Tuesday, January 31, 2012

The Economy Stimulus Story

In the midst of the European sovereign debt crisis, I would like to share with you a story that I came across a few years ago about the economy and how it is stimulated through spending. Here's the story:

The story started with a rich tourist came to a town in which everyone
living there was in debt. The tourist put down a 100 Euro note for the hotel owner as a deposit while he went round to check the conditions of the rooms. With the 100 note on hand, the hotel owner quickly ran to pay off his debt – his supplier, the butcher. The butcher received the money and he quickly settled his debt with the pig grower. Next, the pig grower used the receipt to pay off his debt with his supplier of feed and fuel. And this supplier ran to pay off his debt to his creditor - the prostitute, and finally, the prostitute went to the hotel owner and settled her debt with the hotel owner with the same 100 Euro note.

The hotel owner then put the 100 Euro note back on the counter as it was the deposit of the tourist. The tourist decided not to stay and took his money back.

After all these drama, amazingly, the whole town is now without debt and everyone looks to the future with a lot of optimism. In the final sentence of the story, it says: “This is how the United States Government is doing business today.”

“Does the story make any sense?” I’m sure most of you are pondering hard about this story. In fact, I’m truly amazed that this little story has embraced a number of important economic concepts that I’m going to explain next.

First, the story has brought out one major economic theory - the Keynesian mulitiplier theory. The initial 100 Euro note has changed a number of hands, from the hotel owner, to the butcher, to the pig grower … and back to the hotel owner. Starting with 100 Euros, the economy has created 600 euros worth of market transactions. In order for the Keynesian multiplier theory to function, the initial 100 Euro has to be an autonomous (independent) injection in the form of investment, government spending or exports to the economy. In this case, the rich tourist’s 100 Euro note is treated as exports because the rich man is a foreign tourist, the money is considered as an outside independent source of injection to the economy. (For simplicity, I have left out the multiplier formula here)

Next, we come to the most important concept of the multiplier theory that says that the injection of money creates round after round of spending. In other words, the cycle of ‘one man’s spending creating another man’s income’ repeats itself round after round just like the story.

But the story says each of them “pay back” their individual debt, not “spending” as stated in the multiplier theory. I would argue that the spending has been performed before each one received the 100 Euro note, which means they spend first and pay later. Just like most of us are doing now.

So, did the people in the town really get rid of their debt? The answer is “Yes!”

Because during each round of spending, income is created at the receiver’s end. This means that no matter what is the source of income (be it borrowed money or earned money), the economy is stimulated in the form of more economic activities created by the many rounds of spending. As long as the rate money earned is faster than the rate of debt increased, by theory, we can settle the debt. But in real world, most government in the world is building their debt at a much faster rate than the collection of taxes because in a democratic society when the government is elected based on people's votes, the ruling party tends to run into budget deficits.


Hence, this is how most of the governments in the world are doing business today!


Monday, January 30, 2012

How to value a mining company


By Paul van Eeden

I received an interesting question about company valuations from one of my newsletter subscribers that I thought I would address as a Commentary. It is a multi-part question that will take more than one Commentary to address; this week is part one: Valuing Mining Stocks.

Mining is a finite business. Mineral deposits contain a certain amount of ore and when that ore is mined out the deposit is depleted, no matter what you do or wish.

That is in stark contrast to say, an auto parts manufacturer, who can adapt to new demands and specification changes and (hopefully) stay in business for many decades. When you value an auto parts company, you can compare the company's price to earnings, price to cash flow, operating margin and net profit margin (among other things) to the company's peers to assess whether the stock in question is relatively cheap, or relatively expensive. You can also get a sense of whether the stock is cheap or expensive in an absolute sense by looking at the book value per share and comparing things like the profit margin and dividend rate to prevailing interest rates. But, embedded in all this (except book value per share) is the implicit assumption that the earnings and cash flow are for all intents and purposes infinite. When you are dealing with a business that can be reasonably expected to continue in a similar fashion for many decades, earnings per share, cash flow per share, dividend rate, etc. are meaningful. That is not the case with mining.

Take a hypothetical mining company that has only one mine as an example. Let us assume that mine is going to produce for another five years before the ore will be depleted. Now, let us say that the company's price to earnings ratio is ten. A hypothetical auto parts manufacturer also has a price to earnings ratio of ten. Based on just this one metric, we cannot differentiate between the two stocks. Let us also assume that the prevailing ten-year interest rate is five percent.

