term learned in the last section, investors need to be
interest rates can greatly affect a long-term aware of two main risks that can affect a
bond's price and yield. Put simply, changes in bond's investment value:
short-term interest rates have more of an effect
on short-term bonds than long-term bonds, and -credit risk (default) and interest rate risk (rate
changes in long-term interest rates have an effect fluctuations). The duration indicator addresses
on long-term bonds, but not short-term bonds. the latter issue.
The key to understanding how a change in The term duration has a special meaning in the
interest rates will affect a certain bond's price and context of bonds. It is a measurement of how
yield is to recognize where on the yield curve that long, in years, it takes for the price of a bond
bond lies (the short end or the long end) and to to be repaid by its internal cash flows. It is an
understand the dynamics between short- and important measure for investors to consider, as
long-term interest rates. With this knowledge, you bonds with higher durations carry more risk
can use different measures of duration and have higher price volatility than bonds
and convexity to become a seasoned bond with lower durations.
market investor.
For each of the two basic types of bonds the
duration is the following:
Duration
1. Zero-Coupon Bond - Duration is equal to its
The red lever above represents the four-year time Factors Affecting Duration
period it takes for a zero-coupon bond to mature. It is important to note, however, that duration
The money bag balancing on the far right changes ans the coupons are paid to the
represents the future value of the bond - the bondholder. As the bondholder receives a
amount that will be paid to the bondholder at coupon payment, the amount of the cash flow
maturity. The fulcrum, or the point holding the is no longer on the time line, which means it
lever, represents duration, which must be is no longer counted as a future cash flow that
positioned where the red lever is balanced. The goes towards repaying the bondholder. Our
fulcrum balances the red lever at the point on the model of the fulcrum demonstrates this: as the
time line at which the amount paid for the bond first coupon payment is removed from the red
and the cash flow received from the bond are lever and paid to the bondholder, the lever is
equal. The entire cash flow of a zero-coupon no longer in balance because the coupon
bond occurs at maturity, so the fulcrum is located payment is no longer counted as a future cash
directly below this one payment. flow.
Types of Duration
There are four main types of duration
Example 1: Betty holds a five-year bond with
calculations, each of which differ in the way a par value of $1,000 and coupon rate of 5%.
they account for factors such as interest rate For simplicity, let's assume that the coupon is
changes and the bond's embedded options or paid annually and that interest rates are 5%.
redemption features. The four types of What is the Macaulay duration of the bond?
durations are Macaulay duration, modified
duration, effective duration and key-rate
duration.
Macaulay Duration
The formula usually used to calculate
a bond\'s basic duration is the
Macaulay duration, is calculated by
adding the results of multiplying the
present value of each cash flow by
the time it is received and dividing
by the total price of the security.
through the calculation of her modified
duration. Currently her bond is selling at
$1,000, or par, which translates to a yield to
maturity of 5%. Remember that we
calculated a Macaulay duration of 4.55.
= 4.55 years
Key-Rate Duration
The final duration calculation to learn is key-
rate duration, which calculates the spot
Let's continue to analyze Betty's bond and run durations of each of the 11 "key" maturities
along a spot rate curve. These 11 key bond\'s initial price are constant, the
maturities are at the three-month and one, two, bond with a longer term to maturity will
three, five, seven, 10, 15, 20, 25, and 30-year display higher price volatility and a bond
portions of the curve. with a shorter term to maturity will
display lower price volatility.
Therefore, if you would like to invest in a
In essence, key-rate duration, while holding
bond with minimal interest rate risk, a
the yield for all other maturities constant,
bond with high coupon payments and a
allows the duration of a portfolio to be short term to maturity would be optimal.
calculated for a one-basis-point change in An investor who predicts that interest
interest rates. The key-rate method is most rates will decline would best potentially
often used for portfolios such as the bond capitalize on a bond with low coupon
ladder, which consists of fixed-income payments and a long term to maturity,
securities with differing maturities. Here is the since these factors would magnify a
formula for key-rate duration: bond\'s price increase.
Factor 3: Yield to Maturity (YTM)
The sensitivity of a bond\'s price to
changes in interest rates also depends
on its yield to maturity. A bond with a
high yield to maturity will display lower
price volatility than a bond with a lower
The sum of the key-rate durations along the yield to maturity, but a similar coupon
curve is equal to the effective duration. rate and term to maturity. Yield to
maturity is affected by the bond\'s credit
Duration and Bond Price Volatility rating, so bonds with poor credit ratings
will have higher yields than bonds with
We have established that when interest rates excellent credit ratings. Therefore,
rise, bond prices fall, and vice versa. But how bonds with poor credit ratings typically
does one determine the degree of a price change display lower price volatility than bonds
with excellent credit ratings.
when interest rates change? Generally, bonds
with a high duration will have a higher price All three factors affect the degree to which bond
fluctuation than bonds with a low duration. But it price will be altered in the face of a change in
is important to know that there are also three prevailing interest rates. These factors work
other factors that determine how sensitive a together and against each other.
bond's price is to changes in interest rates. These
factors are term to maturity, coupon rate So, if a bond has both a short term to maturity
and yield to maturity. Knowing what affects a and a low coupon rate, its characteristics have
bond's volatility is important to investors who use opposite effects on its volatility: the low coupon
duration-based immunization strategies, which raises volatility and the short term to maturity
we discuss below, in their portfolios. lowers volatility. The bond's volatility would then
be an average of these two opposite effects.
effective maturity of the bond. Also needed is a management for the following three reasons:
Convexity
Unfortunately, duration has limitations when used
C is convexity
as a measure of interest rate sensitivity. The
B is the bond price Duration indicates how much risk a bond investor
faces from changes in interest rates.
r is the interest rate
A bond with a higher duration will have a lower
d is duration
coupon rate, along with a longer term to maturity
and more volatility. This makes it more vulnerable
In general, the higher the coupon, the lower the
to interest rate risk.
convexity - a 5% bond is more sensitive to
interest rate changes than a 10% bond. Because
If Susan owns a bond with a duration of five, it
of the call feature, callable bonds will
will take five years for Susan to receive her
display negative convexity if yields fall too low,
principal back. If interest rates rise by 1%, the
meaning the duration will decrease when yields
bond will decrease in value by 5%. A 1%
decrease. (To read about some risks associated
decrease in interest rates means Susans bond
with callable and other bonds, read Call
will increase in value by 5%.
Features: Don't Get Caught Off
Guard and Corporate Bonds: An Introduction To If Susan and John own bonds with similar
Credit Risk.) maturities, the bond paying the highest coupon
will have the shortest duration. If their bonds have
Conclusion
the same coupon rate, the bond that matures first
Interest rates are constantly changing and add a
will have the shortest duration.
level of uncertainty to fixed-income investing.
Duration and convexity allow investors to quantify Finally, if Johns bond has a duration of 10 and
this uncertainty and are useful tools in the interest rates change, its price will experience a
management of fixed-income portfolios. bigger change than Susans because of its higher
duration.
Where:
D = Duration
P = Bond\'s market value
r = Interest rate
and D are the Greek
symbol delta, meaning
Figure 1
"change".
Copyright coupons are received), the present
It can be approximated to:
value of cash flows and the future value.
However, even after analyzing countless
scenarios through complex mathematical
formulas, a large number of variables can react in
unexpected ways.
This shows that a bond with a duration of four
What Is Interest Rate Immunization? years will decline in value 4% for each 1%
Interest rate immunization is a hedging strategy increase in interest rates. (Remember that bond
that seeks to limit or offset the effect that changes prices and interest rates move in opposite
in interest rates can have on a portfolio or fixed directions.) A bond with a duration of two years
security. Immunization strategies would decline by 2% for every 1% increase in
use derivatives and other financial instruments to interest rates. Thus, bonds with longer durations
offset as much risk as possible when it comes to are more sensitive to fluctuations in interest rates.
(For more on this, read Advanced Bond
Concepts: Duration.)
Where:
Dm = Macaulay duration
t = How often payment is
received
T = Number of periods
until final maturity
Figure 2
= Bond principal or
payment Copyright 2009 Investopedia.com
PV= Present
value calculation r = Change in the interest rate
To calculate the duration of a bond portfolio, pyou
= A change in a portfolio's value or investment's price
can take a weighted average of each
component's duration. Example - Calculating the Convexity of a Bond Portfolio
Investing In the term of the loan, or that the issuer did not
return the principal investment to the investor
when the bond matured.
to-maturity. The reason for this recommendation relationship; as interest rates fall, the price of
is that a bond with these types of features will not bonds trading in the marketplace generally rises.
be as adversely affected by a rising interest rate Conversely, when interest rates rise, the price of
environment. Of course, you should keep in mind bonds tends to fall. This happens because when
that a bond that offers a higher coupon rate will interest rates are on the decline, investors try to
likely have more default risk than a bond with a capture or lock in the highest rates they can for
lower coupon rate. Third, you can purchase as long as they can. To do this, they will scoop up
a floating rate bond in order to minimize or existing bonds that pay a higher interest rate than
eliminate the impact of interest-rate risk. the prevailing market rate. This increase
in demand translates into an increase in bond
Finally, as a bond investor, you need to determine price. On the flip side, if the prevailing interest
beforehand if your goal for buying a bond is to rate were on the rise, investors would naturally
generate income via periodic coupon payments, jettison bonds that pay lower interest rates. This
or if you are purchasing the bond with the would force bond prices down.
expectation of receiving periodic coupon
payments, as well as a material capital gain Let's look at an example:
Conclusion
Interest rates are constantly changing and add a
level of uncertainty to fixed-income investing.
Duration and convexity allow investors to quantify
this uncertainty and are useful tools in the
management of fixed-income portfolios.
Figure 1
How To Create A Modern
Convexity, which is a measure of the curvature of Fixed-Income Portfolio
the changes in the price of a bond in relation to
changes in interest rates, is used to address this Fixed-income investing often takes a backseat in
error. Basically, it measures the change in our thoughts to the fast-paced stock market, with
duration as interest rates change. The formula is its daily action and promises of superior returns,
as follows: but if you're a retired investor, or are approaching
retirement, fixed-income investing must move into
the driver's seat. At this stage, preservation
of capital with a guaranteed income stream
becomes the most important goal.
Figure 3
Is there a way to protect against such price One or all of these sources should be able to tell
volatility? you the following as well:
The answer is no. The volatility is inevitable. For The coupon rate: the rate of interest to be
this reason, fixed-income investors, regardless of paid on the bond.
the length of the maturity of the bonds they hold,
The maturity date: the date at which the
should be prepared to maintain their positions
security will be redeemed.
until the actual date of redemption. If you have to
sell the bond prior to maturity, you may end up
The call provisions: the outline of options
doing so at a loss if the interest rate has moved the company may have to buy back the
against you. (For more insight, see What are the debt at a later date.
risks of investing in a bond?)
