Finance - Short Selling Strategy

After studying finance knowledge for about a year, there is few things that I found quite interesting. And one of them is the strategy of "short selling".

Usually we assume that when we purchase and hold an asset, we will make profit when price increase and we sell it. But actually we do able to make profit even there is a price decrease of the asset value, and more interesting, the profit large possibly more higher than simple buy low sell high (also known as "long" as inverse to "short")strategy.

Well, the theory is like this, assume we borrow an asset worth RM500, and we sold it to another party at RM500 too. And after that, the asset value dropped till RM200, and we purchase back the asset at RM200 and return it to our lender, thus, the remaining RM300, absolutely is our net profit (and more important, the above trading activities can execute without origin cost!).

It seems interesting if compared to long strategy, but, of course there are few issues that a short seller have to bear in mind when running this strategy. First, a short seller only can make profit if only the price movement is as expected. Second, even though making profit without using initial cost ( high leverage) seems interesting, but when it is in adverse way, the same effect occur that the short seller have to lost a huge margin of money too.

Therefore, a successful short seller must have the ability to predict future asset price movement precisely in order to run a successful short strategy, so it is advise that people who are not damn good in acquire or predict the first hand asset market information better not to touch this~:P, this post just a knowledge to share but not to recommend people to adopt this strategy~^^.

Next post I try to share some famous people who are good in this strategy and how they work it.

Finance - Financial Derivatives

The last finance major subject in USM is a difficult subject, as me myself consider this young born financial instruments as the top level knowledge in finance field with lots of complicated calculation. (even though the greatest investor Warren Buffett named it as finance destruction weapon.) Below is what we learn in coming days through this last semester.

1) Derivatives: Introduction and Overview

2) Malaysian Derivative Markets and Trading

3) Forward and Futures Markets: Pricing and Analysis

4) Stock Index Futures Contracts: Analysis and Applications

5) Interest Rate Futures: The 3-month KLOBOR Futures Contract

6) Introduction to Options

7) Option Contracts: Specification and Trading

8) Option Strategies and Payoffs

9) Option Pricing

10) Replication, Synthetics and Arbitrage

11) Options in Corporate Finance and Real Options

12) Interest Rate Swaps, FRAs and Credit Derivatives

13) Derivative Instruments and Islamic Finance

Major focus will be on futures and option, which is the 2 most common instruments in present.

What to Look For In a Prospectus by Mr Ooi Kok Hwa

Saw Mr Ooi article on analysis IPO in The Star. Actually Mr Ooi is consider as my idol, I used to attend his 3 talks during my University degree study, possibly end of this semester will have the chance to attend his talk again. Dreaming to achieve his level one day later...how nice and useful his articles and lesson are...

Below article is found from The Star:

http://biz.thestar.com.my/news/story.asp?file=/2009/12/30/business/5381351&sec=business

OOI KOK HWA: FOLLOWING better stock market sentiment, there have been a growing number of companies wanting to get listed on Bursa Malaysia.

In every initial public offering (IPO), the vendors, who are mostly the major shareholders of the company, will distribute a prospectus to provide the required information.

However, many investors find it difficult to digest the information provided in the prospectus. In this article, we will briefly go through a few basic pointers for investors to consider before taking up any IPOs.

The most important factor to be considered is the key owners of the IPO company. Despite the lack of track records and the difficulty in determining the quality of the management, we can still get some details on the background, qualifications and experiences of the key owners and management team.

If the majority of the board of directors is comprised of family members, we can expect this family-owned business to exist for a long time.

If the key owner has some corporate finance experiences, we should expect more corporate proposals from this company on, for example, merger and acquisition activities, rights issues and share buybacks.

For operational efficiency, the chief executive officer should possess relevant and long period of working experiences in the core business activities of the company.

Besides this, the independent directors need to have adequate financial training and related working experiences to provide useful inputs to the board of directors.

There are two main types of share offerings – offer-for-sale and public issue. The key difference between these two is that the sale proceeds from offer-for-sale will go directly to the vendors whereas proceeds from public issue will go directly to the company.

The company will need to explain how it plans to use the proceeds – whether the money will be used to fund working capital, reduce bank borrowings or for future expansions.

