I recently suggested Goldman Sachs as a "buy" given its revolving door policy with the US government. As an alternative to owning Goldman Sachs common stock, which can be volatile, you can buy a trust preferred security offered by Goldman Sachs. They are commonly described as a hybrid between a bond and a preferred share. In any case, one offering from Goldman Sachs which I would like to highlight is
Corporate Asset Backed Corp., CABCO Series 2004-1 Trust (Goldman Sachs Capital I), 6.00% Class A-1 Callable Certificates
It trades like a stock on the New York Stock Exchange with the ticker symbol GYA.
Click here for IPO prospectus.
There are of course a lot of technical details associated with this security. I think the following is all you need to know. Assuming Goldman Sachs will never go bankrupt, this security will always be "in the money" and you stand to collect an annual dividend of $1.50 per year and have each share redeemed at $25 if you wait for its maturity on 2/15/2034. With the shares trading around $15 now, you stand to collect a 10% dividend yield on what I consider to be a safe bet. This is much higher than any interest rate you can earn in any bank or investment account. With this security, you also have the potential for capital gains. If Goldman Sachs goes bankrupt, the worst case scenario is you lose the value of your then-investment. In the event of bankruptcy liquidation, you stand to collect residual proceeds before the common shareholders. This makes these shares "safer" than owning common stock.
I doubt Goldman Sachs would ever go bankrupt given their prowess and profitability. So here's a safer alternative to participating in Goldman Sach's corrupt profits without having to actually work for them.
Sunday, March 22, 2009
Friday, March 20, 2009
A case for Philip Morris International
The use of tobacco products, especially cigarettes is hazardous to your health. You hear about the risk of lung cancer, but there are a host of other health ailments that can be contributed to cigarette smoke such as heart disease and gum disease. According to some statistics, an average 400,000 Americans die each year due to smoking-related illnesses.
It may seem that investing in a cigarette manufacturer seems immoral. However, from my standpoint, tobacco companies will exist and prosper and any investment or lack thereof, will not change the situation. It is inconceivable that people will withhold enough investment capital to prevent tobacco companies from conducting business. Therefore, the idea of socially responsible investing is of little significance in effecting change.
An investment in Philip Morris International (PM)
Rationale: This is the world's largest cigarette manufacturer. Following its split from Altria (MO) which handles the domestic market, PM has only international operations. The split diverted the potential litigation liabilities of MO from PM. This was a practical decision as the US has been extremely litigious towards the tobacco industry. Despite a global recession, the company offers stable cash flow as their consumer base is essentially addicted. The company has had double-digit percentage growth in Latin American and Asian markets. As the emerging markets continue to grow, there is little doubt that PM will participate in the growth. In light of the drastic expansionary monetary policy of the US Federal Reserve, coupled with the enormous fiscal budget, the strength of the US dollar does not bode well. Stock in this company is desirable in a well-balanced portfolio as PM's sales are denominated in non-US currencies, which mitigates some of the currency risk in holding other US-denominated assets. This stock also boosts a safe 6% dividend yield @ $36 per share.
Risks:
Currency risk: a strong dollar can devalue the earnings.
Litigation risk: Western Europe is beginning to shift in the direction of the US with regards to litigation against tobacco for the health damages. Other regions of the world may eventually follow suit. Potential liabilities can bankrupt the company.
Raw material costs: Inflation, increased supply shortages, increased raw material costs all diminish earnings.
It may seem that investing in a cigarette manufacturer seems immoral. However, from my standpoint, tobacco companies will exist and prosper and any investment or lack thereof, will not change the situation. It is inconceivable that people will withhold enough investment capital to prevent tobacco companies from conducting business. Therefore, the idea of socially responsible investing is of little significance in effecting change.