This means that you can invest your money in a ten-year bond and earn five percent per year while taking relatively little risk (other than the risk of interest rates rising, which could negatively impact all the investments under consideration and is therefore not considered).

The auto parts manufacturer has a price to earnings ratio of ten. That means for every dollar's worth of stock you buy, you expect to earn ten cents, or ten percent, in earnings. It does not really matter for our purposes whether those earnings are retained by the company or paid out as a dividend since, either way, the earnings accrue to the benefit of shareholders. Furthermore, you can reasonably assume that the auto parts manufacturer is going to be in business for several more decades and, because you have done lots of due diligence, you can also assume that the future earnings are likely to be the same as the current earnings. So, if you buy the auto parts stock, you will earn ten percent per year as opposed to five percent on your bonds. The auto parts stock is probably riskier than a bond; however, if you can make twice as much money it might be tempting.

Then you look at the mining stock and notice that it, too, has a price to earnings ratio of ten and, therefore, you can also make ten percent a year if you bought that stock. But you would be wrong. The mining company's mine only has a five-year life ahead of it. So, if it has a price to earnings ratio of ten it means that for every dollar of stock you buy you get ten cents in earnings. But the earnings are only going to last another five years, so your total earnings per dollar of cost will only be fifty cents — - half of what you paid for the stock — - and then the mine is depleted. That's why comparing a mining stock to other investment opportunities on the basis of price to earnings, price to cash flow, or dividend yield is complete nonsense. It is just as futile to compare mining stocks to each other based on these metrics because mining companies have different mine lives in their operations.

The only reasonable way to evaluate a mining company is to look at the net present value of the potential future cash flow, discounted at an appropriate discount rate. You have to take into account not just the cash flow that the mine(s) is generating, but also sustaining capital costs (including future exploration and development costs) associated with keeping the mine in production. Assuming you can derive a suitable cash flow model for each mine that a company owns you can then calculate the net present value of future cash flow by using an appropriate discount rate to represent the geological, political, social and financial risks. If you sum all the net present values together, add any other assets on the balance sheet and subtract any debt, you will arrive at the net asset value per share. In a rational world you would expect to pay no more for a mining stock than its net asset value per share — - how do you expect to make money if you consistently pay more for stocks than what they are worth? But, in the real world, mining stocks almost always trade for more than the net asset value of their constituent mines, and for a good reason.

Mining stocks also offer leverage to commodity prices. Take a gold mining company as an example. Assume we have a company that mines gold for a total cost of $400 an ounce, and let us pretend the gold price is $500 an ounce. The net present value of the mine would be calculated based on the $100 margin. If the gold price increases by 20% to $600 an ounce the net present value of the mine will double, since the margin would now be $200 an ounce. Thus the value of the company increased five times more than the increase in the gold price. Most people buy mining stocks because of this leverage.

What should be immediately evident is that if you pay more for mining stocks than what they are worth, on the speculation that the price of the underlying commodity will increase, you are merely gambling on the commodity price. Fortunately there is a way to quantify the premium that one should pay for a mining stock to incorporate the leverage it has to the underlying commodity price. There is a formula called the Black-Scholes Model that can be used to calculate the "option" value of a mining stock [Editor's note, you can find more information on the Black Scholes model and further links at http://en.wikipedia.org/wiki/Black-Scholes ]. What should be done is to calculate the discounted net present value of the all the company's mines and then add the "option value" of the mines as calculated by the Black Sholes formula to obtain a more realistic asset value per share. By adding the optionality of mining shares to the net present value of the mines themselves we can account for the fact that mining shares trade at a premium to their net asset value because of their leverage to the underlying commodities.

If you calculate the net asset value of a mining stock as described above you will get a result that can be used to compare different mining companies to each other, and mining companies to investments in other sectors. Unfortunately, very few mining analysts employ the Black Sholes model to calculate mining net asset values, so for most people buying mining stocks really comes down to blind speculation on commodity prices.

Thursday, January 26, 2012

4 Smart Decisions that Save on Car Insurance

The high cost of getting and keeping up with auto insurance can be a big hit on anyone’s budget. Fortunately, for anyone in the car insurance market there are a lot of different ways to save on this insurance. Follow these four tips to start saving hundreds of dollars a year.