If the majority of the offering is offer-for-sale, then we will need to be careful as this may mean that the IPO is providing an exit strategy for some key owners of the company.

We may also need to take a discount on the future prospects stated in the prospectus.

As there will be a lot of uncertainties on the company’s growth prospects, we need to check whether the expansion plans stated are realistic and reasonable, given the size and capacity of the company.

Sometimes, certain owners may be too ambitious in their outlook.

In addition, we need to understand the company’s background, production capacity, types of products, locations of its factories, key major suppliers, customers and competitors.

We need to check the company’s sustainable competitive advantages, such as possession of any intellectual properties, technology, patents, trademarks, licenses as well as strong and recognisable brands.

Other factors to look at are whether the company is dominant in any particular geographical region and niche market, or whether there is a wide distribution network, strong marketing team as well as research and development capability.

A lot of newly listed companies will also explain in detail the key risk factors associated with investing in it in the executive summary of the prospectus. Although some may appear to be standard information, we can still get a feel of the inside risk factors about the company.

Examples of special risk considerations are dependence on a few key customers and suppliers, expiration of its patents as well as special arrangements with key major shareholders, suppliers and customers.

We notice that not many investors were excited about some of the recent IPOs. One of the possible reasons was that the offer price was too expensive.

Despite higher stock market volumes, we still have a lot of listed companies selling at very cheap valuations. If the pricing of the IPO is far above the overall market average valuation, the stock may be hammered down below its IPO prices after the listing of the company.

We can use price-earnings ratio and price-to-book ratio to determine the value of companies. A good company needs to state its dividend payout policy. Even though there may be slight differences compared with the actual dividend payment, investors still need to compute the potential dividend yields from the company’s dividend payments.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

Finance - Financial Market

Continue on earlier post on financial knowledge, this post will be on Malaysia financial market system and structure, well, it is a big picture and I am not able to show it out here, but indeed I get the detailed and useful resources for readers who interested in financial market:

Financial System of Malaysia
http://www.kpmg.com.my/kpmg/publications/tax/I_M/Chapter5.pdf

The Capital Market in Malaysia
http://www.adb.org/Documents/Books/Rising_to_the_Challenge/Malaysia/mal-cap.pdf

Hope the above link may provide value knowledge to you~! :-)

Finance - Financial Market

Being in finance field, it is necessary for us to know the function, structure and operation of financial market, in this post, I will write on the function of financial market.

Aside from the purpose to accumulate wealth, in broader view, finance world actually is a place where firms or similar entities acquire money for their continuing operation and development. Think about this, A like to start a business, but he need a sum of capital to do that; while B, C and D have lots of money, but they do not know how to use their money to accumulate more wealth as they are not good in business stuff.

In your opinion, is it a better way if B, C, and D money being gathered and used by A to start his/her business and thus add value to the money? I do believe most of us will not deny it. So, financial market existed just to meet both parties: A (borrower) and B, C, and D (lenders), and let the cash can be used efficiently instead of keep it under yours and mine beds ~ :D.

Financial market is something important in an economic to help develop a country, and make the country have better living standard (reduce unemployment rate, increase gross domestic product (GDP), increase government income and else), but everything can be both end sword if think in deep; you may refer to one of my post:

http://yappypath.blogspot.com/2009/11/think-deep-in-finance-part-2-asian-rare.html

http://yappypath.blogspot.com/2009/11/think-deep-in-finance.html 

Next post I will touch on financial market structure, thanks.

Finance - Time Value of Money (TVM)

Continue from last post, this post will be touch on calculations of TVM. To get the future value of present money value in ‘n’ years later (or vice-versa) with fixed interest rate annually, the calculation is shown as below: 

PV to FV: PV x (1 + i)ⁿ = FV

FV to PV: FV / (1 + i)ⁿ = PV

*i = interest/discount rate, n = year

When PV to FV, we call that rate as interest rate; in inverse way, it is called as discount rate. 