An investment in Philip Morris International (PM)
Rationale: This is the world's largest cigarette manufacturer. Following its split from Altria (MO) which handles the domestic market, PM has only international operations. The split diverted the potential litigation liabilities of MO from PM. This was a practical decision as the US has been extremely litigious towards the tobacco industry. Despite a global recession, the company offers stable cash flow as their consumer base is essentially addicted. The company has had double-digit percentage growth in Latin American and Asian markets. As the emerging markets continue to grow, there is little doubt that PM will participate in the growth. In light of the drastic expansionary monetary policy of the US Federal Reserve, coupled with the enormous fiscal budget, the strength of the US dollar does not bode well. Stock in this company is desirable in a well-balanced portfolio as PM's sales are denominated in non-US currencies, which mitigates some of the currency risk in holding other US-denominated assets. This stock also boosts a safe 6% dividend yield @ $36 per share.
Risks:
Currency risk: a strong dollar can devalue the earnings.
Litigation risk: Western Europe is beginning to shift in the direction of the US with regards to litigation against tobacco for the health damages. Other regions of the world may eventually follow suit. Potential liabilities can bankrupt the company.
Raw material costs: Inflation, increased supply shortages, increased raw material costs all diminish earnings.
Monday, March 16, 2009
Taxpayers are the slaves of Goldman Sachs
The Federal government "had" to bail out AIG.
Whose opinion?
AIG CEO Edward Libby
(former Goldman Sachs director)?
Then-Treasury Secretary Henry Paulson
(former Goldman Sachs CEO)?
New York Federal Reserve Board of Directors
(many of whom are Goldman Sachs alumni)?
Who was the biggest beneficiary of the AIG bailout?
Goldman Sachs!
What just took place: Transfer of wealth from taxpayer to AIG to Goldman Sachs (and other investment banks).
Commentary: Goldman Sachs had some of the largest hedge funds who bought put options and credit default swaps and then sold short on the respective common stock. They engineered the trillions in losses and billions in profit for themselves. And finally, through the endless federal bailouts, they take the taxpayers' hard-earned money even though the taxpayer was not responsible for any of this scheming.
Opinion on Goldman Sachs common stock: BUY
Rationale: Their revolving door policy with the US government guarantees their success and solvency.
Applicable Tech Ticker video clip
Whose opinion?
AIG CEO Edward Libby
(former Goldman Sachs director)?
Then-Treasury Secretary Henry Paulson
(former Goldman Sachs CEO)?
New York Federal Reserve Board of Directors
(many of whom are Goldman Sachs alumni)?
Who was the biggest beneficiary of the AIG bailout?
Goldman Sachs!
What just took place: Transfer of wealth from taxpayer to AIG to Goldman Sachs (and other investment banks).
Commentary: Goldman Sachs had some of the largest hedge funds who bought put options and credit default swaps and then sold short on the respective common stock. They engineered the trillions in losses and billions in profit for themselves. And finally, through the endless federal bailouts, they take the taxpayers' hard-earned money even though the taxpayer was not responsible for any of this scheming.
Opinion on Goldman Sachs common stock: BUY
Rationale: Their revolving door policy with the US government guarantees their success and solvency.
Applicable Tech Ticker video clip
Saturday, March 14, 2009
Investing admist lies and market manipulation
I think the content of this video is self-explanatory.
http://www.youtube.com/watch?v=5M-OiXUhZNE
Personal advice: Do not believe what you hear and be wary of "expert" opinions. A successful investor invests in good companies that they understand well. If you seek to "guess" or "time" the market, I doubt you will have any success in the long-run, unless you are an insider or a major market player.
http://www.youtube.com/watch?
Personal advice: Do not believe what you hear and be wary of "expert" opinions. A successful investor invests in good companies that they understand well. If you seek to "guess" or "time" the market, I doubt you will have any success in the long-run, unless you are an insider or a major market player.
Lehman Brothers bankruptcy was engineered?
I hope the following video will be available for as long as this blog is online.
http://www.youtube.com/watch?v=ATDsUk10BKE
According to hedge fund insider, Jim Cramer, this is what happened.
Lehman Brothers had $158 billion in debt.
Hedge funds bought $365 billion worth of credit default swaps* (bond insurance) on Lehman Brothers debt. The SEC, under the corrupt aegis of Bush-appointed Christopher Cox, allowed for this to happen. This should have never happened because why would a rationale person insure something for more than it is worth (and at this magnitude).