1. Start your search for insurance by shopping around.

Be sure to compare car insurance prices at several different auto insurance companies. During your search, you’ll probably realize that car insurance rates can vary a lot between companies. In addition to just the normal market differences, auto insurance companies typically vary their rates based on a variety of factors, all of which differ among different companies. For example, the driver’s age and gender can be among the biggest factors in determining someone’s premium at one company, while another company may give more weight to a person’s driving history. Additionally, credit history and where the car is kept at night are also used by some companies to determine premiums.



2. Explore the possibility of bundling your insurance policies.

Many auto insurance companies offer their most significant discounts to customers who have more than one policy with them. This can mean insuring multiple cars, or switching over policies such as homeowner’s, life, or renter’s insurance to your auto insurance company.

3. Ask about how increasing your deductible could save you money.

With many companies, increasing a deductible by as little as $500 can save a consumer a lot of money on their premium. This lower cost to the consumer is a result of the insurance company decreasing their liability. Of course, it is critical to make sure that you have enough cash in a savings account to make up the difference for a higher deductible in the case of an accident. In general, though, since it is likely that you would not claim small damage amounts to your vehicle, increasing your deductible won’t really affect your budget much.

4. Finally, ask your insurer about discounts you already qualify for or could start doing.

Many insurance companies will offer their clients discounts for a variety of safe and normal activities. For example, auto insurance companies currently offer discounts to their customers who regularly wear a seatbelt, have a car alarm system installed in their vehicle, have airbags installed in their car, change their oil on a regular basis, and/or are considered by their state licensing board to be good drivers.

Saving on car insurance doesn't have to be an annoying nag by commercial after commercial. It can be achieved in these four simple steps with the added comfort of saving online.


Author Bio: Brittney L. is a freelance writer and car insurance expert. She enjoys traveling the New England area with her husband and compares travel car insurance rates online to help save money.

Wednesday, January 25, 2012

Campus Updates: The Global Imperative

New Cornell dean Dutta: INSEAD import
For more than a decade, most top business schools have made it an important objective to "go global." They've incorporated international topics and issues in all phases of the curriculum.  They've encouraged or even required students to do internships or semesters of study in foreign countries. They've hired professors (full-time and adjunct) to teach courses that address business challenges around the world.  Some schools push students to master a foreign language and/or study abroad at a peer business school.  Students have eagerly embraced these opportunities. It's not unusual for MBA students today to spend a spring break in Tanzania observing corporate activity in East Africa, do a consulting project in Brazil and Peru, or do a summer internship in Indonesia, as some Consortium students did in the past three years.

Business schools, we know, evolve, reassess and reinvent themselves--from year to year. They also observe and dissect what is hip and try to determine what is critically important or what is merely a fad of the times. "Ethics" has been the imperative at business schools in the years after Enron's collapse. "Leadership," "technology" and "innovation" have been priorities at most schools.

"Globalization" continues to be a primary objective, among all.  The best schools want to attract talented foreign students and professors and want to implement programs that take on topics such as the impact of China, the fragility of Europe, and the sudden opportunities in Brazil. 

Cornell (Johnson) announced its new dean in 2011, Soumitra Dutta, and proved to the b-school world that to have global influence it must hire global.  The new dean was a professor of business technology at INSEAD business school in Europe and arrives in Ithaca with an agenda to push Cornell further down the globalization road.  Dean Dutta, educated as an undergraduate in India, received his Ph.d. from California-Berkeley. He was at INSEAD for 22 years.

"Poets and Quants" (http://www.poetsandquants.com/), the popular site that chronicles what business schools are doing these days (under the guidance of Fortune magazine), named Virginia-Darden's Dean Robert Bruner its first "Dean of the Year."  It praised Dean Bruner for his globalization push in all phases of the school--from the composition of students to forcing students and professors to think in unconventional ways about international topics.

An App for That

Two professors from Consortium schools teamed up to produce a corporate-valuation app for the iPad and iPhone.  Does it mean financiers can discard elaborate cash-flow spreadsheets and complex valuations? Does it mean first-year associates no longer have to produce sheets with several scenarios and lofty projections? No.

But it's a handy tool that can be as simple as the user wants it or as a complicated as the user needs it (with all those necessary scenarios and assumptions).  The app, uValue, was developed because the professors claim "poor investment decisions start with poor valuations."

