Monthly Archives: September 2007

What is a reverse stock split ? (investments)

Rather than increase the number of shares of common stock outstanding, a company may want to reduce the number of such stocks. It can accomplish this with a reverse from undertaking a reverse stock split.

Much of this stock split and the reverse stock split is an expertise of the investment bankers and other stalwarts of the finance industry. You can get lots of learning and advantages from your bank since all banks provide a number of valuable services and facilities. You can apply for a credit card as well as for a home loan. A home loan is a good facility for those people who wish to have their own house and do not have enough of equity to put into its purchase. The home loan helps citizens across the nations to increase their security quotient. You can also apply for consolidation loan and second mortgage as well. It is also very necessary to have your home insured by using the options of home insurance because mitigates any financial distress due to untimely death of the bread winner. Having said that you can easily get free information about different auto insurance quotes from Internet since auto insurance in a statutory requirement.

The irrelevance of dividends and why re-investments are a better option (investments)

One of the most comprehensive investment arguments for the irrelevance of dividends was provided by Modigliani and Miller in their research.

They asserted that given the investment decision of the firm, the dividend payout ratio is a mere detail and that it does not affect the invested wealth of the shareholders. The argument is that the investment value of the firm is determined solely by the earning power of the firm’s assets or its investments policy and that the manner in which the earnings stream is split between dividends and retained earnings do not affect this value.

The assumption being that the perfect capital markets exist and that there are no floatation and translation costs. The firm’s future revenues are also based of high certainties.

The crux is that the effect of dividend payments on shareholder wealth is exactly offset by other means of financing. Consider selling additional common stock to raise equity capital instead of simply retaining earnings. After the firm has made its investment decision, it must decide whether a) to retain earnings or b) to pay dividend and sell new stock in the amount of these dividends in order to finance the investments.

The sum of of the discounted value per share of common stock after financing plus current dividends paid is exactly equal to the market value per share of common stock before the payment of current dividends.

In other words the, the common stock’s decline in market price because of the dilution caused by external equity financing is exactly offset by the payment of the dividend. Thus the shareholder is supposed to be indifferent between receiving dividends and having earnings retained by the firm .

Economic Rationale for Leasing

The prime reason for the existence of leasing is that the companies, individuals and financial institutions derive different tax benefits from the ownership of assets. The marginally profitable company may not be able to reap the full benefits of accelerated depreciation, whereas the high income taxable corporation or individual is able to realize such. The former may be able to obtain a greater portion of the overall tax benefits by leasing the asset from the latter party as opposed to buying it. Because of competition among lessors, part of the tax benefits may be passed on to the lessee in the form of lower lease payments than would otherwise be the case.

Another tax disparity has to do with the alternative minimum tax. For a company subject to the AMT, accelerated depreciation is a ‘tax preference item’, whereas a lease payment is not. Such a company may prefer to lease, particularly from another party that pays taxes at higher effective rate. The greater the divergence in abilities of various parties to realize the tax benefits associated with owning an asset, the greater the attraction of lease financing overall. It is not the existence of taxes per se that gives rise to leasing but divergences in the abilities of various parties to realize the tax benefits.

Another consideration, although smaller one, is that lessors enjoy a somewhat superior position in bankruptcy proceedings over what would be case if they were secured lenders. The riskier the firm that seeks financing, the greater is the incentive for the supplier of capital to make the arrangement a lease rather than a loan.

You can easily take a debt from various banks and can fulfil your needs and requirements with the help of it. One can also also easily apply and get debt from banks at some very easy, affordable and comfortable financial conditions. You can also apply for loans and amazingly secure them easily in many instances.

Home mortgage is a another good facility that can be availed from banks in a low markup to facilitate all your financial needs. You can apply for a mortgage loan with the help of a mortgage broker.

Consolidation loan is another option in the debt equity market. A debt equity is a term that is used in the finance and banking sector to define the percentile of equity participation by the borrower.

The benefit of investing early in your life (investments) – Make more money by starting early

Most of the individuals do not plan out their financials early in the life. One of the prime reasons they feel is that what’s the hurry – there’s enough time left. The later you start the weaker you end. Finance and growth are a function of time and not luck. Let us understand this through a hypothetical example.