Hedge funds then set to destroy Lehman Brothers by collapsing its equity through short selling of their common stock. They assumed correctly that the government would not bail out this investment bank. With the loss of confidence, credit rating downgrades, investor panic, covenant violations, and with no savior, Lehman Brothers had no choice, but to file for bankruptcy. As a result of the bankruptcy, Lehman Brothers bonds were in default and the hedge funds were set to gain $365 billion in insurance proceeds
An analogy of what the hedge funds did - you buy a house for $1 million, but insure it for $20 million. You then set the house on fire and collect $20 million in insurance proceeds.
AIG was one of the largest counterparties in this type of deal. They were essentially insurers of Lehman's solvency and now had to pay the hedge funds hundreds of billions in insurance payments for which the hedge funds only paid a pittance in premiums.
AIG faces a financial crisis and the government bails out AIG using billions of US tax dollars so that AIG could fulfill their insurance obligations.
Take-away message: Hundreds of billions of hard-earned US tax dollars (your money) is given to diabolical hedge funds who brilliantly exploited the system.
Lamentation: What's the point of working? Our wealth just gets stolen anyway.
Additional note: To top off collecting a $365 billion insurance jackpot, hedge funds also profited handsomely by short selling and buying put options.
*Credit default swaps can be thought of as bond insurance. The buyer pays a fee (premium) to a counterparty who will insure a bond's payment. In the event of the bond's underlying company defaulting, the counterparty will make a payout to the buyer according to the agreed terms (which in many cases is the principal and interest that the defaulted company should have paid).
http://www.youtube.com/watch?v=ATDsUk10BKE
According to hedge fund insider, Jim Cramer, this is what happened.
Lehman Brothers had $158 billion in debt.
Hedge funds bought $365 billion worth of credit default swaps* (bond insurance) on Lehman Brothers debt. The SEC, under the corrupt aegis of Bush-appointed Christopher Cox, allowed for this to happen. This should have never happened because why would a rationale person insure something for more than it is worth (and at this magnitude).
Hedge funds then set to destroy Lehman Brothers by collapsing its equity through short selling of their common stock. They assumed correctly that the government would not bail out this investment bank. With the loss of confidence, credit rating downgrades, investor panic, covenant violations, and with no savior, Lehman Brothers had no choice, but to file for bankruptcy. As a result of the bankruptcy, Lehman Brothers bonds were in default and the hedge funds were set to gain $365 billion in insurance proceeds
An analogy of what the hedge funds did - you buy a house for $1 million, but insure it for $20 million. You then set the house on fire and collect $20 million in insurance proceeds.
AIG was one of the largest counterparties in this type of deal. They were essentially insurers of Lehman's solvency and now had to pay the hedge funds hundreds of billions in insurance payments for which the hedge funds only paid a pittance in premiums.
AIG faces a financial crisis and the government bails out AIG using billions of US tax dollars so that AIG could fulfill their insurance obligations.
Take-away message: Hundreds of billions of hard-earned US tax dollars (your money) is given to diabolical hedge funds who brilliantly exploited the system.
Lamentation: What's the point of working? Our wealth just gets stolen anyway.
Additional note: To top off collecting a $365 billion insurance jackpot, hedge funds also profited handsomely by short selling and buying put options.
*Credit default swaps can be thought of as bond insurance. The buyer pays a fee (premium) to a counterparty who will insure a bond's payment. In the event of the bond's underlying company defaulting, the counterparty will make a payout to the buyer according to the agreed terms (which in many cases is the principal and interest that the defaulted company should have paid).
Friday, March 13, 2009
Must See TV - Jon Stewart confronts Jim Cramer
Muckraking journalism from Comedy Central's The Daily Show with Jon Stewart, what has happened to cable news?
Click here to watch the full episode
Click here to watch the full episode
Thursday, March 12, 2009
America’s Economic Outlook: Bad policy beget bad results
We are unfortunately in a downward spiral (no different than in the Great Depression). What was seen in the Great Depression is now being witnessed:
Negative GDP, increasing unemployment, increasing corporate bankruptcies, increasing personal bankruptcies, falling real estate values, bank failures, etc.