The call information: this is particularly
Know The Claim Status And Features Of The important to know because of the
Bond numerous pitfalls that can be associated
In the event of bankruptcy, bond investors have with this feature. For example, suppose
first claim to a company's assets. In other words, interest rates decline sharply after you
at least theoretically, they have a better chance of purchase the bond. The good news is that
being made whole if the underlying company the price of your holding will increase; the
goes out of business. bad news is that the company that issued
the debt may now be able to go into the
The trouble is that not all bonds are created market, float another bond and raise
equal. There are senior notes, which are often money at a lower interest rate and then
use the proceeds to buy back, or call your
backed by collateral (such as equipment) that are
bond. Typically, the company will offer you
given first claim. There are also subordinated
a small premium to sell the note back to
debentures, which still rank ahead of the
them before maturity. But where does that
common stock in terms of claim preference, but
leave you? (For more on this, read Call
below that of the senior holder. It is important to Features: Don't Get Caught Off Guard.)
understand which you own, especially if the issue
you are buying is in any way speculative. After your bond is called, you may owe a big tax
liability on your gains, and you will probably be
How can you tell what type of bond you own? forced to reinvest the money you received at the
If you have the certificate in front of you, it will
prevailing market rate, which may have declined A good tip for bond investors is to take a look at
since your initial investment. the issuer's common stock to see how it is being
perceived. If it is disliked, or there is unfavorable
Interest Coverage research in the public domain on the equity, it will
Just because you own a bond or because it is likely spill over and be reflected in the price of the
highly regarded in the investment community bond as well.
doesn't guarantee that you will earn a dividend
payment, or that you will ever see the bond Issuer's History
redeemed. In many ways investors seem to take It is important that an investor peruse old annual
this process for granted. reports and review a company's past
performance to determine whether it has a
But rather than make the assumption that the history of reporting consistent earnings and has
investment is sound, the investor should review made all interest, tax and pension plan obligation
the company's financials and look for any reason payments in the past.
it won't be able to service its obligation. They
should look closely at the income statement and Specifically, a potential investor should read the
then take the annual net income figure and add company's management discussion and
back taxes, depreciation and any other non-cash analysis (MD&A) section for this information. Also
charges. This will help you to determine how read the proxy statement - it, too, will yield clues
many times that figure exceeds the annual debt about any problems or a company's past inability
service number. Ideally, there should be at least to make payments. It may also indicate future
two times coverage in order to feel comfortable risks that could have an adverse impact on a
that the company will have the ability to pay down company's ability to meet its obligations or
its debt. (To learn how to read and break down service its debt. (To learn more about
financial statements, see What You Need To management, see Evaluating A Company's
Know About Financial Statements, Get Management and Get Tough On Management
Organized With An Investment Analysis Puff.)
Form, Introduction To Fundamental
Analysis and Advanced Financial Statement The goal of this homework is to gain some level
Analysis) of comfort that the bond you are holding isn't
some type of experiment. In other words, that the
Market Perception company has paid its debts in the past and,
As mentioned above, bond prices can and do based upon its past and expected future
fluctuate. One of the biggest sources of volatility earnings, that it is likely to do so in the future.
is the market's perception of the issue and the
issuer. If other investors don't like the issue or Ignoring Inflation
think the company won't be able to meet its When bond investors hear reports
obligations, or if the issuer suffers a blow to its of inflation trends, they need to pay attention.
reputation, the price of the bond will decrease in Inflation can eat away a fixed income investor's
value. The opposite is true if Wall Street views future purchasing power quite easily. (To continue
the issuer or the issue favorably. reading about inflation, see The Importance Of
Inflation And GDP, All About Inflation and The daily in large volumes, is being quoted by the
Forgotten Problem Of Inflation.) large brokerage houses and has a fairly
narrow spread, it is probably suitable.
For example, if inflation is growing at an annual
rate of 4%, this means that each year it will take a The Bottom Line
4% greater return to maintain the Contrary to popular belief, fixed income investing
same purchasing power. This is important, involves a great deal of research and analysis.
particularly for investors that buy bonds at or Those who don't do their homework run the risk
below the rate of inflation, because they are of suffering low or negative returns.
actually guaranteeing they'll lose money when
Understanding
they purchase the security!
Bond Prices
shouldn't buy a low yielding bond from a highly
rated corporation. But investors should
understand that in order to defend against
and Yields
inflation, they must obtain a higher rate of return
from other investments in their portfolio such
as common stocks or high yielding bonds.
Let's look at how we calculated this number. A Because you will be the holder of record when
nd
bond's price consists of a "handle" and "32 s". the actual coupon payment is made and will
The two-year Treasury's handle is 99, and the receive the full coupon payment, you must pay
nd
32 s are 29. We must convert those values into the previous owner his or her percentage of that
a percentage to determine the dollar amount we coupon payment at the time of trade settlement.
will pay for the bond. To do so, we first divide 29 In other words, the actual trade settlement
by 32. This equals .90625. We then add that amount will consist of the purchase
amount to 99 (the handle), which equals price plus accrued interest.
99.90625. So, 99-29 equals 99.90625% of the
par value of $100,000, which equals Discount Vs. Premium Pricing
$99,906.25.Calculating When would someone pay more than a bond's
par value? The answer is simple: when However, for non-callable bonds such as U.S.
the coupon rate on the bond is higher than Treasury bonds, the yield calculation used is
current market interest rates. In other words, the a yield to maturity. In other words, the exact
investor will receive interest payments from a maturity date is known and the yield can be
premium priced bond that are greater than what calculated with certainty (almost). But even yield
they could earn in the current market to maturity has its flaws. A yield to maturity
environment. The same holds true for bonds calculation assumes that all the coupon
priced at a discount; they are priced at a discount payments are reinvested at the yield to maturity
because the coupon rate on the bond is below rate, although this is highly unlikely because
current market rates. future rates can't be predicted.
Yield Tells It All (Almost) A Bond's Yield Moves Inversely to Its Price
A yield relates a bond's dollar price to its cash A bond's yield is the discount rate (or factor) that
flows. A bond's cash flows consist of coupon equates the bond's cash flows to its current dollar
payments and return of principal. Principal is price. So what is the appropriate discount rate or
usually returned at the end of a bond's term, conversely, what is the appropriate price?
known as its maturity date.
When inflation expectations rise, interest rates
A bond's yield is the discount rate that can be rise, so the discount rate used to calculate the
used to make the present value of all of the bond's price increases, making the bond's price
bond's cash flows equal to its price. In other drop. It's that simple. The opposite scenario
words, a bond's price is the sum of the present would be true when inflation expectations fall.
value of each cash flow. Each cash flow is
present valued using the same discount factor. How to Determine the Appropriate Discount
This discount factor is the yield. Rate
We've established that inflation expectation is the
Intuitively, discount and premium pricing makes primary variable that influences the discount rate
sense. Because the coupon payments on a bond investors use to calculate a bond's price, but
priced at a discount are smaller than on a bond you'll notice in Figure 1 that each Treasury bond
priced at a premium, if we use the same discount has a different yield and that the longer the
rate to price each bond, the bond with the smaller maturity of the bond, the higher the yield. This is
coupon payments will have a smaller present because the longer a bond's term to maturity, the
value (lower price). greater the risk that there could be future
increases in inflation and the larger the current
In reality, there are several different yield discount rate that is required/used by investors to
calculations for different kinds of bonds. For calculate the bond's price will be. By this time,
example, calculating the yield on a callable you should recognize this higher discount rate as
bond is difficult because the date at which the being a higher yield.
bond might be called (the coupon payments go
away at that point) is unknown. The credit quality (the likelihood that a
bond's issuer will default) is also considered
when determining the appropriate discount rate bonds that can be converted by the holder into
(yield); the lower the credit quality, the higher the the common stock of the issuing company. In this
yield and the lower the price. article, we'll cover the basics of these
chameleon-like securities as well as their upsides
Bond Prices and the Economy and downsides.
Inflation is a bond's worst enemy. When inflation
expectations rise, interest rates rise, bond yields What Is a Convertible Bond?
rise and bond prices fall. To that end, bond As the name implies, convertible bonds, or
prices/yields, or the prices/yields of bonds with converts, give the holder the option to exchange
different maturities are an excellent predictor of the bond for a predetermined number of shares
future economic activity. To see the market's in the issuing company. When first issued, they
prediction of future economic activity, all you have act just like regular corporate bonds, albeit with a
to do is look at the yield curve. The yield curve in slightly lower interest rate.
Figure 1 predicts a slight economic slow down Because convertibles can be changed into stock
and slight drop in interest rates between months and thus benefit from a rise in the price of
six and 24. After month 24, the yield curve is the underlying stock, companies offer
telling us that the economy should grow at a lower yields on convertibles. If the stock performs
more normal pace. poorly there is no conversion and an investor is
stuck with the bond's sub-par return (below what
The Bottom Line a non-convertible corporate bond would get). As
Understanding bond yields is a key to always, there is a tradeoff between risk and
understanding expected future economic activity return. (For more insight, read Get Acquainted
and interest rates, which is important With The Bond Price-Yield Duo.)
in everything from stock selection to deciding
when to refinance a mortgage. Use the yield Conversion Ratio
curve as an indication of potential economic The conversion ratio (also called the conversion
conditions to come. premium) determines how many shares can be
converted from each bond. This can be
Convertible
expressed as a ratio or as the conversion price,
and is specified in the indenture along with other
provisions.
Bonds: An Example
A conversion ratio of 45:1 means one bond
Example
It is important to remember that convertible
Suppose that TSJ Sports issues $10 million in
bonds closely follow the underlying's price. The
three-year convertible bonds with a 5% yield
exception occurs when the share price goes
and a 25% premium. This means that TSJ will
down substantially. In this case, at the time of the
have to pay $500,000 in interest annually, or a
bond's maturity, bond holders would receive no
total $1.5 million over the life of the converts.
less than the par value.
If TSJ\'s stock was trading at $40 at the time
Forced Conversion of the convertible bonds issue, investors would
One downside of convertible bonds is that the have the option of converting those bonds for
issuing company has the right to call the bonds. shares at a price of $50 ($40 x 1.25 = $50).
In other words, the company has the right to Therefore if the stock was trading at say $55
forcibly convert them. Forced conversion usually by the bond\'s expiration date, that $5
occurs when the price of the stock is higher than difference per share is profit for the investor.
the amount it would be if the bond However there is usually a cap on the amount
were redeemed, or this may occur at the the stock can appreciate through the issuer\'s
bond's call date. This attribute caps the capital callable provision.
appreciation potential of a convertible bond. The For instance, TSJ executives won\'t allow the
sky is not the limit with converts as it is with share price to surge to $100 without calling
common stock. (To learn more about callable their bonds - and capping investors\' profits.
bonds, read Bond Call Features: Don't Get Alternatively, if the stock price tanks to $25 the
safety and stability. In fact, for many investors
convert holders would still be paid the face
it makes sense to have at least part of their
value of the $1,000 bond at maturity. This
portfolio invested in bonds.
means that while convertible bonds limit risk if
the stock price plummets, they also limit
This tutorial will hopefully help you determine
exposure to upside price movement if the
whether or not bonds are right for you. We'll
common stock soars.
introduce you to the fundamentals of what
Conclusion bonds are, the different types of bonds and
Getting caught up in all the details and intricacies their important characteristics, how they
of convertible bonds can make them appear behave, how to purchase them, and more.
more complex then they really are. At their most
basic, convertibles provide a sort of security
blanket for investors wishing to participate in the Read more: Bond Basics: Introduction |
growth of a particular company they're unsure of. Investopedia http://www.investopedia.com/uni
By investing in converts you are limiting versity/bonds/#ixzz4ZOPikIQG
your downside risk at the expense of limiting your Follow us: Investopedia on Facebook
upside potential.
6 Bond Basics: What Are Bonds?
Bondas basics tutorial
7 Have you ever borrowed money? Of
5 Bond Basics: Introduction course you have! Whether we hit our
parents up for a few bucks to buy candy
The first thing that comes to most people's
as children or asked the bank for
minds when they think of investing is the
a mortgage, most of us have borrowed
stock market. After all, stocks are exciting.
money at some point in our lives.