Well, we use the above calculation if only certain assumptions met. What if the money being invested/lend/save/borrow in regularly terms like installment? Let’s look at below annually paid installment calculation (also known as annuity): 

FV of annuity: annual payment x 1 / i ( [1 + i]ⁿ – 1 ) 
PV of annuity: annual payment x 1 / i ( 1 – 1 / [1 + i]ⁿ )

*You may wonder that the annuity calculation is so complicated and how people always calculate in this way? Actually finance people have a calculator designed specific for finance usage only, so we need not calculate by using formula anymore ~ :D .

These are only a few basic calculations for TVM, there will be much more to explore in depth, like different cash flow stream, different rates and else. Here is just to let you have a basic understanding in finance. 

So far for the basic quantitative stuffs, in next post, I will touch on structure of financial market, good day~!

Finance - Risk and Return (Rate)

In finance field, it is common for people to hear this phrase: higher risk compensated with higher return (take note; there is not necessary in vice-versa form). Well, what is risk then? Let’s look at an example: If you are going to lend a sum of money to two of your friends, A and B, and you know that A had a stable income, while B still being unemployed, who do you think will have the higher probability of failure in return back your money? In common sense, you should assume that B will more probably to default in his/her payment, hence, the lending to B will be more riskier than A. So, from the above example, we can define that risk is the uncertainty of something, and which out of our control extension.

When we said that proportion of risk have to be compensated by equivalence proportion of return, then how to determine the form of return? In finance, people use different rates to measure different risk. Loan risk compensated by loan rate, deposit has a return based on deposit rate, and so on. Before further the discussion on different types of rates, I would like to show you the impact of rate on value of money first. To understand the effect, there are few terms that you should know: Time Value of Money (TVM), Compounding Effect, Present Value (PV), Future Value (FV) and Discount/Interest Rate (i).

Assume that you are holding RM1 now (PV = 1), with annual interest rate of 5% (i = 0.05), and we make an assumption that the rate will be remain the same in next 10 years. So, what is your RM1 value after 10 years if it is value added by 5% interest rate annually? Now, to calculate the value, we have to consider compounding effect, compounding effect is occur when interest rate is build on principle value + previous accumulated interest. To make it simple, let’s look at below calculation example.

Compounding Effect:

Value of RM1 after 1st year: RM1 + RM1 x 0.05 = RM1.05

Value of RM1 after 2nd year: RM1.05 + RM1.05 x 0.05 = RM1.1025

Without Compounding Effect:

Value of RM1 after 1st year: RM1 + RM1 x 0.05 = RM1.05

Value of RM1 after 2nd year: RM1.05 + RM1 x 0.05 = RM1.1

See the difference? In common, we only multiply directly the interest rate on principle value, but we had ignored the previous accumulated interest on principle.

We discuss this far till here, next post I will continue on the various calculations of Time Value of Money, have a nice day~!

Finance - Value of Money

Finance is basically study about value of money in different time interval and how to determine it. Just look at a simple example: For a RM1 in your hand now, is it still worth the RM1 value as same as today in 10 years later? Today you can buy a product X with RM1, but 10 years later, you may need to spend RM5 or more on the same product X, due to inflation effect.

In economic, we call the above money value measurement as “buying power”. So, let’s have a look at Malaysia inflation rate, it is about 5% - 6% in average annually, if you are going to save your money in a commercial bank fixed deposit, with deposit rate of 2% - 3% annually, it is definitely unable to cover the gap left behind inflation rate, in simple words, it means that your money “buying power” value will gradually reduced in future no matter how much your saving is. Well, how to avoid this?

Set aside on personal view on money; now let’s change your sight to a company view. When a company considering investing in a project, launch new product, buying new asset or else, they will firstly think about the return on the investment, as company is profit-oriented. Well, how do they decide whether to make an investment? If there are more than one investment alternative, which should they go in? How do they determine the minimum required rate of return?

Look, the answers to the above questions were what we study in finance. Even things are quite complicated in this field, but, in a big picture; the main point in finance is just about “value of money”.

Next post will be touch on various rates (return rate, discount rate, interest rate and else) and their what-and-how effect on money value. Thanks for reading my post~! :)

Buffettology

Among the most important laws that Buffett learned:

1) It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

2) When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.

3) Management does better by avoiding dragons, not slaying them.

4) As if governed by Newton’s first law of motion, an institution will resist any change in its current direction.

5) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds.

6) Any business craving of the leader, however foolish, will be quickly supported by detailed rate of return and strategic studies prepared by troops.

7) The behavior of peer companies, whether they are expanding, acquiring, setting compensation, or whatever, will be mindless imitated.

8) It is not a sin to miss a business opportunity outside one’s area of expertise.

9) If your actions are sensible, you are certain to get good results.

10) Do not join with managers who lack admirable qualities, no matter how attractive the prospects of their business.

11) Fearful when others are greedy, greedy when others are fearful.

12) First investment rule: do not lose money, second rule: don’t forget the first rule.

Securities Investment and Portfolio Management

Securities Investment and Portfolio Management course is an introductory investment course on investment alternatives available and to the theory and practice of investments and portfolio management. This course covers the primary financial securities – stocks, bonds, and derivatives, and methods for combining these underlying assets into a portfolio.

A) Introduction to Investments

1) Introduction

2) Equity Markets

3) Buying and Selling Equities

4) Risk and Return

B) Market Efficiency and Investor Behavior

1) Asset Pricing Theory and Performance Evaluation

2) Efficient Market Hypothesis

3) Market Anomalies

4) Psychology and the Stock Market

C) Investment Analysis

1) Business Environment

2) Financial Statement Analysis

3) Value Stock Investing

4) Growth-Stock Investing

5) Technical Analysis

D) Fixed Income

1) Bond Instruments and Markets

2) Bond Valuation

E) Investment Management

1) Mutual Funds

2) Global Investing

3) Option Markets and Strategies

4) Futures Markets

5) Real Estate and Tangible Assets

Financial Statement Analysis

Financial statement analysis is an integral and important part of a broader field of business analysis. Business analysis is the process of evaluating a company’s economic prospects and risks. This includes analyzing a company’s business environment, its strategies, and its financial position and performance.

Business analysis is useful in a wide range of business decisions such as whether to invest in equity or in debt securities, whether to extend credit through short or long term loans, how to value a business in an initial public offering (IPO), and how to evaluate restructurings including mergers, acquisitions, and divestitures.

Financial statement analysis is the application of analytical tools and techniques to general purpose financial statements and related data to derive estimates and inferences useful in business analysis. Financial statement analysis reduces reliance on hunches, guesses, and intuition for business decisions. It decreases the uncertainty of business analysis. It does not lessen the need for expert judgment but, instead, provides a systematic and effective basis for business analysis.

This subject’s content divided into 3 categories: Overview, Accounting Analysis and Financial Analysis.

A) Analysis Overview
1) Overview of Financial Statement Analysis
2) Financial Reporting and Analysis

B) Accounting Analysis
1) Analyzing Financing Activities
2) Analyzing Investing Activities
3) Analyzing Investing Activities: Intercorporate Investments
4) Analyzing Operating Activities

C) Financial Analysis
1) Cash Flow Analysis
2) Return on Invested Capital and Profitability Analysis
3) Prospective Analysis
4) Credit Analysis

5) Equity Analysis and Valuation

Think Deep In Finance - Part 2: Asian Rare Earth Private Ltd and Bukit Merah Village

Continue on my previous post on the inverse perception on finance. If you had read the supplement of China Press currently (started at 23th Nov 2009), you should have know that there used to be a toxic (rare earth) plant operated near Kampung Baru Bukit Merah, Lahat in Perak a few decades ago, which is also where my house located.

In 1979, Asian Rare Earth (a Japan company) came under close scrutiny after it was discovered that its operation was causing radioactive emissions in the area. It was extracting yttrium, which is used in making colour TV tubes, from monazite, and the process created the radioactive thorium hydroxide waste. The company was de-commissioned in the early 1990s after a long-drawn legal battle and countless public protests.

Even it had decommissioned, but there are lots of things at the back there, from what the protestors said, the government had arrested them under ISA that time. And I was unable to understand what the Fucking Hell of the Damn Shit “high” officer thinking that time.

Man, the solid facts that so much villagers suffering due to that damnable toxic plant, and the officer just to guarantee so easily that there is no problem on the operation of that plant? And when villagers stepped out to protest for the sake to protect their own lives and healthy population for their beloved, but the Fucking authority captures them under ISA, how could it be? Why?