Unlike past recessions, this economic downturn strikes at the very heart of America's economic growth: the availability of credit (and too much of it).
America was able to grow at the pace it did because the availability of credit allowed Americans to buy more than they could afford. This large-scale purchasing led to greater consumption, greater sales, greater profits, more opportunities for expansion, more jobs, more income, more investment, and the cycle just kept feeding upon itself.
Unlike diamonds, which DeBeers advertises as being forever, "easy" credit is apparently not forever. Getting a mortgage with no money-down and no income check made no economic sense and when the situation became unsustainable, the amount of easy credit disappeared. A ceiling on rising home prices began to develop. However, those already with homes could no longer afford to pay their mortgages especially if they received teaser mortgages rates (generally adjustable rate mortgages (ARMs)) and the new interest rate made monthly payments impossible. Inevitable foreclosures led housing prices to drop and a downward spiral began to develop.
Bank losses and drops in new home construction led to job losses, which led to a decrease in demand for all goods and services, which led to a decline in manufacturing output, which led to more job losses, more foreclosures and further declines in property values. The middle-class could no longer rely on home equity loans and/or refinancing as real estate values declined. Disposable personal income dropped, drastic attempts to save money further decreased spending, and the result was more unemployment. Simultaneously, corporate profits fell, corporate spending dropped, more jobs were lost, the stock market crashed, investment income investment losses rose, personal disposable income dropped, bankruptcies increased, and this dynamic cycle continued its destructive force. As banks faced mounting loan and investment losses, America's driving force for economic expansion, credit, diminished.
Thus far, I have seen nothing in terms of policy that would turn this vicious downward spiral around.
1) Bank bailouts have no direct effect on unemployment and declining consumption. Instead, bailouts only encourage moral hazard and dramatically increase the national debt.
Moral hazard example: Citibank can take on risky investments for gain. If the bank succeeds, the CEO and company are rich. If they fail, the government cannot let it collapse because it is too big to fail. There is no loss. Bank bailouts encourage bad behavior and bad investments that would otherwise have never been made.
While working at the International Monetary Fund, Timothy Geithner criticized Japan's banking bailout of the 1990s. Yet, he is the mastermind behind the present bailouts. This contradiction is disturbing. I am beginning to believe that the present administration is not working in the best interests of the country. The immense costs of the banking bailout will be passed to future generations of taxpayers.
The bank bailout is also very unfair. The trillions of government money is going to the pockets of the very people responsible for this financial disaster: bankers who were greedy and unscrupulous, scheming hedge fund managers, and an unknown elite group of wealthy speculators.
2) Obama's stimulus package spends money ineffectively. The key to a successful stimulus plan is to create enough jobs to reverse a downward economic spiral. The $45.2 billion to be spent on infrastructure construction will not create enough jobs to reverse the over half-million jobs lost each month. The tax breaks and subsidies do little in the way of job creation.
3) There is little need for American labor, so even with a global economic recovery, unemployment in America may be high. American labor is expensive and far from the best. As globalization continues, corporations who outsource jobs have little incentive to hire Americans for the jobs they outsourced, especially when the outsourced labor is cheaper and better.
4) Education priorities are ignored. States immediately cut school budgets with any loss of tax revenue. What can make the American labor force be in demand is a talented pool of workers. Without easy access to quality education, we will have no competitive advantage. In the arena of higher education, tuition costs are staggering and are only going to increase. Federal Stafford loan rates for graduate students are fixed at 6.8% even though the Federal Reserve funds rate is at 0%. Why does the government disregard the importance of education and, in one case, profit off of student indebtedness?
5) Obama’s mortgage stabilization plan is ineffective in halting the slide in real estate prices if the employment situation continues to deteriorate. No loan modification, except complete loan forgiveness, can help a borrower who becomes unemployed in a few months due to the economy and has no savings.