The swings in the market are scrutinized in
the newspapers and even covered by local 8 Just as people need money, so do
evening newscasts. Stories of investors companies and governments. A company
gaining great wealth in the stock market are needs funds to expand into new markets,
common. while governments need money for
everything from infrastructure to social
Bonds, on the other hand, don't have the programs. The problem large
same sex appeal. The lingo seems arcane organizations run into is that they typically
and confusing to the average person. Plus, need far more money than the average
bonds are much more boring - especially bank can provide. The solution is to raise
during raging bull markets, when they seem money by issuing bonds (or other debt
to offer an insignificant return compared to instruments) to a public market.
stocks. Thousands of investors then each lend a
portion of the capital needed. Really, a
However, all it takes is a bear market to bond is nothing more than a loan for which
remind investors of the virtues of a bond's you are the lender. The organization that
sells a bond is known as the issuer. You (bonds) an investor becomes a creditor to
can think of a bond as an IOU given by a the corporation (or government). The
borrower (the issuer) to a lender (the primary advantage of being a creditor is
investor). that you have a higher claim on assets
than shareholders do: that is, in the case
Of course, nobody would loan his or her of bankruptcy, a bondholder will get paid
hard-earned money for nothing. The before a shareholder. However, the
issuer of a bond must pay the investor bondholder does not share in the profits if
something extra for the privilege of using a company does well - he or she is
his or her money. This "extra" comes in entitled only to the principal plus interest.
the form of interest payments, which are
made at a predetermined rate and To sum up, there is generally less risk in
schedule. The interest rate is often owning bonds than in owning stocks, but
referred to as the coupon. The date on this comes at the cost of a lower return.
which the issuer has to repay the amount
borrowed (known as face value) is called
9
the maturity date. Bonds are known
as fixed-income securities because you
Why Bother With Bonds?
know the exact amount of cash you'll get
It's an investing axiom that stocks return
back if you hold the security until maturity.
more than bonds. In the past, this has
generally been true for time periods of at
For example, say you buy a bond with a
least 10 years or more. However, this
face value of $1,000, a coupon of 8%, and
doesn't mean you shouldn't invest in
a maturity of 10 years. This means you'll
bonds. Bonds are appropriate any time
receive a total of $80 ($1,000*8%) of
you cannot tolerate the short-term volatility
interest per year for the next 10 years.
of the stock market. Take two situations
Actually, because most bonds pay interest
where this may be true:
semi-annually, you'll receive two payments
of $40 a year for 10 years. When the bond
1) Retirement - The easiest example to
matures after a decade, you'll get your
think of is an individual living off a fixed
$1,000 back.
income. A retiree simply cannot afford to
lose his/her principal as income for it is
Debt Versus Equity
required to pay the bills.
Bonds are debt, whereas stocks
are equity. This is the important distinction
2) Shorter time horizons - Say a young
between the two securities. By purchasing
executive is planning to go back for an
equity (stock) an investor becomes an
MBA in three years. It's true that the stock
owner in a corporation. Ownership comes
market provides the opportunity for higher
with voting rights and the right to share in
growth, which is why his/her retirement
any future profits. By purchasing debt
fund is mostly in stocks, but the executive
cannot afford to take the chance of losing (more on this later). When a bond trades
the money going towards his/her at a price above the face value, it is said
education. Because money is needed for to be selling at a premium. When a bond
a specific purpose in the relatively near sells below face value, it is said to be
future, fixed-income securities are likely selling at a discount.
the best investment.
Coupon (The Interest Rate)
These two examples are clear cut, and The coupon is the amount the bondholder
they don't represent all investors. Most will receive as interest payments. It's
personal financial advisors advocate called a "coupon" because sometimes
maintaining a diversified portfolio and there are physical coupons on the bond
changing the weightings of asset classes that you tear off and redeem for interest.
throughout your life. For example, in your However, this was more common in the
20s and 30s a majority of wealth should past. Nowadays, records are more likely to
be in equities. In your 40s and 50s the be kept electronically.
percentages shift out of stocks into bonds
until retirement, when a majority of your As previously mentioned, most bonds pay
investments should be in the form of fixed interest every six months, but it's possible
income. for them to pay monthly, quarterly or
annually. The coupon is expressed as a
10 Bond Basics: Characteristics
percentage of the par value. If a bond
11 Bonds have a number of characteristics of pays a coupon of 10% and its par value is
which you need to be aware. All of these $1,000, then it'll pay $100 of interest a
factors play a role in determining the value year. A rate that stays as a fixed
of a bond and the extent to which it fits in percentage of the par value like this is a
your portfolio. fixed-rate bond. Another possibility is an
adjustable interest payment, known as a
12 Face Value/Par Value floating-rate bond. In this case the interest
The face value (also known as the par rate is tied to market rates through an
value or principal) is the amount of money index, such as the rate on Treasury bills.
a holder will get back once a bond
matures. A newly issued bond usually You might think investors will pay more for
sells at the par value. Corporate bonds a high coupon than for a low coupon. All
normally have a par value of $1,000, but things being equal, a lower coupon means
this amount can be much greater for that the price of the bond will fluctuate
government bonds. more.
Key Strategies
Credit risk can also affect liquidity risk, which is
influenced by investor supply and demand. Low
liquidity usually manifests itself through a
To Avoid
widening of the bid-ask spread, or a greater
difference in the quoted price between an
investor that buys a bond from one that sells.
Negative Bond
Finally, other risks include call risk, which exists if
a company is allowed to call in a bond and issue
a new one. This almost always occurs in a period
Returns
of declining rates. Finally, there is reinvestment
risk, which takes place in a period of rising rates
when an investor must reinvest a bond that has
matured, for example.
When it comes to financial markets, investors can
be sure of three things: that markets will rise, fall
Given the above risks, below are several
and at times remain the same. Everything else is
strategies of how to avoid negative bond returns.
essentially up to chance, though investors can
Again, prices are at the highest risk of falling in a
employ a mix of strategies to attempt to prudently
rising rate environment, but certain risks also
navigate the ups and downs in the markets.
exist during periods of falling or more stable rate
When it comes to investing in fixed
environment.
income or bond markets, portfolios can sustain
quite a bit of damage when interest rates are Maintain Individual Bond Positions
rising. They can even lose if expectations are that The simplest way to avoid losses in your bond
interest rates will increase in the future. portfolio in a period of rising interest rates is to
buy individual bonds and hold them to maturity.
The Primary Risks in Bond Investing
With this method, an investor is reasonably
In order to navigate the risk of negative
assured to receive principal back at maturity, and
bond returns, investors must be cognizant of the
this method eliminates interest rate risk. The
primary risk factors that affect bond prices. The
current bond price may decline when rates rise,
first is interest rate risk. Bonds fall in price when
but the investor will receive his or her original
interest rates rise, because investors are able to
investment back at the defined maturity date of
invest in new bonds with similar features that pay
the bond.
the higher bond coupon rates. To equalize the
market coupon rate, the existing bonds must fall Credit risk can also be eliminated, especially for
in price. Secondly, bond prices can fall because stronger credit ratings because there is minimal
risk that the underlying company Sell Short Your Bonds
becomes insolvent and is unable to pay back its For more adventurous investors, there are some
debts. Liquidity risk is also eliminated by buying opportunities to short bonds. As with any
and holding a bond until maturity, because there security, going short means borrowing the
is no need to trade it. In a period of declining security and anticipating a fall in price, after
interest rates, the one risk that cannot be which the investor can buy it and return what has
eliminated is reinvestment risk, because the been borrowed. The market for shorting an
funds received at maturity will need to be individual bond is not large or liquid, but there are
reinvested at a lower coupon rate. However, this plenty of opportunities for individual investors to
is a favorable outcome in a period of rising rates. invest in short bond mutual funds and exchange-
traded funds.
The main alternative to investing in individual
bonds is through bond funds. In a period of rising Other Considerations
rates, these funds will see their positions decline There are, of course, many other strategies and
in market value. A key reason that these losses combinations to employ to try and avoid negative
can be permanent is many fund bond returns. This includes hedging techniques,
managers actively buy and sell bonds, meaning such as using futures, options and swap spreads
they are highly likely to sell positions at a loss to speculate on rising (or falling) rates along
after a rise in rates, decline in credit rating or certain parts of the yield curve, or on specific
when a lack of liquidity may mean they have to bond classes or credit ratings. Inflation rates and
sell at a lower market price. For these reasons, expectations for future inflation are also
individual bonds can definitely make more sense. important considerations when investing in
bonds. Inflation-adjusted bonds, such
Stay Short when Rates Rise as Treasury Inflation Protected Securities, can
In a rising interest rate environment, or period help investors reduce the damage that inflation
where rates are projected to rise in the future, can do on real bond returns.
staying invested in bonds with nearer-term
maturity dates can be important. Fundamentally, As detailed above, investing in bond funds can be
interest rate risk is lower for bonds that have tricky in a period of rising rates, but they do have
closer maturity dates. Bond duration, which benefits in that the investor is outsourcing his or
measures the sensitivity of a bond price to her capital to a bond professional that should
changes in interest rates, demonstrates that have a fair level of expertise in specific bond
prices change less for closer maturity dates. At strategies in a mix of interest rate environments.
the shortest maturity date for money markets
funds, they adjust immediately to the higher rate The Bottom Line
and in the vast majority of cases do not Despite the nearly infinite combination of
experience any loss of principal. Overall, staying strategies that can be employed to speculate on
on the shorter end of the maturity schedule can rising or falling rates as well as try and eliminate
help the bond investor avoid negative bond the key risks to investing bonds identified above,
returns, and provide for a pick-up in yield during a the best approach to investors may be to hold a
period of rising rates. diversified mix of bond classes across a wide
array of maturity dates. As with any asset, stable returns. (For background reading, check
speculators will try and predict the market's out our Bond Basics Tutorial.)
direction, but most investors would sleep better at
night by simply buying bonds at existing interest A Safe Investment
rate levels and holding them until maturity. The Government-backed bonds come in the form
hiring of a bond professional or investing directly of Treasury bills (T-bills), notes and bonds. T-bills
in bond funds can also make sense in certain are short-term U.S. government securities with
circumstances. maturity of a year or less. They can be bought
through a broker, a bank or directly from the
It is most difficult to make money in bonds in a
government. At maturity, the buyer of the T-bill
rising rate environment, but there are ways to
receives the full amount stated on the bond
avoid losses of principal and minimize the hit to
certificate. The difference between the face
your current bond portfolio. At the end of the day,
amount and the amount the bondholder paid for
higher rates are better for your portfolio as they
the certificate is considered the interest gained.
increase portfolio income levels, but investors
This interest is exempt from state and local
should work to make as smooth a transition as
income taxes, but not from federal income taxes.
possible to eventually benefit from the increase in
yields. Treasury notes have a longer term; they are
issued for two-, three-, five-, or 10-year periods,
How To Choose
and their interest rates are fixed. Treasury note
and bond owners receive interest payments
every six months. That interest must be reported
For You
securities (TIPS) and U.S. government savings
bonds such as Series EE bonds. (Several factors
affect the taxable interest that must be reported;
When it comes to investing, bonds are generally learn more in Bond Taxation Rules.)
the best low-risk financial instruments available.
Although they gain low interest amounts, the I Bonds
majority of bonds have the advantage of being I bonds are savings bonds backed by the U.S.
government-backed. In times of market volatility, government. The difference between these bonds
the allure of bonds gains momentum because of and the regular treasury bonds is in the interest
their dependability. Usually, investors look for gained. The rate earned on these bonds is
security after experiencing a precipitous actually a combination of two rates: a fixed
downturn in the stock market. As a result, more interest rate set when the investor buys the bond
investors will park their funds in securities such and a semiannual variable rate tied to the
as U.S. Treasuries, which gain conservative yet current inflation rate. The maximum purchase for
an I bond is $5,000 per calendar year, and the
interest stops accruing 30 years after it is issued. all the bonds. (Learn more in The Lowdown On
Earnings from these bonds are exempt from state Savings Bonds and Bond Taxation Rules.)
and local taxes, and federal taxes can be
deferred until the bond is either redeemed or Corporate bonds - long-term debt issued by a
reaches the maturity date. One key benefit here corporation - are also interest bearing.
is that if this bond is cashed to pay education Companies issue these bonds as a way to
expenses, it is completely tax exempt. However, if increase company funds to finance major
the bond is redeemed within the first five years, projects. These are long-term taxable bonds that
the holder will be penalized the previous three pay the highest interest rate of all the bonds, due
months' interest rate. (ILBs, such as TIPS and I- to increased risk of default. The advantage for
Bonds, allow investors to curb the corrosive the investor is that companies are required to pay
effects of inflation and increase portfolio bondholders first, before short-term creditors, in
diversification; see Hedge Your Bets With times of financial difficulty.
Inflation-Linked Bonds.)