Study the two finance and investment return tables below:

Investment matures at the Age of: 50

Investment frequency: Yearly (beginning of the year)

Investment amount: $10000

Investment rate of return: 10% (assumed)

Table I (investment age: 21)

(In $$$$)

Age Inflow Opening Earned Closing balance

21 10000 1000 100 1100
22 10000 11100 1110 12210
23 10000 22210 2221 24431
24 10000 34431 3443 37874
25 10000 47874 4787 52662
26 10000 62662 6266 68928
27 10000 78928 7893 86820
28 10000 96820 9682 106502
29 10000 116502 11650 128153
30 10000 138153 13815 151968
31 10000 161968 16197 178165
32 10000 188165 18816 206981
33 10000 216981 21698 238679
34 10000 248679 24868 273547
35 10000 283547 28355 311902
36 10000 321902 32190 354092
37 10000 364092 36409 400501
38 10000 410501 41050 451552
39 10000 461552 46155 507707
40 10000 517707 51771 569477
41 10000 579477 57948 637425
42 10000 647425 64743 712168
43 10000 722168 72217 794385
44 10000 804385 80438 884823
45 10000 894823 89482 984305
46 10000 994305 99431 1093736
47 10000 1103736 110374 1214109
48 10000 1224109 122411 1346520
49 10000 1356520 135652 1492172
50 10000 1502172 150217 1652390

Table II (investment age: 31)

(In $$$$)

Age Inflow Opening Earned Closing balance

31 10000 1000 100 1100
32 10000 11100 1110 12210
33 10000 22210 2221 24431
34 10000 34431 3443 37874
35 10000 47874 4787 52662
36 10000 62662 6266 68928
37 10000 78928 7893 86820
38 10000 96820 9682 106502
39 10000 116502 11650 128153
40 10000 138153 13815 151968
41 10000 161968 16197 178165
42 10000 188165 18816 206981
43 10000 216981 21698 238679
44 10000 248679 24868 273547
45 10000 283547 28355 311902
46 10000 321902 32190 354092
47 10000 364092 36409 400501
48 10000 410501 41050 451552
49 10000 461552 46155 507707
50 10000 517707 51771 569477

Age Inflow Opening Earned Closing balance

In both the investment tables the yearly cash investments and the yearly rate of return on investments are same. The only difference is the age at which the person starts investing his money. In Table I the person starts investing $ 1000 at the age of 21 and accumulates a financial wealth of whopping $ 1.65 million by the time he has turned 50.

In Table II the person starts investing $ 1000 at the age of 31 and accumulates a financial wealthy of $ 0.56 million.The striking difference is the value of the accumulated investment wealth at the age 50 for both the investors. For the investor in the Table II, accumulated wealth is a paltry $0.56 million compared to the whopping $1.65 million for the investor of Table I. Just by starting 10 years early, you can go on to make thrice of what you would make otherwise at the age of 50.

Amazing ! Isn’t it ? This is the power of financial compounding ! The time value of money ! Just imagine the difference if the assumed rate of returns are higher than what has been fed into the table.

What is a stock split and how does it affect the investors at large?

One of the most enigmatic financial and investment strategies of the companies has been the stock split. Why is such a stock split done and how does it affect the company, its finance? How does the stock split affect the investment decision of the investors?

With a stock split the number of shares is increased through a proportional reduction in the par value of the stock. However with a stock dividend the par value of the stock does not get reduced.

As a result, the common stock, the paid in capital amount, the retained earnings does not change with a stock split. The total shareholder equity also remains unchanged. The only change is in the par value of the stock which now becomes half of what is used to be.

Let us see through an example:

Company: X

Total shares: 1000

Par value : $ 90

Total book value = $90 x 1000 = $ 90,000

Paid in capital $ 10,000

Total shareholder equity $100,000

Now with a stock split it would look like this:

Total book value = $ 45 x 2000 = $ 90,000

Paid in capital $ 10,000

Total shareholder equity $100,000

The only change is the change in the par value of the stock, which, on per share investment valuation is half of what it was earlier. A stock split is generally conducted for reasons when the company want to achieve a substantial reduction in the market price per share of the its traded common stock. The main objective of such a move is to bring the stock price within the purchasing purview of a large number of smaller investors.

Such a strategy makes the stock more popular with the investment fraternity because it requires a less amount of capital/investment to own a part in the company. It also mitigates the stock risk by distributing the ownership among a large number of investors. Such strategic investment and financial moves also help in thwarting any hostile takeover bid or allowing some scrupulous players in the market to manipulate the stock prices of the company.

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The payback period: Investments (viability techniques)

The payback period of an investment project indicates to the investor the number of years required to recover the initial cash investment bases on the project’s future cash flows.

If the payback period of the initial investment in within the accepted time frame the project is deemed viable from the investor’s point of view, if not, it is not deemed as viable.

One of the shortcomings of the payback period methodology is that it does not take into consideration the cash flows beyond the pay back period time frame. Hence the Payback Period (PBP) is not the true measure of profitability.

Let us look at an example:

Two proposals costing $ 20,000 each have the same payback period of 2 years assuming that both have annual cash in flows on $ 10,000 in the first two initial years.

But the first project might not have any cash flows beyond year 2 where as the second project might have cash flows beyond year 2 (extending up to year 5).

The Payback period can be a deceptive yardstick for profitability.