6) America is burdened by trade deficits, budget deficits, and trillions in debt. The end result will be more taxes to pay. With increasing unemployment, the tax burden on those who do have jobs will be enormous. This tax burden will greatly hinder future economic growth as valuable capital is diverted away from investment and spent on public debt repayment.
The current administration, which was given a mandate in the 2008 election to bring hope and change, is not sowing the seeds for a better tomorrow. In fact, it is exacerbating the situation. With such poor economic policy, I do not expect the American stock market or economy to perform well.
Negative GDP, increasing unemployment, increasing corporate bankruptcies, increasing personal bankruptcies, falling real estate values, bank failures, etc.
Unlike past recessions, this economic downturn strikes at the very heart of America's economic growth: the availability of credit (and too much of it).
America was able to grow at the pace it did because the availability of credit allowed Americans to buy more than they could afford. This large-scale purchasing led to greater consumption, greater sales, greater profits, more opportunities for expansion, more jobs, more income, more investment, and the cycle just kept feeding upon itself.
Unlike diamonds, which DeBeers advertises as being forever, "easy" credit is apparently not forever. Getting a mortgage with no money-down and no income check made no economic sense and when the situation became unsustainable, the amount of easy credit disappeared. A ceiling on rising home prices began to develop. However, those already with homes could no longer afford to pay their mortgages especially if they received teaser mortgages rates (generally adjustable rate mortgages (ARMs)) and the new interest rate made monthly payments impossible. Inevitable foreclosures led housing prices to drop and a downward spiral began to develop.
Bank losses and drops in new home construction led to job losses, which led to a decrease in demand for all goods and services, which led to a decline in manufacturing output, which led to more job losses, more foreclosures and further declines in property values. The middle-class could no longer rely on home equity loans and/or refinancing as real estate values declined. Disposable personal income dropped, drastic attempts to save money further decreased spending, and the result was more unemployment. Simultaneously, corporate profits fell, corporate spending dropped, more jobs were lost, the stock market crashed, investment income investment losses rose, personal disposable income dropped, bankruptcies increased, and this dynamic cycle continued its destructive force. As banks faced mounting loan and investment losses, America's driving force for economic expansion, credit, diminished.
Thus far, I have seen nothing in terms of policy that would turn this vicious downward spiral around.
1) Bank bailouts have no direct effect on unemployment and declining consumption. Instead, bailouts only encourage moral hazard and dramatically increase the national debt.
Moral hazard example: Citibank can take on risky investments for gain. If the bank succeeds, the CEO and company are rich. If they fail, the government cannot let it collapse because it is too big to fail. There is no loss. Bank bailouts encourage bad behavior and bad investments that would otherwise have never been made.
While working at the International Monetary Fund, Timothy Geithner criticized Japan's banking bailout of the 1990s. Yet, he is the mastermind behind the present bailouts. This contradiction is disturbing. I am beginning to believe that the present administration is not working in the best interests of the country. The immense costs of the banking bailout will be passed to future generations of taxpayers.
The bank bailout is also very unfair. The trillions of government money is going to the pockets of the very people responsible for this financial disaster: bankers who were greedy and unscrupulous, scheming hedge fund managers, and an unknown elite group of wealthy speculators.
2) Obama's stimulus package spends money ineffectively. The key to a successful stimulus plan is to create enough jobs to reverse a downward economic spiral. The $45.2 billion to be spent on infrastructure construction will not create enough jobs to reverse the over half-million jobs lost each month. The tax breaks and subsidies do little in the way of job creation.
3) There is little need for American labor, so even with a global economic recovery, unemployment in America may be high. American labor is expensive and far from the best. As globalization continues, corporations who outsource jobs have little incentive to hire Americans for the jobs they outsourced, especially when the outsourced labor is cheaper and better.
4) Education priorities are ignored. States immediately cut school budgets with any loss of tax revenue. What can make the American labor force be in demand is a talented pool of workers. Without easy access to quality education, we will have no competitive advantage. In the arena of higher education, tuition costs are staggering and are only going to increase. Federal Stafford loan rates for graduate students are fixed at 6.8% even though the Federal Reserve funds rate is at 0%. Why does the government disregard the importance of education and, in one case, profit off of student indebtedness?