Anant Sundaram from Dartmouth-Tuck and Aswath Damodaran from NYU-Stern created the app and made it available for free. Damodaran writes a popular corporate-finance blog that analyzes corporate-finance topics, sometimes with lightweight humor:  http://www.aswathdamodaran.blogspot.com/. (He was also named by BusinessWeek as one of the 10 most popular business-school professors in the U.S.)

Most Satisfied MBA Students

In the business media, a cottage industry in ranking business schools has developed. Everybody wants to weigh in.  Many are critical of the randomness, carelessness and whimsy of rankings. Some deans are likely frustrated by them.  But they proliferate.

In mid-2011, Fortune magazine unveiled a variation of business-school rankings that rated MBA alumni satisfaction with the schools they attended. Consortium school Dartmouth was tops on that list. This month rival magazine Forbes rolled out its list of most satisfied b-school graduates, using its own set of surveys and criteria. It measures "satisfaction" based on quality of education, preparation for a career, and happiness in the current job.

In Forbes' ranking, Stanford emerged as no. 1. Five Consortium schools, however, appear in this version of the top 10.  They include Virginia, Carnegie Mellon, Yale, Dartmouth and UCLA.

In yet another ranking (whew), perhaps worth noting because of the importance of the topic, Virginia was selected as the top school in business ethics, because it most ensured the topic is well-embedded and sufficiently covered in the curriculum. Business & Society, an academic journal, prepared that list.

Tracy Williams
_________________________________________

For more about Damodaran, see
http://consortiumfinancenetwork.blogspot.com/2011/08/mba-professors-most-popular-10.html

For more about Fortune's satisfaction ranking of schools, see
http://consortiumfinancenetwork.blogspot.com/2011/07/business-schools-satisfied-alumni.html


Sunday, January 22, 2012

Getting Started in Forex Trading


Read on for 3 great tips to help you getting started in forex trading and well on your way to becoming a successful foreign exchange trader.

1)      Before you enter a market, you need to know your market 

Think of the world of forex as a virtual casino. What’s the first thing you do upon entering a casino for the first time? You assess the behavior of each of the tables before placing a bet, so you have a good idea of what sorts of odds you are facing and become aware of any potential high-risk and high-loss games, as well as those with potential high-winnings to be had.   It’s much the same with the foreign currency markets; some currencies are volatile while others ensure solid returns. You should study the forex market and get a feel for patterns and stay ahead of market activity by reading the financial news, keeping a wide-angle view of international news and their economic consequences on the currency market.


Pick a currency pair that suits your trading hours 

Your success as a currency trader is of course dependent on skill and chance, but there are some choices you make that can heavily influence the tenor of your trading volume. If you know you are only available to trade during certain hours, perhaps because of other commitments such as a “day job” or childcare duties, select the currencies that are open during the hours of your trading session so that you are able to follow the movements of that pair as and when it happens, rather than relying purely on advanced trading and risky predictive strategies for currencies whose trading sessions will be open once you have stopped trading for the day.
3)      
Limit your exposure to risk

Apply effective stopping measures to control your risk exposure. By having a watchful eye and implementing practical risk limitation measures, you are doing the smartest thing a trader can do to protect profits and minimize loss. Two examples: Position Sizing; this is a strategy which varies trade sizes according to the current trend; and Stop Placement; this marries indicators to stop loss placement and uses the two in tandem.

Rick Silver is a Financial Writer and contributor to Everest Forex. She spent many years working at leading U.S. investment firms and banks, within the fields of foreign exchange, commodities, structured finance, asset finance and corporate finance.

Thursday, January 19, 2012

How to Save Money While Attending College

College is pricey. From costly textbooks to the constant hikes in tuition rates, going to college requires a significant financial investment. The prospects of a good career ahead of you should make this investment worthwhile, but you still won’t want to graduate with astronomical debt. An overwhelming amount of debt can haunt you for decades and some people never manage to fully pay it off. 

Truth be told, college is more expensive than ever before. However, the good news is that there are many simple ways you can save money and still get a great education. By incorporating just a few money saving tips and adjustments into your lifestyle you will be able to make big savings.

Here are a few of our top tips for saving money while attending college:

Go Online

You won’t get the exciting social life you will likely find at a traditional brick and mortar school, but studying online will definitely save you a lot of money! An online university degree program generally offers significantly lower tuition rates in comparison to regular four-year schools. What’s more, you won’t have to re-locate or have to commute to class. Many of your textbooks will likely be downloadable and thus more affordable as well. Furthermore, many online degrees allow you to make your own hours and study at your own pace, so you can easily still hold down your regular day job while you study online!