Where to Put Your Money
TIPS Moody's Bond Survey and Standard and
To protect yourself against inflation, you can also Poor's can also help you make a decision on
purchase the inflation indexed $1,000 bonds where to put your money. These rating services
known as TIPS. These bonds guarantee to beat grade bonds based on the credit risk of the
inflation because the principal is adjusted every corporation or municipality issuing the bond. The
six months according to the consumer price quality and creditworthiness of the issuing
index, so if inflation occurs the principal amount company is displayed through these bond ratings.
increases. The interest rate on these bonds never A high quality bond rating of AAA from Standard
changes and is set when the security is and Poor's, for example, means the bond is of
purchased. The terms of these bonds are from the highest investment quality, suggesting the
five to 30 years and interest is paid out to company will have the ability to pay both principal
investors every six months until maturity. and interest at maturity. On the opposite end of
the spectrum, a rating of DDD means the
5 Fixed Income Plays After the Fed move more toward investing in professionally
managed bond mutual funds or exchange-traded
Rate Increase funds (ETFs). Professional bond portfolio
managers can often make better or timelier
Rising interest rates can cause problems for fixed
adjustments to the changing rate environment
income investors. One of the basic concepts of
than an individual investor operating on his own
bond investing is the inverse relationship that
might manage.
exists between interest rates and bond prices. As
interest rates rise, bond prices normally fall.
Rates mean that the prices of existing bonds
2) Shorter Maturities
offering lower rates must drop to attract buyers. Investors can adjust their bond holdings to bonds
For example, if an investor buys a $5,000 bond of shorter duration. Shorter-term bonds are less
with a coupon rate of 5%, but the interest rate susceptible to negative value impacts from rising
offered on the same type of bond rises to 6%, rates, since interest rates do not generally
bond buyers will be unwilling to pay the $5,000 change significantly over the short term. Bonds
original price for those 5% bonds when they can with shorter durations afford investors the
now invest the same amount of money and opportunity to cash in their bonds and reinvest
receive 6% interest. To make the 5% bonds within a shorter span of time, when negative
marketable, they must be offered for sale at a effects from rising rates should be minimal. As
discounted price. Investors who already hold the rates do gradually rise, investors can regularly
5% bonds are looking at their investments losing reinvest in new bonds offered at higher interest
value. rates.
Long Dates
APY = (1 + 0.03)^2 1 =
For "long-dated" T-bills that have a maturity of
6.09%
more than 182 days, the usual conversion
Yields on Treasury notes and bonds, corporate formula is a little more complicated because of
bonds and municipal bonds are quoted on compounding. The formula is:
a semiannual bond basis (SABB) because their
coupon payments are made semiannually.
Compounding is twice a year, and a 365-day year
is used.
Conversions
Short Dates
In order to properly compare the yields on implicit compounding period for the BEY is the
different fixed-income investments, it is important number of days between settlement and maturity.
However, the BEY for a long-dated T-bill does not
have any well-defined compounding assumption
which makes its interpretation rather difficult.
BEYs are systematically less than the annualized A convenient feature in this equation is that it is
yields for semi-annual compounding. In general, stated as a function only of N and DR, which are
for the same current and future cash flows, more directly observable for any traded T-bill. It is not
frequent compounding at a lower rate necessary to calculate the price of the bill,
corresponds to less frequent compounding at a making the equation a little easier to program into
higher rate. A yield for more frequent than a spreadsheet and avoiding
semiannual compounding - such as is implicitly unnecessary rounding errors. Another key
assumed with both short-dated and long-dated feature is that this conversion formula applies to
BEY conversions - must be lower than the both short-dated and long-dated T-bills. Unlike
corresponding yield for actual semiannual BEYs, the SABB presents the yields in a form
compounding. fully comparable to the yields on Treasury notes
and bonds. The formula converts the T-bill
BEYs and the Treasury discount rate, quoted for a 360-day year and
BEYs reported by the Federal Reserve and 360/N compounding periods per year, to a more
other financial market institutions should not be reasonable investment yield, quoted for a 365-
used as a comparison to the yields on longer day year and two compounding periods.
maturity bonds. The problem is not that the
widely used BEYs are inaccurate, they just serve Conclusion
a different purpose. That purpose is to facilitate In summary, comparison of alternative fixed-
comparison of yields on T-bills, T-notes and T- income investments always requires conversion
bonds maturing on the same date. To make an of yields to a common basis. The general rule is
accurate comparison, discount rates should be that the effects of compounding should be
converted to a semiannual bond basis (SABB), included and conversions should always be done
because that is the basis commonly used for on a 365-day bond basis. Comparing bond yields
longer maturity bonds. may not be easy, but it shouldn't be too difficult
for the average investor either.
To calculate SABB, the same formula to calculate
Advanced Bond
APY is used. The only difference is that
compounding happens twice a year. Therefore,
APYs using a 365-day year can be directly
Concepts
compared to yields based on SABB.
periods one, two and three. Notice how the present semi-annual, divide the coupon rate in half. The
value decreases for those coupon payments that are coupon rate is the percentage off the bond's par
further into the future the present value of the second value. As a result, each semi-annual coupon
coupon payment is worth less than the first coupon payment will be $50 ($1,000 X 0.05).
the less it is worth today - is the fundamental concept coupon rate, the required yield of 12% must be
for which the PV-of-ordinary-annuity formula accounts. divided by two because the number of periods
It calculates the sum of the present values of all future used in the calculation has doubled. If we left the
cash flows, but unlike the bond-pricing formula we saw required yield at 12%, our bond price would be
earlier, it doesn't require that we add the value of each very low and inaccurate. Therefore, the required
coupon payment. semi-annual yield is 6% (0.12/2).
By incorporating the annuity model into the bond
pricing formula, which requires us to also include the 4. Plug the Amounts Into the Formula:
In the last section of this tutorial, we touched on So, if you purchased a bond with a par value of
the concept of required yield. In this section we'll $100 for $95.92 and it paid a coupon rate of 5%,
explain what this means and take a closer look this is how you'd calculate its current yield:
into how various yields are calculated.
Notice how this calculation does not include place of the market price in the above
any capital gains or losses the investor would equation. The dirty price is what you will
make if the bond were bought at a discount or actually pay for the bond, but usually the
premium. Because the comparison of the bond figure quoted in U.S. markets is the clean
price to its par value is a factor that affects the price.
actual current yield, the above formula would give
a slightly inaccurate answer - unless of course Now we must also account for other factors
the investor pays par value for the bond. To such as the coupon payment for a zero-
correct this, investors can modify the current yield coupon bond, which has only one coupon
formula by adding the result of the current yield to payment. For such a bond, the yield
the gain or loss the price gives the investor: [(Par calculation would be as follows:
Value Bond Price)/Years to Maturity]. The
modified current yield formula then takes into
account the discount or premium at which the
investor bought the bond. This is the full n = years left until maturity
calculation: If we were considering a zero-coupon bond that
has a future value of $1,000 that matures in two
years and can be currently purchased for $925,
we would calculate its current yield with the
following formula:
To demonstrate this method, we first need to Thirdly, remember to think of YTM as the yield a
review the relationship between a bond's price bondholder receives if he or she reinvested all
and its yield. In general, as a bond's price coupons received at a constant interest rate,
increases, yield decreases. This relationship which is the interest rate that we are solving for. If
is measured using the price value of a basis we were to add the present values of all future
point (PVBP). By taking into account factors cash flows, we would end up with the market
such as the bond's coupon rate and credit value or purchase price of the bond.
rating, the PVBP measures the degree to
which a bond's price will change when there is The calculation can be presented as:
a 0.01% change in interest rates.
T-bills are issued by the government, but they do When inflation rates are increasing (or the
not have maturities greater than one year. As a economy is contracting) the credit spread
result, the bootstrapping method is used to fill in between corporate and Treasury securities
interest rates for zero-coupon securities greater widens. This is because investors must be
than one year. Bootstrapping is a complicated offered additional compensation (in the form of a
and involved process and will not be detailed in higher coupon rate) for acquiring the higher risk
this section (to your relief!); however, it is associated with corporate bonds.
important to remember that the bootstrapping
method equates a T-bill's value to the value of all When interest rates are declining (or the
zero-coupon components that form the security. economy is expanding), the credit spread
between Federal and corporate fixed-income
The Credit Spread securities generally narrows. The lower interest
The credit spread, or quality spread, is the rates give companies an opportunity to borrow
additional yield an investor receives for acquiring money at lower rates, which allows them to
a corporate bond instead of a similar federal expand their operations and also their cash flows.
instrument. As illustrated in the graph below, the When interest rates are declining, the economy is
spread is demonstrated as the yield curve of the expanding in the long run, so the risk associated
corporate bond and is plotted with the term with investing in a long-term corporate bond is
also generally lower.
Let's first work through some visual models that
Now you have a general understanding of the demonstrate the properties of duration for a zero-
concepts and uses of the yield curve. The yield coupon bond and a vanilla bond.
curve is graphed using government securities,
which are used as benchmarks for fixed income Duration of a Zero-Coupon Bond
investments. The yield curve, in conjunction with
the credit spread, is used for pricing corporate
bonds. Now that you have a better understanding
of the relationship between interest rates, bond
prices and yields, we are ready to examine the
degree to which bond prices change with respect
to a change in interest rates.
Macaulay Duration
Example 1: Betty holds a five-year bond
The formula usually used to calculate a
with a par value of $1,000 and coupon rate
bond\'s basic duration is the Macaulay
of 5%. For simplicity, let's assume that the
duration, which was created by Frederick
coupon is paid annually and that interest
Macaulay in 1938, although it was not
rates are 5%. What is the Macaulay duration
commonly used until the 1970s. Macaulay
of the bond? an approximate 1% change in yield.
Because the modified duration formula
shows how a bond's duration changes in
relation to interest rate movements, the
formula is appropriate for investors wishing
to measure the volatility of a particular bond.
Modified duration is calculated as the
following:
OR
Modified Duration
Modified duration is a modified version of
the Macaulay model that accounts for
changing interest rates. Because they affect
yield, fluctuating interest rates will affect
duration, so this modified formula shows
how much the duration changes for each = 4.33 years
percentage change in yield. For bonds
without any embedded features, bond price Our example shows that if the bond's yield
and interest rate move in opposite changed from 5% to 6%, the duration of the
directions, so there is an inverse bond will decline to 4.33 years. Because it
relationship between modified duration and calculates how duration will change when
interest increases by 100 basis points, the interest rates. The key-rate method is most
modified duration will always be lower than often used for portfolios such as the bond
the Macaulay duration. ladder, which consists of fixed-income
securities with differing maturities. Here is
Effective Duration the formula for key-rate duration:
The modified duration formula discussed
above assumes that the expected cash
flows will remain constant, even if prevailing
interest rates change; this is also the case
for option-free fixed-income securities. On The sum of the key-rate durations along the
the other hand, cash flows from securities curve is equal to the effective duration.
with embedded options or redemption
Duration and Bond Price Volatility
features will change when interest rates
More than once throughout this tutorial, we have
change. For calculating the duration of
established that when interest rates rise, bond
these types of bonds, effective duration is
prices fall, and vice versa. But how does one
the most appropriate.
determine the degree of a price change when
interest rates change? Generally, bonds with a
Effective duration requires the use of
high duration will have a higher price fluctuation
binomial trees to calculate the option-
than bonds with a low duration. But it is important
adjusted spread (OAS). There are entire
to know that there are also three other factors
courses built around just those two topics,
that determine how sensitive a bond's price is to
so the calculations involved for effective
changes in interest rates. These factors are term
duration are beyond the scope of this
to maturity, coupon rate and yield to maturity.
tutorial. There are, however, many programs
Knowing what affects a bond's volatility is
available to investors wishing to calculate
important to investors who use duration-
effective duration.
based immunization strategies, which we discuss
below, in their portfolios.
Key-Rate Duration
The final duration calculation to learn is key-
rate duration, which calculates the spot Factors 1 and 2: Coupon rate and Term
durations of each of the 11 "key" maturities to Maturity
along a spot rate curve. These 11 key If term to maturity and a bond\'s initial price
maturities are at the three-month and one, remain constant, the higher the coupon, the
two, three, five, seven, 10, 15, 20, 25, and lower the volatility, and the lower the
30-year portions of the curve. coupon, the higher the volatility. If the
coupon rate and the bond\'s initial price are
In essence, key-rate duration, while holding constant, the bond with a longer term to
the yield for all other maturities constant, maturity will display higher price volatility
allows the duration of a portfolio to be and a bond with a shorter term to maturity
calculated for a one-basis-point change in will display lower price volatility.