5) Obama’s mortgage stabilization plan is ineffective in halting the slide in real estate prices if the employment situation continues to deteriorate. No loan modification, except complete loan forgiveness, can help a borrower who becomes unemployed in a few months due to the economy and has no savings.
6) America is burdened by trade deficits, budget deficits, and trillions in debt. The end result will be more taxes to pay. With increasing unemployment, the tax burden on those who do have jobs will be enormous. This tax burden will greatly hinder future economic growth as valuable capital is diverted away from investment and spent on public debt repayment.
The current administration, which was given a mandate in the 2008 election to bring hope and change, is not sowing the seeds for a better tomorrow. In fact, it is exacerbating the situation. With such poor economic policy, I do not expect the American stock market or economy to perform well.
An Investment in ConocoPhillips
ConocoPhillips (Stock Ticker Symbol: COP)
Rationale: Its refined oil and gas products are in demand around the world. Fluctuations in oil and gas prices will translate into significant cash flow changes (either negative or positive). The outlook for the price of crude oil and natural gas will continue to be positive as long as fossil fuels remain the main means of energy production. An increasing demand for oil and gas is expected in the short-term as there is usually an increase in automobile use in the Northern Hemisphere during seasons of warmer weather. An increasing demand is also expected in the long-term when economic activity recovers from the present downturn. Emerging markets, such as those in China, Vietnam, Brazil, Mexico, and India, will most likely support the price of crude oil as their economies grow in the future. As the largest natural gas producer, this company is poised for the greatest growth among the integrated oil and gas giants if natural gas demand increases. Such growth is possible with natural gas increasingly being used to heat homes and with the automobile industry considering the use of gas-powered engines. Natural gas is seen as an alternative to oil as it is more abundant and produces less air pollution when combusted.
Risk: Substantial drops in energy prices due to supply shocks, falling demand with increasing use of alternative energy sources (wind, solar, nuclear).
Temporary hedging for COP investment:
Long April 30 Put - puts a floor on losses if stock price drops below $30 per share before April 17, 2009
Short May 45 Call - puts a ceiling on gains if stock price goes above $45 per share before May 15, 2009 - purpose of this sale was to use call premium to pay for the above put option.
Rationale: Its refined oil and gas products are in demand around the world. Fluctuations in oil and gas prices will translate into significant cash flow changes (either negative or positive). The outlook for the price of crude oil and natural gas will continue to be positive as long as fossil fuels remain the main means of energy production. An increasing demand for oil and gas is expected in the short-term as there is usually an increase in automobile use in the Northern Hemisphere during seasons of warmer weather. An increasing demand is also expected in the long-term when economic activity recovers from the present downturn. Emerging markets, such as those in China, Vietnam, Brazil, Mexico, and India, will most likely support the price of crude oil as their economies grow in the future. As the largest natural gas producer, this company is poised for the greatest growth among the integrated oil and gas giants if natural gas demand increases. Such growth is possible with natural gas increasingly being used to heat homes and with the automobile industry considering the use of gas-powered engines. Natural gas is seen as an alternative to oil as it is more abundant and produces less air pollution when combusted.
Risk: Substantial drops in energy prices due to supply shocks, falling demand with increasing use of alternative energy sources (wind, solar, nuclear).
Temporary hedging for COP investment:
Long April 30 Put - puts a floor on losses if stock price drops below $30 per share before April 17, 2009
Short May 45 Call - puts a ceiling on gains if stock price goes above $45 per share before May 15, 2009 - purpose of this sale was to use call premium to pay for the above put option.
Bonds and Risks to Fixed-Income Investments
A bond is a financial instrument and the quinessential example of corporate debt. Companies issue bonds to raise capital or fund their business enterprises. Bonds typically pay a fixed interest rate, called a coupon rate. This nomenclature has a historical context: traditionally, a bond investor was issued a bond certificate with coupons to cut out and mail to the company each time interest payments came due. Better known as bearer bonds, whoever bears the bond certificate is the owner and the person entitled to receive the interest payments. These days, electronic databases keep track of the owners and the interest payments. No paper is necessary.