Moreover it also does not recognize the time value of money. The maximum payback period which shall be treated as the cut off is also subjective.

 

Credit card: Debt consolidation (personal finance)

Having a credit card debt is worrisome but having multiple credit card debt is suicidal. Many of us have at some point of time been in a situation where we must have contemplated to transfer such multiple debts into one single card in order to make the accounts more manageable.

Noble thoughts, I would say. But before you execute your noble thoughts and get into action mode give your debt consolidation a second thought. It is important to understand and decipher the inherent risks involved in debt consolidation. In all probability, it would require you to mortgage your home or some other immovable asset with the credit card company. Effectively it means that you are going to trade your secured debt for unsecured debt. Not a good proposition. Consider this: in case you fail to pay up the consolidated debt, you risk losing your house for the credit card pay default. Which otherwise (when no debt consolidation was undertaken) would have only resulted in a bad credit report. The risk of losing your house would not have existed. Another factor is that the new card company where you would be moving your debts might not have great interest rates to offer against the situation where you always would in a position to negotiate the rates with you present Credit Card Company.

Variables in marketable securities selection (investments)

While considering a decision to invest in marketable securities every portfolio manger (you) must analyze how each potential investment purchase relates to certain key investment variables:

Safety

The most basic test that all investments much pass is the first concern of safety of invested principal. It indicates the probability of getting back the same amount of fund that has been invested. Safety is judged relative to US Treasury bills which are considered certain if held to maturity. For investments other than the treasury bills, the safety of the investment depends upon the issuer and the type of investment instrument issued. A relatively high degree of safety is a must for short term investments and a moderate safety quotient is necessary for long term investments.

Marketability

The marketability of the liquidity of the investment (security) is related with the investor’s ability to convert the investment into cash at short notice. Although it is possible for an investment to be safe it might not be possible that is always easy to sell the investment instrument before maturity without incurring a loss (although marginal). In general a large secondary market where the investment instrument can be actively traded after issuance is necessary for the investment to have a high marketability or liquidity. No brownie points for guessing the secondary market availability for investment instruments like shares of a company, or the commodities market. Go ahead and share a list of other such instrument which has secondary markets (you are invited to put up your comments)

Yield

The yield or the return on your investment is related to the interest / appreciation in the value of your principal invested in the instrument. The higher the investment the higher would be the risk associated with the investment instrument.

Playing with the float – How to increase your returns with better fund management ?

The balance in your cheque leaves hardly represent the accurate available amount of dollars/euro available in your bank account. The funds available in your account are generally greater than what the amount against the balance columns shows in your cheque leaves. The dollar / euro difference between a company’s bank balance and book balance is referred to as float. The float is the difference between the time period when the checks are written and clearing done by the bank.

So it is possible for a company to have a negative bank balance in its books while positive balance in the bank, because the checks written by the company might still be not presented in the bank or they might be in the clearing process and would be outstanding. If the size of this float can be measured accurately the float funds can be used to earn some extra returns. This activity in the finance corporate world is known as ‘playing with the float’.

Insurance – basic objectives for taking insurance

Broadly the basic objectives for taking insurance can be classified into 3 categories:

  • Risk coverage
  • Savings and Investments
  • Retirement

Risk coverage

The most basic and the inherent objective of insuring oneself must be to cover the risk part. The objective is to ensure a fund for a future uncertain event like death. But the fact of the matter remains that risk is the most neglected of insurance aspect across all the countries. Such an insurance policy that covers pure risk is referred to as the term plan. It covers the life for a fixed premium against a sum assured. There are no survival benefits. The sum assured is paid in case of death of the life assured during the policy period. The premiums for the term plan are the lowest among all other plans. It would cost a person in the age group 20-30 around $ 0.30 (30 cents) a day for an approximate risk coverage of $25,000. Minuscule, isn’t it? But somehow the insurance companies are also hesitant to promote this product, for it accounts for less revenue compared to other savings and investment products.

Savings and Investments

Saving regularly to create a corpus which can be utilized at a future date for a particular occasion is another reason why insurance products are subscribed to. The objective is to save for the future certain events (unlike term plans where the objective is to insure against the uncertain event of death). Regular cash outflows at regular intervals are paid into the insurance product. These cash payments attract bonuses (interests) from the insurance companies and the corpus keeps on accumulating. A marginal amount of insurance in case of death in attached to the product. The accumulated corpus is paid at the end of the period.

Retirement solutions

The world is growing grey with each passing moment and the retirement solutions are gaining importance along with. Everyone gets haunted with the thought of what if I have no money after retirement? How do I sustain my standard of living? How do I sustain myself? Starting early is the key to create a large corpus for retirement. There are no death benefits and the risk coverage is zero. The objective is to sustain the certainty of old age.