Therefore, if you would like to invest in a
bond with minimal interest rate risk, a bond So, if a bond has both a short term to maturity
with high coupon payments and a short and a low coupon rate, its characteristics have
term to maturity would be optimal. An opposite effects on its volatility: the low coupon
investor who predicts that interest rates will raises volatility and the short term to maturity
decline would best potentially capitalize on lowers volatility. The bond's volatility would then
a bond with low coupon payments and a be an average of these two opposite effects.
long term to maturity, since these factors
would magnify a bond\'s price increase. Immunization
Factor 3: Yield to Maturity (YTM) As we mentioned in the above section, the
The sensitivity of a bond\'s price to changes interrelated factors of duration, coupon rate, term
in interest rates also depends on its yield to to maturity and price volatility are important for
maturity. A bond with a high yield to maturity those investors employing duration-based
will display lower price volatility than a bond immunization strategies. These strategies aim to
with a lower yield to maturity, but a similar match the durations of assets and liabilities within
coupon rate and term to maturity. Yield to a portfolio for the purpose of minimizing the
maturity is affected by the bond\'s credit impact of interest rates on the net worth. To
rating, so bonds with poor credit ratings will create these strategies, portfolio managers use
have higher yields than bonds with excellent Macaulay duration.
credit ratings. Therefore, bonds with poor
credit ratings typically display lower price For example, say a bond has a two-year term
volatility than bonds with excellent credit with four coupons of $50 and a par value of
ratings. $1,000. If the investor did not reinvest his or her
proceeds at some interest rate, he or she would
have received a total of $1200 at the end of two
All three factors affect the degree to which bond
years. However, if the investor were to reinvest
price will change in the face of a change in
each of the bond cash flows until maturity, he or
prevailing interest rates. These factors work
she would have more than $1200 in two years.
together and against each other. Consider the
Therefore, the extra interest accumulated on the
chart below:
reinvested coupons would allow the bondholder
to satisfy a future $1200 obligation in less time
than the maturity of the bond.
Yield to Put
corporate bond provides based specifically on its maturity rate, then the investor's yield will differ
market price and coupon rate as opposed from the yield to maturity. It's important to note
to basing it on par or face value. This yield is that the calculation for a yield to maturity includes
determined by taking the bonds annual interest consideration for any capital losses, gains, or
and dividing that amount by its current market income investors experience when holding a
price. To make this clear, consider this simple bond all the way to maturation).
Should Avoid
will take for the price of a bond to be repaid by
internal cash flows. In essence, duration
measures price sensitivity to yield changes by
Fixating on
measuring the approximate change of a
securitys price that will result from a 100 basis
point change in yield. Longer durations suggest
Bond Portfolio
greater sensitivity to changes in interest rates and
vice versa. (For more, see: Advanced Bond
Concepts: Duration.)
For instance, the 2008 economic crisis saw Duration Doesnt Always Work
government bonds gain nearly 28% and non- Standard bond valuation formulas look at a
government investment grade bonds fall nearly simple set of criteria, including interest rates,
4%, according to Morningstar, Inc. (MORN) data, yield, and duration to determine expected cash
despite the similar durations, interest rate risk, flows that can be discounted to present value.
and other characteristics. The opposite dynamics When looking at Treasury bonds, these dynamics
occurred in 2009 when the market snapped back. are extremely predictable and work pretty well at
The irony is that bonds are usually a part of a approximating valuations, although raw
clients portfolio designed to have less risk. economics can have an impact during a so-called
flight to safety. (For more, see: Use Duration
and Convexity to Measure Bond Risk.)
When analyzing other types of bonds, its not Foreign exchange risks and other risks may apply
always appropriate to use duration as the only to specialized funds that invest in foreign markets
metric, particularly when referencing Treasury or exotic bonds.
bonds. Treasury bonds may be effectively used
as proxies during non-volatile times for For financial advisors, bond choices should look
investment-grade bonds, but these comparisons beyond yield to include safety as it applies to a
can fall apart during volatile periods (when they clients financial objectives. Bonds are often
really matter), such as during the 2008 decline intended to be a safety net of sorts to hedge
and again during the 2009 recovery. against a decline in equities, but the safety net
may not be very effective if the bond portfolio
Bond portfolio durations are also simply a consists of risky junk bond issues. In summary,
weighted average of its underlying bonds, which its tempting to look at duration and yield, but
have various weights and maturities. there are many other important factors. (For
Consequently, the gain or loss predicted by more, see: Six Biggest Bond Risks.)
analyzing duration will only be accurate if the
market yields change the same amount for every The Bottom Line
bond across the maturity spectrum a scenario Duration can be useful for estimating the interest
thats highly uncommon which makes looking rate risks associated with bonds that are closely
at the fine print of these funds very important. tracking Treasury bonds. When investors deviate
(For more, see: Investments with Low Interest too far from those bonds, the metric becomes far
Rate Risk and High Yields.) less useful at encompassing all of the different
types of risks being measured. Financial advisors
Consider Other Risk Factors and their clients should then focus on a bond
Duration is certainly an important consideration funds portfolio rather than relying on any single
when interest rates are expected to rise or fall, metric like duration. (For more, see: Is it Time to
but there are many other risks that should also be Buy Floating Rate Bonds?)
carefully evaluated, including inflation risk, default
risk, and call risk, among others. While some of
these risks may not apply to U.S. government Portfolo managment
bonds like default risk corporate bonds and
17.1 Introduction
bond funds must be discounted to account for
these risks. (For more, see: Interest Rates and Welcome to the wild and wonderful world of Debt
Your Bond Investments.) Securities. In this part of the guide you will learn
the basic definitions and calculation concerning
Bond funds also have a number of separate fixed income securities. This study guide is
dynamics that should be carefully evaluated, designed so that every LOS is answered.
such as risk concentration among individual However, if you do not understand a concept, be
bonds or bond types. In some cases, credit risk sure to refer to the reading recommended by the
can be mitigated through diversification, but it CFA Institute or one of Investopedia's tutorials.
doesnt make these risks disappear entirely.
Formula 17.1
We'll start with the Example: Real risk-
Real risk free rate (Rf) = (1 + nominal risk-free rate) - 1
basics of debt free rate of return
(1 + inflation rate)
investments in the first Determine the real
half of the section. In risk-free rate if the
the second half, we'll examine bond analysis and nominal risk-free rate is 8% and the inflation rate
valuation. The first portion of this section will is 3%.
describe a bond's features. The next portion will
mainly cover the 10 risks of debt investments Answer:
before moving on to more challenging concepts.
Rf = (1 + 0.08) - 1 = 4.85%
(1 + 0.03)
If the topic of debt securities is new to you or you
haven't reviewed its theory for a while, you may
Nominal risk-free rate of return (Rnominal)
want to check out the following tutorial: Bond and
This is simply the real risk-free rate of return
Debt Basics
adjusted for inflation.
This return varies over time and is comprised of Rnominal = (1 + 0.03) x (1 + 0.03) - 1 = 6.09%
the following:
1. Business Risk: Business risk is the risk Read more: The Risk Premium - CFA Level 1 |
that a business' cash flow will not meet its Investopedia http://www.investopedia.com/exam-
needs due to uncertainty in the company's guide/cfa-level-1/portfolio-management/risk-
business lines. premium.asp#ixzz4ZOV1exNf
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2. Financial Risk: Financial risk is the risk to
equity holders as a company increases its 17.4 The Security Market Line (SML)
debt load. As debt load increases, interest
The security market line (SML) is the line that
expense also increases, leading to less
reflects an investment's risk versus its return, or
income to be paid out to investors.
the return on a given investment in relation to
3. Liquidity Risk: Liquidity risk is the risk. The measure of risk used for the security
uncertainty around the ability to sell an market line is beta.
investment. The more liquid an investment
is the easier it is to sell. The line begins with the risk-free rate (with zero
risk) and moves upward and to the right. As the
4. Exchange-Rate Risk: Exchange-rate risk risk of an investment increases, it is expected
is the risk a company faces when it has
that the return on an investment would increase. The portfolio management process is the process
An investor with a low risk profile would choose an investor takes to aid him in meeting his
an investment at the beginning of the security investment goals.
market line. An investor with a higher risk profile
would thus choose an investment higher along The procedure is as follows:
the security market line.
1. Create a Policy Statement -A policy
Figure 17.1: Security Market Line statement is the statement that contains
the investor's goals and constraints as it
relates to his investments.
Wealth and income - an investor may 4. Total Return - Total return is the need to
have a greater ability to invest in a grow the capital base through both capital
portfolio if he or she has existing wealth or appreciation and reinvestment of that
high income. appreciation.
Worst
10% 10%
Case
+ .....+ pnRn
n actually will occur in state n
Example:
For Newco's stock, assume the following
potential returns.
Example: Figure: Expected return for Newco in various
Assume an investment manager has created a states
portfolio with the Stock A and Stock B. Stock A
has an expected return of 20% and a weight of Probabili Retur Expected
Scenario ty n Return
30% in the portfolio. Stock B has an expected
return of 15% and a weight of 70%. What is the Worst 10%
10% 0.01
expected return of the Case
portfolio?
Base Case 80% 14% 0.112
Formula 17.5
Answer: Best Case 10% 18% 0.018
Variance =
E(R) = (0.30)(20%) +
Where: Pn = probability of occurrence
(0.70)(15%)
Rn = return in n occurrence
= 6% + 10.5% = 16.5%
E(R) = expected return Answer:
The expected return of the
2 = (0.10)(0.10 - 0.14)2 + (0.80)
portfolio is 16.5%
(0.14 - 0.14)2 + (0.10)(0.18 - 0.14)2
= 0.0003
Computing Variance and Standard Deviation
for an Individual
The variance for Newco's stock is 0.0003.
To measure the risk of an investment, both the
variance and standard deviation for that
Given that the standard deviation of Newco's
investment can be calculated.
stock is simply the square root of the variance,
the standard deviation is 0.0179 or 1.79%.
Covariance
The covariance is the measure of how two assets
relate (move) together. If the covariance of the
two assets is positive, the assets move in the
same direction. For example, if two assets have a
covariance of 0.50, then the assets move in the
same direction. If however the two assets have a
negative covariance, the assets move in opposite
directions. If the covariance of the two assets is
Example: Variance and Standard Deviation of zero, they have no relationship.
an Investment
Given the following data for Newco's stock,
calculate the stock's variance and standard
deviation. The expected return based on the data
is 14%.
The correlation coefficient is the relative measure
of the relationship between two assets. It is
between +1 and -1, with a +1 indicating that the
two assets move completely together and a -1
indicating that the two assets move in opposite
directions from each other.
Returns
Ra Rb
N
Example: Calculate the correlation of Asset A
1 10% 18%
Answer: with Asset B.
2 15% 25% Given our covariance of 18 in the example above,
what is the correlation coefficient for Asset A
3 5%
Ra Rb 2% Ra- Avg Ra
N relative to Asset B if Asset A has a standard
4 13% 8% deviation of 4 and Asset B has a standard
1 10 18 0 deviation of 3.
5 8% 17%
2 15 25 5
Answer:
3 5 2 -5 Correlation coefficient = 18/(8)(4) = 0.563
4 13 8 3
Components of the Portfolio Standard
5 8 17 -2
Deviation Formula
Remember that when calculating the expected
Sum return of a portfolio, it is simply the sum of the
weighted returns of each asset in the portfolio.
Unfortunately, determining the standard deviation
The covariance would equal 18 (90/5). of a portfolio, it is not that simple. Not only are the
weights of the assets in the portfolio and the
standard deviation for each asset in the portfolio
Correlation
needed, the correlation of the assets in the
portfolio is also required to determine the portfolio 5. No Taxes and Transaction Costs -
standard deviation. assume that investors' results are not
affected by taxes and transaction costs.
The equation for the standard deviation for a two
6. All Investors Have the Same
asset portfolio is long, but should be memorized
Probability for Outcomes -When
for the exam.
determining the expected return, assume
that all investors have the same probability
for outcomes.