I just wanna keep questioning on the officers in charged, did you Fucking ever live at that area? How do you know there will be no effect on the villagers as you are not one of them and didn’t ever visit them who are suffering once? As you just live at your luxury house and stay at your comfortable working place, but able to judge everything without seeing them by your own Ass Hole eyes?

Well, I just wondering, is that a country development and capital inflow much more important than human’s life? Why the damn authority that time (one of them included country’s top leader that time, Dr. M…), didn’t ever care for the poor villagers? What the hell stuffs running in their mind? That’s why I said before, if you think finance is a field to help developing the world, you should think twice on it, for there are lots of stories behind that beyond yours and mine knowledge.

I am glad and paid my full salute to the peoples who fight endlessly and persistently to banish that toxic plant that time. You are the great people, much greater than the Fucking Hell Ants class which only think of and chasing for power and wealth, in the past, current (presently the cases that most of us seen, almost not “news” anymore…) and forever, but never care for the citizens in sincere. God sake, maybe this is only piece of the pie only…pitiful citizens.

Think Deep In Finance

In finance field, it is the responsibility for the professionals to make sure the clients and employers they service for have the most value return to their investment or wealth. However, I always think about something else out of this box, something that worth of us to think deeply in it.

Currently, you should have heard lot of news about the destructive non-stop cloudburst in many places in the world, as a sequent from rapidity critical global warming phenomena. As a finance student, I think and ask myself, what is the relationship between Finance and these natural (or maybe man-made) disasters?

Did Finance help to avoid this, or it is one of the factors which prick up these disasters? In common, we knew that factories, cars, cigarettes, toxic wastes, and lots more things appear and increase rapidly only in modern times, is the main reason which contribute to current earth critical condition. Well, how do these modern things acquire the capital or finance resources to get being build, manufactured and produced? Even this is my field, but as a fact, yes, I have to admit that it is finance world which contribute the capital to the existing of those modern things.

We finance people always proud that we are the one which contribute to a country’s economy and development, but how if we are also the one who contribute towards earth destruction? Is it also worth for us to proud for? Well, I did not deny that we also the one to help gather the finance resources for lots of projects which trying to save the world from the brink of destruction. But, I believe that it is only a small amount if compared to the capital flow in the industries which produce modern things as they can give big return to the investment, for finance field have a rule, great investment must be compensate with great return, thus, it is common that our main investment is always towards industries creating pollution.

Finance did have ethics, but the ethics is mainly on accountability and responsibility on the money only, but rarely a point to point at which field or industry that should be invested. Well, this is what I discussed so far in this post, there will be lots more things I am going to explore and discuss in later post, hopefully my posts on these issues will let people in this field think another way deeply.

Financial Markets & Institutions

This post will introduce on another financial subject under USM management course, Financial Market is a subject on examining how financial markets (such as bonds, stocks, and foreign exchange) and financial institutions (banks, insurance companies, mutual funds, and other institutions) work. Financial markets and institutions not only affect you’re your everyday life but also involve huge flows of funds – trillions of RM – throughout our economy, which in turn affect business profits, the production of goods and services, and even the economic well-being of countries. What happens to financial markets and institutions is of great concern to politicians and can even have a major impact on elections.

This subject’s learning content will be generally divided into two major categories: Financial Markets & Financial Institutions.

a) Financial Markets

1) Fundamentals of Financial Markets
- What Do Interest Rates Mean and What Is Their Role in Valuation?
- Why Do Interest Rates Change?
- How Do Risk and Term Structure Affect Interest Rates?
- Are Financial Markets Efficient?