Look for Grants and Scholarships

Most schools offer substantial amounts of grants and scholarships which essentially equates to free money for the awarded students. Explore any grants and scholarships available and also look into needs-benefits such as veterans education benefits. If you have difficulty understanding what benefits are available to you, most schools have representatives at their financial aid office that can assist you and walk you through the process of applying for grants and any benefits you may be entitled to.


Buy Secondhand

Aside from tuition and accommodation, perhaps the next most expensive aspect of college is textbooks. Buying textbooks brand new can prove to be extremely expensive, so you may want to buy secondhand when you can. Many campus bookstores sell used copies of books as well as new ones and often the used ones are significantly cheaper. In addition, you can usually find even cheaper secondhand books for sale online and there are even online stores where you can rent books per semester. Therefore, always look for potential secondhand copies when possible.

Attend Community College

We all want to go to a prestigious school, but you may want to try attending a community college at first and transferring to your dream school later. Virtually all universities accept transfer students from community colleges and in some cases it has even been reported that it is easier to transfer to a prestigious school as a community college student than it is to get accepted as a freshmen. Community colleges generally offer very affordable course rates and classes can be surprisingly small. You can also find them in all major towns and cities, so you can probably remain living at home which likely means paying no rent!


Prepare for Your Future Career

You are more likely to be crushed by college debt if you are unable to get a solid job shortly after graduation. Interest rates will start to gather and if you are unemployed or earning minimum wage you will unlikely be able to pay your debts back anytime soon. However, there are various ways you can prepare yourself for a prosperous and financially rewarding career while you are still in college. One excellent way to prepare yourself is to complete several internships while in college. Employers are always impressed if you have real world work experience and internships also allow you to build up contacts that you can call upon when you are looking for work as well as for references in the future.  

As you can see, college doesn’t have to completely drain your financial resources. It is pretty likely that you will graduate with some level of debt, but this debt doesn’t have to be crippling if you make wise financial decisions while in college. Whether you decide to attend an online university or simply only buy secondhand books the savings you will accumulate have the potential to help you stay further out of the red. Be cautious with your spending and always keep an eye out for thrifty ways to complete your education. Good luck! 

Price Patterns of Stocks

By looking at stock charts, an investor can spot different price patterns of stocks. Today I'll illustrate 2 famous chart patterns here.

Head and Shoulders
A head and shoulders formation, by its name, consists of a head and two shoulders. The left and the right shoulders represent two smaller rallies before and after the big head (big rally).



Reverse Head and Shoulders




Trend Reversal Point

Draw a line connecting the two troughs at the base of the head. This line is known as the neckline. When the neckline is breeched on the right shoulder, it sends a warning signal to traders that the price is going to plunge.

Similarly, for the reverse head and shoulders, we draw a neckline to connect the two small rallies beside the head. Once the price surge passes the neckline on the right shoulder, it indicates a positive move in the price.

In order for the trend reversal to materialise, the violation of the necklines in both cases has to be supported by an expanded volume at the right shoulders.

Double Top

A double tops formation consists of two peaks, like a Twin Tower. The two peaks may not be of the same height. The interesting part about this price pattern is that when the price is forming the second rally, its volume is lighter than before (the first rally). This shows that investors have lost their buying interest and the rising price may not be sustainable.


Trend Reversal Point

Draw a line at the bottom of the trough between the two tops as shown in the above. As soon as the line is violated at the right peak, followed by an expanding volume, the stock will experience heavy selling by investors.

Double Bottom

Double bottoms has a similar effect as the double top, but in the opposite way. Here, you’ll see two troughs with volume declining in the second bottom.

Trend Reversal Point

Draw a line at the peak between the two troughs. When the line is violated at the right trough with an increasing volume, investors are snapping up the stocks and pushing the price higher.

However, there is no guarantee that when the trendline is violated, the prices will move accordingly. Sometimes they are just a temporary interruption in the prevailing trend. It could be a false alarm, or whipsaw, for the trend reversal.

Last but not least, when you see a big chart pattern forming infront of you, its a warning sign that there is going to be a big price movement as shown in the chart below.


Happy investing,

Pauline Yong