Answer:
The standard deviation equation for a
portfolio of two assets is rather long,
however, given the standard deviation of
the risk-free asset is zero, the equation is
simplified quite nicely. The standard
Systematic and Unsystematic Risk
Total risk to a stock not only is a function of the
risk inherent within the stock itself, but is also a Example: CAPM model
function of the risk in the overall Determine the expected return on Newco's stock
market. Systematic risk is the risk associated with using the capital asset pricing model. Newco's
the market. When analyzing the risk of an beta is 1.2. Assume the expected return on the
investment, the systematic risk is the risk that market is 12% and the risk-free rate is 4%.
cannot be diversified away.
Answer:
Unsystematic riskis the risk inherent to a stock. E(R) = 4% + 1.2(12% - 4%) = 13.6%.
This risk is the aspect of total risk that can be
diversified away when building a portfolio. Using the capital asset pricing model, the
expected return on Newco's stock is 13.6%.
e market Answer:
Asset Allocation: The key to effective portfolio entails the sale of high-priced/low-value
management is the long-term mix of assets. securities and the redeployment of the proceeds
that different types of assets do not move in securities. The annual iteration of rebalancing
concert, and some are more volatile than others. enables investors to capture gains and expand
Asset allocation seeks to optimize the risk/return the opportunity for growth in high potential
profile of an investor by investing in a mix of sectors while keeping the portfolio aligned with
assets that have low correlation to each other. the investors risk/return profile.
Allocation
distinct from direct investment, which involves
taking a sizable stake in a target company and
possibly being involved with its day-to-day
management.
Dynamic asset allocation is a portfolio
management strategy that involves rebalancing a BREAKING DOWN 'Portfolio
portfolio so as to bring the asset mix back to its
long-term target. Such rebalancing would Investment'
generally involve reducing positions in the best- Portfolio investments can span a wide range
performing asset class, while adding to positions of asset classes such as stocks, government
in underperforming assets. The general premise bonds, corporate bonds, Treasury bills, real
of dynamic asset allocation is to reduce the estate investment trusts (REITs), exchange-
fluctuation risks and achieve returns that exceed traded funds (ETFs), mutual funds
the target benchmark. and certificates of deposit. Portfolio investments
can also include options, derivatives such as
BREAKING DOWN 'Dynamic warrants and futures, and physical investments
such as commodities, real estate, land and
Asset Allocation' timber.
For example, an investor with a $100,000
The composition of investments in a portfolio
portfolio may want to hold 50% each of stocks
depends on a number of factors. Some of the
and bonds. After a couple of years, when stocks
most important include the investors risk
have outperformed bonds, the portfolio now holds
tolerance, investment horizon and amount
$65,000 in stocks and $55,000 in bonds.
invested. For a young investor with limited funds,
Assuming the investor wishes to retain the
mutual funds or exchange-traded funds may be
original 50:50 asset mix, dynamic asset allocation
appropriate portfolio investments. For a high net
would result in the sale of $5,000 worth of stocks
worth individual, portfolio investments may
from the portfolio, and the proceeds would be
include stocks, bonds, commodities and rental
used to buy bonds
properties.
Retirement
BREAKING DOWN 'Aggressive
Investors saving for retirement should focus on a
diversified mix of low-cost investments for their Investment Strategy'
portfolios. Index funds have become popular in The aggressiveness of an investment strategy
individual retirement accounts (IRAs) and 401(k) depends on the relative weight of high-reward,
accounts due to their broad exposure to a high-risk asset classes such as equities
number of asset classes at a minimum expense and commodities within the portfolio.
level. These types of funds make ideal core
holdings in retirement portfolios. Those wishing to For example, Portfolio A which has an asset
take a more hands-on approach may tweak allocation of 75% equities, 15% fixed income and
portfolio allocations by adding additional asset 10% commodities would be considered quite
classes such as real estate, private equity and aggressive, since 85% of the portfolio is weighted
individual stocks and bonds to their portfolio mix. to equities and commodities. However, it would
still be less aggressive than Portfolio B, which BREAKING DOWN 'Asset
has an asset allocation of 85% equities and 15%
commodities. Allocation'
There is no simple formula that can find the right
But even within the equity component of an asset allocation for every individual. However, the
aggressive portfolio, the composition consensus among most financial professionals is
of stocks can have a significant bearing on its risk that asset allocation is one of the most important
profile. For instance, if the equity component only decisions that investors make. In other words, the
comprises blue-chip stocks, it would be selection of individual securities is secondary to
considered less risky than if the portfolio only the way that assets are allocated in stocks,
held small-capitalization stocks. If this is the case bonds, and cash and equivalents, which will be
in the earlier example, Portfolio B could arguably the principal determinants of your investment
be considered less aggressive than Portfolio A, results.
even though it has 100% of its weight in
Investors may use different asset allocations for
aggressive assets.
different objectives. Someone who is saving for a
An aggressive strategy needs more active new car in the next year, for example, might
management than a conservative buy-and-hold invest her car savings fund in a very conservative
strategy, since it is likely to be much more volatile mix of cash, certificates of deposit (CDs) and
and would need more frequent adjustments to short-term bonds. Another individual saving for
tailor it to changing market conditions. More retirement that may be decades away typically
frequent rebalancing would also be required to invests the majority of his individual retirement
bring portfolio allocations back to their target account (IRA) in stocks, since he has a lot of time
levels, as the volatility of the assets that comprise to ride out the market's short-term fluctuations.
an aggressive portfolio will quite often lead Risk tolerance plays a key factor as well.
allocations to deviate significantly from the Someone not comfortable investing in stocks may
original or target weights.} put their money in a more conservative allocation
despite a long time horizon.
Bonds = 35%
Allocation TAA
Commodities = 10%
Actively
very large increase in demand for commodities
over the next 18 months. It may be prudent for an
investor to shift more capital into that asset class
Managed ETF
to take advantage of the opportunity. While the
above portfolio's strategic allocation will remain
the same, the tactical allocation may then
become:
An exchange-traded fund that has a manager or
Cash = 5% team making decisions on the underlying
portfolio allocation or otherwise not following a
Bonds = 35% passive investment strategy. An actively
managed ETF will have a benchmark index, but
Stocks = 45% managers may change sector allocations,
market-time trades or deviate from the index as
Commodities = 15%
they see fit. This produces investment returns
that will not perfectly mirror the underlying index.
Tactical shifts can also occur within an asset
class. Assume the 45% strategically allocated to
stocks consists of 30% large cap and 15% small BREAKING DOWN 'Actively
cap. If the outlook for small-cap stocks does not Managed ETF '
look favorable, it may be a wise tactical decision
There's no hard-and-fast rule as to whether an
to shift the allocation within stocks to 40% large
actively managed fund will under- or outperform a
cap and 5% small cap for a short time until
passive-ETF rival. Passive ETFs can at least be
conditions change.
counted on to follow their indexes faithfully, which
allows investors to know up front
Usually, tactical shifts range from 5 to 10%,
the holdings and risk profile of the fund. This
though they can be lower. In practice, it is very
helps to keep a diversified portfolio in line with
rare to tactically adjust any asset class by more
expectations.
than 10%. This would show a fundamental
problem with the construction of the strategic
Actively managed funds, however, have the
asset allocation.
freedom to trade outside of their benchmark
indexes, which makes it more difficult for
investors to anticipate the future makeup of the returns of the equity markets. Proponents of the
portfolio. risk parity strategy state that while the 60/40
approach performs well during bull markets and
Risk Parity
periods of economic growth, it tends to fail
during bear markets and economic slumps. The
risk parity approach attempts to balance the
portfolio to perform well under a variety of
Risk parity is a portfolio allocation strategy based
economic and market conditions.
on targeting risk levels across the various
components of an investment portfolio. The Several risk parity-specific products,
risk parity approach to asset allocation allows including mutual funds, are available, and
investors to target specific levels of risk and to investors can also build their own risk parity
divide that risk equally across the entire portfolios through careful research or by working
investment portfolio in order to achieve optimal with a qualified financial professional. The first
portfolio diversification for each individual risk parity fund, the All Weather hedge fund, was
investor. Risk parity strategies are in contrast to introduced by Bridgewater Associates in 1996.
traditional allocation methods that are based on
holding a certain percentage of investment
classes, such as 60% stocks and 40% bonds,
within one's investment portfolio.
Capital Growth
BREAKING DOWN 'Risk Parity'
The risk parity approach to portfolio asset
Strategy
allocation focuses on the amount of risk in each
An asset allocation strategy that seeks to
component rather than the specific dollar
maximize capital appreciation, or the increase in
amounts invested in each component. In other
value of a portfolio or asset over the long term.
words, risk parity focuses not on the allocation of
capital (like traditional allocation models), but on
the allocation of risk. Risk parity considers four
BREAKING DOWN 'Capital
different components: equities, credit, interest Growth Strategy'
rates and commodities, and attempts to spread Portfolios with the goal of capital growth consist
risk evenly across the asset classes. The goal of mainly of equities. The exact proportion of
risk parity investing is to earn the same level of equities to the total portfolio will vary according to
return with less volatility and risk, or to realize the individual investor's investment horizon,
better returns with an equal amount of risk and financial constraints, investment goals and risk
volatility (versus traditional asset allocation tolerance.
strategies).
In general, a capital growth portfolio will contain
A traditional 60/40 portfolio can attribute 80 to
approximately 65-70% equities, 20-25% fixed-
90% of its risk allocation to equities. As a result,
income securities and the remainder in cash
the portfolio's returns will be dependent upon the
or money market securities. While seeking high Further diversification benefits can be gained by
returns, this mixture still somewhat protects the investing in foreign securities because they tend
investor against a severe loss in portfolio value if to be less closely correlated with domestic
the higher-risk equity portion of the portfolio takes investments. For example, an economic
a plunge. downturn in the U.S. economy may not affect
Japan's economy in the same way; therefore,
Note that an aggressive portfolio strategy also having Japanese investments gives an investor a
aims to maximize capital growth, but of the total small cushion of protection against losses due to
portfolio value, these strategies are of an American economic downturn.
considerably higher risk; sometimes consisting
entirely of equities! Most noninstitutional investors have a limited
investment budget and may find it difficult to
Diversification
create an adequately diversified portfolio. This
fact alone can explain why mutual funds have
been increasing in popularity. Buying shares in
a mutual fund can provide investors with an
Diversification is a risk management technique inexpensive source of diversification.
that mixes a wide variety of investments within a
portfolio. The rationale behind this technique Diversification and Exchange-
contends that a portfolio constructed of different
kinds of investments will, on average, yield higher Traded Funds
returns and pose a lower risk than any individual While mutual funds provide diversification across
investment found within the portfolio. various asset classes, exchange-traded funds
(ETF) afford investor access to narrow markets
BREAKING DOWN such as commodities and international plays that
would ordinarily be difficult to access. An
'Diversification' individual with a $100,000 portfolio can spread
Diversification strives to smooth out unsystematic the investment among ETFs with no overlap. If an
risk events in a portfolio so the positive aggressive investor wishes to construct a
performance of some investments neutralizes the portfolio composed of Japanese equities,
negative performance of others. Therefore, the Australian bonds and cotton futures, he can
benefits of diversification hold only if purchase stakes in the iShares MSCI Japan ETF,
the securities in the portfolio are not perfectly the Vanguard Australian Government Bond Index
correlated. ETF and the iPath Bloomberg Cotton Subindex
Studies and mathematical models have shown Total Return ETN. The specificity of the targeted
that maintaining a well-diversified portfolio of 25 asset classes and the transparency of the
to 30 stocks yields the most cost-effective level of holdings ensure true diversification, with
risk reduction. Investing in more securities yields divergent correlations among securities, can be
further diversification benefits, albeit at a achieved.
drastically smaller rate.
Diversification and Smart Beta companies with large cash flows, international vs.
domestic companies, stocks vs. bonds, etc. The
Smart beta strategies offer diversification by
mix of these types of investments is dependent
tracking underlying indices but do not necessarily
on the clients investment needs and risk
weigh stocks according to market cap. ETF
tolerance. For instance, a manager overseeing a
managers further screen equity issues on
portfolio for a client with low risk tolerance and a
fundamentals and rebalance portfolios according
long term investment horizon will invest in blue
to objective analysis and not just company size.
chip stocks and low risk bonds such as U. S.