2) Central Banking and the Conduct of Money Policy
-Structure of Central Banks and the Federal Reserve System
- Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics

3) Financial Markets
- The Money Market
- The Bond Market
- The Stock Market
- The Mortgage Market
- The Foreign Exchange Market
- The International Financial System

b) Financial Institutions

1) Fundamentals of Financial Institutions
- Why Do Financial Institutions Exist?
- What Should Be Done About Conflicts of Interest? A Central Issue in Business Ethics

2) The Financial Institutions Industry
- Banking and Management of Financial Institutions
- Commercial Banking Industry: Structure and Competition
- Savings Associations and Credit Unions
- Banking Regulation
- The Mutual Fund Industry
- Insurance Companies and Pension Funds
- Investment Bank, Security Brokers and Dealers, and Venture Capital Firms

3) The Management of Financial Institutions
-Risk Management in Financial Institutions - Hedging with Financial Derivatives

Corporate Finance

As I had stated earlier, I will post what USM finance major learned in overall. This post will be about the content of Corporate Finance. So, what and why learning Corporate Finance?

Finance and financial thinking are everywhere in our daily lives. Consider your decision to go to college. You surely weighed alternatives, such as starting a full-time job immediately, and then decided that college provided you with the greatest net benefit. More and more, individuals are taking charge of their personal finances with decisions such as:

- When to start saving and how much to save in retirement.

- Whether a car loan or lease is more advantageous.

- Whether a particular stock is a good investment.

- How to evaluate the terms for a home mortgage.

Our career paths have become less predictable and more dynamic. In previous generations, it was common to work for one employer your entire career. Today, that would be highly unusual. Most of us will instead change jobs, and possibly even careers, many times. With each new opportunity, we must weigh all the costs and benefits, financial and otherwise.

Some financial decisions, such as whether to pay RM2.00 for your meal, are simple, but most are more complex. In your business career, you may face such questions as:

- Should your firm launch a new product?

- Which supplier should your firm choose?

- Should your firm produce a part of the product or outsource production?

- Should your firm issue new stock or borrow money instead?

- How can you raise money for your start-up firm?

In this course, you will learn how all of these decisions in your personal life and inside a business are tied together by one powerful concept, the Valuation Principle. The Valuation Principle shows how to make the costs and benefits of a decision comparable so that we can weigh them properly. Learning to apply the Valuation Principle will give us the skills to make the types of comparisons - among loan options, investments, and projects - that will turn you into a knowledgeable, confident financial consumer and manager.

This course main content:

1. Interest Rates and Valuing Cash Flows

- The Valuation Principle: The Foundation of Financial Decision Making

- Net Present Value (NPV) and the Time Value of Money (TVM)

- Interest Rates

- Bonds

2. Valuation and the Firm

- Investment Decision Rules

- Fundamentals of Capital Budgeting

- Valuing Stocks

3. Risk and Return

- Risk and Return in Capital Markets

- Systematic Risk and the Equity Risk Premium

- Determining the Cost of Capital

4. Long-Term Financing

- Raising Equity Capital

- Debt Financing

5. Capital Structure and Payout Policy

- Capital Structure

- Payout Policy

6. Financial Planning and Forecasting

- Financial Modeling and Pro Forma Analysis

- Working Capital Managamenet

- Short Term Financial Planning

7. Special Topics

- Option Applications and Corporate Finance

- Risk Manegement

- International Corporate Finance

Accounting vs Finance

Many people (especially junior) wonder what is the main difference between accounting and finance, I myself had ask the same question many times since I taking accounting subject in Form 6 even till the earlier stage of entering finance major in USM management course.

Well, after studying finance for quite a period, what I had found between the differences between these two fields is:

1) Accounting is a subject mainly focus on determine facts and accuracy of reporting, while Finance is a subject on using facts to determine both current and future value.

2) Accounting is working on accuracy and reliability, while Finance is working on prediction and creating value on money.

3) Accounting is mainly on studying numbers and figures, but Finance is mainly study on variable on real cash.

4) What a people always hear in Accounting is asset, liability, historical cost, matching principle and else accounting terms, in Finance, you will always hear of various interest rates and time value of money.

5) Example: Accountant must responsible for the accuracy on the financial report that he/she prepared or audited. Finance related jobs have to determine and make sure that the current money/cash in hand can have a maximum value in specified future time period.

Even both of the subjects are closely related, but differences are still existed. In USM, the finance major will learn these particular courses: Corporate Finance, Financial Market, Investment, Financial Statement Analysis, and Financial Derivatives.

Later I will post the main contents of the above courses, and hopefully this will help those junior to make a good choice when considering your further study in this field.