While smart beta portfolios are unmanaged, the
Treasury bonds. He will avoid stocks of
primary goal becomes outperformance of the
companies in developing nations and tech start-
index itself. As of July 2016, the iShares Edge
ups.
MSCI USA Quality Factor ETF holds 125 large-
and mid-cap U.S. stocks. By focusing on return There are two types of portfolio management with
on equity (ROE), debt-to-equity (D/E) ratio and respect to mutual funds active and passive.
not solely market cap, a $10,000 investment in Active management means that a portfolio
the funds underlying index grew to about $10, manager actively trades securities to try to make
530 in one year ending June 2016. A similar a better return than the market, taking into
investment in the S&P 500 Index grew to about account the funds objectives and asset class
$10,385. limitations. Most closed-end funds are actively
managed.
Management
such as the S&P 500 or the NYSE.
management
about how to manage a portfolio. The chosen
philosophy will dictate whether the portfolio
manager invests in high growth companies,
and financial
hold the same licenses as a portfolio manager.
Individuals going through the financial planning
process often develop a plan aimed at meeting
planning?
short- and long-term financial objectives,
including building an emergency fund, saving for
a new home or reducing debt, accumulating
retirement assets and creating estate or tax
Utilizing the expertise of a financial professional efficiency. Financial planning may also include a
can be beneficial to an individual wanting to discussion about portfolio management, but it is
reach an investment goal or other financial focused on what rate of return needs to be
objective. However, it is important to know which achieved to meet a specific goal or what
types of services are provided by the financial allocation is most appropriate for an investor's
professional. Although it is common to use the risk appetite.
terms "portfolio management" and "financial
planning" as synonyms, these staples of
the financial services industry are not the same.
Portfolio management is the act of creating and
Analyzing
maintaining an investment account, while
financial planning is the process of developing
financial goals and creating a plan of action to
Investments in a
achieve them. Understanding the difference
between the two may help in selecting the most
suitable financial professional.
Portfolio
Portfolio management is provided by financial
professionals who hold certain FINRA Series Framework
licenses that allow them to create and
recommend portfolios of stocks, bonds, mutual Clients need to know their financial advisors are
funds, exchange-traded funds (ETFs) competent enough to analyze their investments
or alternative investments to meet the investment from an aggregate portfolio context. Not properly
objectives of a specific investor. Professionals analyzing a single investment or the portfolio as a
who perform portfolio management are focused whole can lead to disastrous results and throw off
on meeting the needs of investors through an entire financial plan. The following are five
the rate of return achieved within a portfolio, and items financial advisors should be specifically
they are often responsible for rebalancing the looking at when analyzing an investment
account to remain in line with the investor's portfolio.
allocation preferences.
Achieving billion.
Allocation
to lower liquidity.
Minimizing Risk So, while part of your portfolio may contain more
The main goal of allocating your assets is to volatile securities - which you've chosen for their
minimize risk given a certain expected level of potential of higher returns - the other part of your
return. Of course to maximize return and portfolio devoted to other assets remains stable.
minimize risk, you need to know the risk-return Because of the protection it offers, asset
characteristics of the various asset classes. allocation is the key to maximizing returns while
Figure 1 compares the risk and potential return of minimizing risk.
some popular choices:
Deciding What's Right for You
As each asset class has varying levels of return
and risk, investors should consider their risk
tolerance, investment objectives, time horizon or an index fund, since the goal is not to beat the
and available capital as the basis for their asset market.
composition. Investors with a long time horizon
and larger sums to invest may feel more
comfortable with high risk, high return options.
Contrastingly, investors with smaller sums and
shorter time spans may feel more comfortable
with low risk, low return allocations.
Conservative Portfolios
Conservative model portfolios generally allocate
a large percent of the total portfolio to lower-risk
securities such as fixed-income and money
market securities. The main goal of a
conservative portfolio is to protect the principal
value of your portfolio (the money you originally
Moderately Aggressive
invested). As such, these models are often Portfolios
referred to as "capital preservation portfolios". Moderately aggressive model portfolios are often
referred to as "balanced portfolios" since the
Even if you are very conservative and prefer to
asset composition is divided almost equally
avoid the stock market entirely, some exposure
between fixed-income securities and equities in
can help offset inflation. You could invest the
order to provide a balance of growth and income.
equity portion in high-quality blue chip companies
Since moderately aggressive portfolios have a
higher level of risk than conservative portfolios, value of the portfolio will vary widely in the short
this strategy is best for investors with a longer term.
time horizon (generally more than five years),
and a medium level of risk tolerance.
2) Suitable Risk: What type of risk you put on select the products in which you have the most
understanding. Modern Portfolio Theory is one
this money will likely be directly proportionate to
tool most investors have when it comes to
the expected return. Wherever you invest money,
understanding risk/return and portfolio
there is a chance you could lose money. What is
construction and whether to adopt a 90/10
an acceptable level of risk for you as an investor?
aggressive portfolio, 80/20 or 70/30 growth
Does your acceptable level of risk correspond to
portfolio, 60/40 moderate growth portfolio or a
your purpose and expected return for this
20/70/10 conservative (stocks/bonds/cash)
money? (For more, see: Five Things to Know
About Asset Allocation.) portfolio. This basic approach is a principled one
and could serve you well.
3) Tax Treatment: Don't be surprised, the
government will take their share. "That's my Diversification Above All
money. I don't have to pay taxes on it." Proper diversification is something you'll want to
The Internal Revenue Service (IRS) says you do. consider when selecting investments.
As a professional, I've actually had that Investments are broken down into categories like
conversation more times than I'd like to admit. size, style, and foreign or domestic.
Taxes cannot be avoided but an investor should
Understanding the corresponding risk level with unmanageable. Consider sound independent
each investment will be important when selecting research and I don't mean from your television. If
the percent composition for your portfolio. For you do, you'll likely be disappointed. Most TV
instance, a 45% allocation to foreign small- spots are for ratings and fear mongering, not for
cap growth stocks might not be a bad place to be comprehensive investment advice. Spending
but that might not be true for someone who is some of your hard earned money for some
purposing this money to be used in the next investment advice from a bona fide research firm
three-to-five years. (For more, see: The may help to tilt the odds in your favor. Create a
Importance of Diversification.) rules-based approach to managing investments.
When to buy, when to sell, desired returns and
Consider Current Conditions acceptable losses are some categories to
Current economic conditions could impact your consider.
portfolio composition in sharp contrast to a
traditionally-styled portfolio. Let's consider rising Always Continue Learning
rates. Mid- to long-term bonds have typically Educate yourself on the industry. Research topics
been a safe place for the last three decades. But that interest you. Nothing beats passion when it
that might not be true for an investor who is two comes to spending time caring for your
years from retirement and is currently allocated investment portfolio. Never do anything you're not
60% to mid- to long-term bonds in a rising comfortable with. There are so many places to
interest rate environment. get information. (For more, see: A Guide to
Portfolio Construction.)
Stay the Course
DIY-ers will have to manage the fear mongering The Bottom Line
that has become so commonplace with our major Start with your foundational pillars and purpose
market news channels. Trading during volatile your money. Get your investor ID. Who are you
times created by current events like what we've as an investor? Make a road map. Stay abreast
experienced around the world as of late could be of the changes to our economy. You just might
a huge detriment to your portfolio. Moving money learn how to take advantage of the information
in and out of the market frequently is ill advised. you're filtering. As always, don't let yourself be
Make some rules for your investment approach bogged down. If it gets to be too much, consult a
and don't deviate from that principled, professional. Don't be surprised if they don't work
unemotional approach. Yes, it's easier said than for free when you ask for advice. (For more,
done - even for professionals. (For more, see: Asset Allocation Strategies.)
see: Portfolio Management Pays Off in a Tough
Market.) The opinions voiced in this material are for
general information only and are not intended to
provide specific advice or recommendations for
Stick to Your Process
any individual. Bonds are subject to market and
Put a plan in place and stick to it. Create
interest rate risk if sold prior to maturity. Bond
contingencies in the event things get
values will decline as interest rates rise and
bonds are subject to availability and change in SEE: 3 Ways To Increase Your Investment
price. Performance
The economic forecasts set forth in the How the Strategy Works
presentation may not develop as predicted and The basic idea is to use past trends to determine
there can be no guarantee that strategies a sound investment balance for the future.
promoted will be successful. There is no However, this does not mean trying to predict the
guarantee that a diversified portfolio will enhance future from the past. Indeed, it is just the
overall returns or outperform a non-diversified opposite. The allocation to stocks and bonds
portfolio. Diversification does not protect against works according to fixed mathematical rules and
market risk. Asset allocation does not ensure a criteria without "active management" in the usual
profit or protect against a loss. Past performance sense. There is no stock picking, with the stocks
is no guarantee of future results. and bonds being held in the form
of index investments such as exchanged-traded
A Strategy For
funds. Given the dangers of stock picking and of
trying to predict the markets, this is a sound basis
for a strategy.
And Bond
adjusted as necessary. The aim is to
systematically overweight the better performing
asset class and vice versa. If the stocks are
Allocation
performing badly, they will be underweighted and
bonds overweighted. Of particular importance is
the fact that within a given year, the allocation to
one of the classes can rise to 100% or fall to
One of the most difficult elements of investing is
zero. The portfolio is always fully invested, such
to know when to get in and out of specific
that the stock and bond proportions total 100% at
markets. However, a buy and hold strategy has
any point in time.
never been optimal, and even less so in recent
years. Thus, two key questions have to be More on the Mechanics
answered: How can one avoid a major downturn Option price theory is used to calculate how to
and improve performance? And how can one allocate the funds to the two asset classes.
ensure that, to the greatest possible extent, one Because no suitable and standardized options
is optimally invested in the best asset classes? are available and OTC ones have some serious
One way of doing this is to restrict oneself to disadvantages, a replication is used. This
stocks and bonds and use a proven and effective enables an investment in the two asset classes in
strategy known as the "best of two." the right proportions. Monte Carlo
simulations have also indicated that a monthly
adjustment is sufficient. The full details are too considerably reduced volatility. Furthermore, the
complex to be explained here. performance beats a constant 50/50 allocation
between stocks and bonds. It is thus a better bet
SEE: Cut Down Option Risk With Covered Calls than mixed funds working with such fixed
proportions.
Who Should Go for the Best of Two?
The strategy is ideal for people who like the idea The best of two clearly enables a sustainable
of relying on a fixed formula, says Dr. Ulrich participation in positive stock market
Stephan, the chief investment strategist of the developments, and provides good protection
Deutsche Bank in Germany. Naturally, the against major declines and crashes. It should be
strategy won't perform as well as a pure equity noted that the strategy has more of a total return
investment in a bull market, but in a bear market, than an absolute return character through the
there is a fair amount of protection. Furthermore, blend of stocks and bonds with an index basis.
the strategy generally works better over time than
a rigid equity-bond allocation. Also, it is Using the Strategy for Institutional
straightforward in that it just has stocks and Investments
bonds, both of which work in terms of indexes. So Given the proven performance potential and the
it is appealing for those who like simplicity. high level of flexibility of the best of two strategy,
it is well suited to managing funds. For example,
From a time perspective, at least five years is it could be used to switch between a Dow Jones
recommended, so that the strategy can maximize tracker and the Merrill Lynch Domestic Master.
its potential over various market phases. This facilitates a systematic and professional
stock/bond exposure over time. The right
The Risks
integration of strategic and dynamic asset
The strategy is certainly not risk-free, particularly
allocation can be achieved, and that is no mean
if both asset classes do badly at the same time.
feat.
However, there is nothing to stop investors from
having other investments too (above and beyond The Bottom Line
the best of two), such as real estate or The best of two method facilitates a retrospective
infrastructure. Additionally, the best of two can be switching between two asset classes, namely
global; it does not have to focus only on the stocks and bonds. The application of
United States or Germany, for instance. derivatives in the form of exchange option
enables one to avoid poorly performing markets
SEE: Straddle Strategy A Simple Approach To
and to be there for the good times. It does not
Market Neutral
achieve this with complete perfection or in all
situations, but it does a fine job over time. Who
The Results
could ask for more than that?
Hubert Dichtl and Christian Schlenger, from the
German consulting company Alpha Portfolio
Advisors, evaluated the performance of the
strategy over a 30-year period and found that it
beat the equity markets over time and
3 Ways To
In order to make a profit on your investment, it's
often best to use one of two strategies to do that.
The first is called value investing. Stocks, just like
Increase Your
the products you purchase every day, go on sale
from time to time and value investors wait for that
sale price. This makes it even easier to make a
Investment
profit, because stocks that are undervalued (on
sale) have more room to grow. (Learn how to
value invest, read 5 Must-Have Metrics For Value
Performance
Investors. and The Value Investor's Handbook.)
Calls
give up your 100 shares.
What ETF Fund changes to the portfolio only when the index is
periodically rebalanced. However, even managing
index funds requires regular investment
Return
return will be a rate that satisfies the following
equation:
HPR = (($196.5 - $200)/$200) = (-3.5)/200 = Note: The annualized number is the same as a
-1.75%. geometric average, a concept covered in the
statistics section.
Period 2 (Mar 31, 2004, to June 30, 2004):
Example: Money Weighted Returns
HPR = (($200 - $196.5)/$196.5) = 3.5/196.5 = Calculating money-weighted returns will usually
+1.78%. require use of a financial calculator if there are
cash flows more than one period in the future.
Period 3 (June 30, 2004, to July 30, 2004): Earlier we presented a case where a money-
weighted return for two periods was equal to the
HPR = (($222 - $20) - $200)/$200) = 2/200 =
IRR, where NPV = 0.
+1.00%.
Answer:
Period 4 (July 30, 2004, to Sept 30, 2004):
For money-weighted returns covering a single
period, we know PV (inflows) - PV (outflows) = 0.
HPR = ($243 - $222)/$222 = 21/222 = +9.46%.
If we pay $100 for a stock today, and sell it in one
Period 5 (Sept 30, 2004, to Dec 31, 2004): year later for $105, and collect a $2 dividend, we
have a money-weighted return or IRR = ($105)/(1
HPR = (($250 - $2) - $243)/$243 = 5/243 = + r) + ($2)/(1 + r) - $100 = $0. r = ($105 + $2)/
+2.06% $100 - 1, or 7%.
Money-weighted return = time-weighted return for
a single period where the cash flow is received at
the end. If the period is any time frame other than DEals
one year, take (1 + the result), raised to the
power 1/Y and subtract 1 to find the annualized PwC Deals Graduate Programme
return.
T aportas la actitud y el talento
Cursars una preparacin inicial de 6 semanas
para preparar tu primera asignacin a un grupo
Te beneficiars de 800 horas de formacin en
tus primeros 3 aos de la mano de preparadores
del CFA pertenecientes al Instituto de Estudios
Burstiles y de los mejores profesionales de Deals
de PwC. Tendrs otros programas impartidos por
los formadores de referencia de la London School of
Economics and Political Science (LSC). Tendrs la
oportunidad de graduarte en el Master de Deals
de PwC y obtener tu certificacin CFA.
Trabajars en diferentes reas de Deals y te
involucrars en todo el ciclo de una transaccin en
un ambiente internacional.
En tu tercer ao, te especializars en el rea o
industria que mejor se adapte a ti y donde tengas
la oportunidad de desarrollar una carrera de
xito.
En tu cuarto ao y quinto ao podrs estar
involucrado en una asignacin internacional y
secodment en algn pas de la red.
Los profesionales de ms potencial con cinco
aos de experiencia en Deals sern reconocidos con
una formacin de MBA en una Escuela de Negocios
de referencia.
Areade de deals:
1)M&A:orifinaicon y M&A
Un campo de tenis y yo con una raqueta jugando Un gran logro en en mi exepriencai priogesional
dobles en una cancha de arcilla uqe quedan cerca que fue mas bien compratidio con un eqeuipo
de mi casa y una pantalla viendo noticias Trbajo multidispcilinario fue la obtencin dela
economicas y faincnieras nacional y del mundo. buena proc ed un proeycto comercia y
El tenis implica mucha concentracin, persevancia penitenciario.
y fuerza mental para ganar a tus oponentes, Era un proeycto que se encargba de la
requiere de mucho entremaient y disicplina y infraestrucutra epoenitneciaria, disei y
estartegia, asi como un poco de habilidad conctruccion de un nuevo penal para la ciduad de
deportiva. En el tenis se prioriza mucho la precisin lima a cambio de recibir el terrno del penal san
Jorge para que le consosrico tnega el derecho de 5 preguntas para ganarte al recruiter en una
la cosntruccion e implementacin de un proecy entrevista de banca
tocomercial compuesto pro galaerias, vivienda
estabelcimeinto comerciale, y tiendas 1)pregutna la iuntimo de la entrevista, ks tienes
alguna pregunta?
Tanto el costo de la conturcion del neuvo penal(54)
y el proecyo comecial(45) era de 100 MMde Como se siente en banca d einveriso ne le
doalres en un palzo de ejcucion de 3 aos., . citibank?
Los beneficios del estado eran obtener un nuevo
penal totalemnte eqeuipo y con mayor segurairad, 1. Qu porcentaje del trabajo de un
la renovaicon urbana en elc ecrdao delima, una analista/asociado (segn la posicin para la
que te ests entrevistando) es pitching y que
contribucin a la formalizaion del comrcio, y la
nivel de exposicin a la realizacin de modelos
apmliaicond e vacante de reclusos
puedo esperar?
Deje mi enteorio trbajo porque sent que quera
trbajr en una mepresa una consultora mas grande 2. Le hace poco acerca de una operacin que
con mas proyectos, responsabilidades y desarrollo su grupo con la empresa X. Durante
aspiraicones de lnea de carrera. esta operacin, quin facilito la financiacin
del deal y cun a menudo utiliza su grupo a
* Cul es la definicin de xito en sus trminos? otros bancos como medio de financiacin?
Hacerclo que mas tegusta y hacerlo lo mejor 4. Qu le influy a usted a la hora de decidir
posible desarrollar su vida profesional en este banco y
no en otro?
Preguntas tcnicas en una entrevista en banca
de inversin 5. En este trabajo el horario puede ser muy
exigente y a veces puede ser difcil compaginar
Qu es un DCF? Explcame como haras vida personal y vida profesional Cmo lo hace
uno. usted para compaginar la vida profesional y la
vida privada y familiar?
Cules son los diferente mtodos de
Bancos americanos: Goldman Sachs, JP Morgan,
valoracin?
Morgan Stanley, Merril Lynch, Citigroup
Resto de Bancos: UBS, Deutsche Bank, Barclays,
Cul es la diferencia entre un LIFO y un Nomura, Socit Gnrale, etc.
FIFO?
Boutiques de M&A: son asesores con un foco
Cundo emitiras deuda y cundo local que no pueden prestar financiacin a sus
acciones? clientes. Suelen tener un tamao ms pequeo
y encargarse de operaciones a nivel nacional.
Qu es el EBIDTA? Se podra dividir en:
Internacionales: Rothschild, Lazard, Mediobanca,
etc.
Cmo vara el capital circulante si tus
Nacionales: Montalbn Atlas Capital, GBS
proveedores te dan ms plazo para pagarles?
Finanzas, Arcano, AZ Capital, 360 Corporate, etc.
1532? Big Four: las multinacionales denominadas Big
Four (PwC, Deloitte, E&Y y KPMG) tambin tienen
Cmo calculas el FCF? sus departamentos de M&A. Suelen tener
mandatos ms pequeos que, en ocasiones,
Explcame lo que es la crisis en 5 minutos vienen derivados de un mandato de Due
y en ingls Diligence Comercial o Financiero.
Recommended by: Helane Becker from he companies with the most skin in the
game are banks, whose profit margins
generally improve as rates riseand whose
stocks have recently soared in anticipati
1- Depsitos a plazo
3- Mercado de valores
2- Simplicidad.
Fuente: www.nasdaq.com
Renta Fija
ejecutivo recomienda ser cautos en las inversiones
Infraestructura lider el
en instrumentos de renta fija, principalmente por
los aumentos paulatinos que pueden haber en la mercado de fusiones el
tasas de referencia de la Fed.
ntara por recortar las duraciones de los portafolios 2016
de bonos y aprovechar de manera tctica, los bonos
vinculadas a riesgo crediticio que puedan ayudar a Operaciones en este sector
amortiguar el efecto de aumento en tasas de habran movido ms de US$800
referencia millones en el mercado de
Asimismo, el inversionista, de manera tctica,
fusiones y adquisiciones peruano.
podra optar por posicionarse en bonos de
pases emergentes cuyas polticas
monetarias puedan ser expansivas, por ejemplo, tenemos el caso del gigante brasileo
menciona. Odebrecht, que se vio obligado a vender casi el
60% de la operacin de la concesin vial Rutas de
Plazos Lima.
Rutas de Lima; Gaseoducto Sur Peruano, todava
azos dependen de la habilidad de
no pero se trata; Linea Amarilla, que se firm pero
tomar riesgo y de la liquidez de los todava no se cierra; H2Olmos.
inversionistas.
os montos de transaccin promedio de las
operaciones en este sector habran superado la
Si el inversionista tiene cifra de ms de US$800 millones. "Hay algunas de
flexibilidad, Rebolledo aconseja US$600, US$800, US$1.000",
Van a continuar algunas de estas transacciones Transportadora de Gas del Per en una fusin y
grandes de infraestructura que ya estamos adquisicin de cerca de US$97 millones. Uno de
trabajando, pero creo que, adems, van a ver estas los agentes de venta fue la Corporacion Financiera de
nuevas (transacciones) que empiezan en retail, Inversiones. (F
energa, en minera, en agro
mrica Latina concentra el 2,3% de todas las
transacciones de fusiones y adquisiciones del
mundo, y en mensos de 3% en cuandto a vlaor de El Rancho lleg un acuerdo con la empresa
de transascons. constructora Viva GyM, por US$49,8 millonesoto:
Andina)
Brasil lder en el mercado de fusiones y adquisiciones
durante el 2016. Durante el tercer trimestre este La firma experta en soluciones para el mercado de
pas concentr el 43% del total de los acuerdos valores, Cavali S.A, se fusion con la Bolsa de
generados de fusiones y adquisiciones en Latinoamrica. Valores de Lima (BVL) por US$38,07 millones
103 operaciones,inversin significan ms de
US$14.000 millones. Mientras que peru en el trcecr
trmete 18 operaciones en temrinos de inverison 65 MM
doalres Aumentan las operaciones de M&A en el
pas por la mayor participacin de
Las operaciones en Per aumentaron 20% este
ao hasta 131 operaciones. El Per descendi
extranjeros y de sectores
al ltimo lugar de las fusiones y
adquisiciones (M&A, en ingls), debido a vinculados a la demanda interna
menores valoraciones y pese al incremento
de estas operaciones el 2016. Se estn Las transacciones de extranjeros vienen
ahciendo mas trnasacicone de empresa sosteniendo el crecimiento del mercado de
mediana pero de menro vlaor M&A peruano. A mayo se registran 58
operaciones, por US$1,595 millones, y los
En el caso de la salud, los proyectos extranjeros participaron en 35 de ellas (ver
gubernamentales de inversiones en grfico). El Per sigue siendo un receptor de
Asociaciones Pblico Privadas generan un inversionistas, dice Daniel Hernndez,
ambiente favorable de percepcin en los analista de la consultora espaola TTR. Los
inversionistas, y adems sera un factor dinmico inversionistas de Chile, Estados Unidos y
en el mercado transaccional para el prximo ao, Mxico sumaron nueve transacciones, agrega
concluy.
Del 2015:
La millonaria adquisicin de Corporacin Scotiabank anunci el cierre de la operacin de
Lindley, comercializador de Inca Kola, por compra de los negocios de banca personal y
parte de Arca Continental, se sell mediante un comercial de Citibank en el Per, tras haber obtenido
acuerdo, el 10 de septiembre. La fusin y el permiso de la Superintendencia de Banca, Seguros
adquisicin estuvo valuada en US$760 y AFP (SBS) para la operacin, valorizada en US$295
millones. millones