There are a wide variety of bonds these days from zero-coupon bonds to perpetual interest-only bonds. Bonds that pay fixed interest rates fall under the umbrella term of fixed-income investments. I'll run through the specifics of a typical bond with an example of a bond I personally own.
023139AA6
AMBAC FINL GROUP INC DEB 9.37500% 08/01/2011
The first set of letters and numbers is the CUSIP, a 9-character alphanumeric security identifier. It is similiar to a stock ticker symbol. Use of it ensures the identification of the precise security (bond, stock). Many companies have bonds with different maturities and interest rates, so using a CUSIP saves time in identifying a particular bond. To say "I want to buy a General Electric bond" to a broker would be very inexact as GE has hundreds of bonds outstanding with different maturities and interest rates. A CUSIP would direct the broker to purchase a particular bond with its set maturity and interest rate.
In the example above, the bond I purchased is issued by AMBAC, the infamous municipal bond insurer who dabbled in the MBS/CDO universe and lost billions. Another great reason to use CUSIP is because different databases have different names and designations for bonds and it is sometimes impossible to find the bond you are looking for. For example, one database could have the bonds of the utility company, Consolidated Edison, as "Con Edison," while another could have it with the full name. Using the CUSIP can be a time-saver as it is universal.
What is not mentioned in the example is the par and the market price. Par is the bond's notional value (generally, 1 bond unit is $1000). I bought 1 bond and paid $970. A multitude of market factors (which could be a whole seperate discussion) explains why I paid below par. Market dynamics aside, as long as the bond is not in default, the bond operates at the par-value. Most relevant here is the interest calculation, which is based on par. 9.37500% is the interest or coupon rate of the bond. This bond will pay an annual interest rate of 9.37500% on the par amount. Since I bought 1 bond, I will receive 9.37500% x $1000 = $93.75 a year.
08/01/2011 is the maturity date, i.e. this bond matures on August 1, 2011. On that day, if there is no default, the final interest payment is paid and the par-value ($1000 per bond) is paid to the bondholders. The corporate debt is then paid-off and the bond ceases to exist. This bond, like most bonds, pays semiannually. So the annual interest payment of $93.75 is actually split into two equal payments per year: every August and February. You can always use the maturity date to as a reference as to when the interest payments will be paid.
Rationale for my investment:
I wanted to invest in something more stable (versus equities), but was willing to accept greater risk (for a higher return) in the corporate bond market. I bought this bond in June of 2008 and at that time, I felt that AMBAC would survive the financial mess at the time (I may be totally wrong). Assuming I am right, on August 1, 2011, I will receive $1000 for my $970 investment in principal and have collected interest at a rate of 9.375% on $1000 during the time I held the bond.
Universal risks applicable to this and any other fixed-income instrument:
1) Interest rate risk: the bond earns interest at a fixed rate; any drastic increases in interest rates diminishes the value of the bond
2) Inflation: the bond earns interest at a fixed rate; any drastic increases in the rate of inflation diminishes the value ofthe assets. The "real" return (after adjusting for inflation) can be negative should the compounded rate of inflation exceed that of the coupon rate.
3) Currency risk: the bond is denominated in US Dollar; any depreciation of the dollar will diminish the value of theassets. While the obligations of the bond may be met, your resulting cash flow has reduced purchasing power.
4) Default risk: the performance of the bond depends on the financial stability and viability of the underlying company, the bond is at risk of defaulting if the company is unprofitable for too long and unable to "break-even." Generally, an instrument is in default when any obligation is not met, e.g. interest payment isnot paid in full or not paid at all.
In the case of Washington Mutual Bank, its assets were seized by the FDIC and sold to J.P. Morgan Chase. The supermajority of bondholders and equityholders were given nothing in compensation. The interest (and principal due) on Washington Mutual bonds will remain unpaid and as a result are in default.
There are a wide variety of bonds these days from zero-coupon bonds to perpetual interest-only bonds. Bonds that pay fixed interest rates fall under the umbrella term of fixed-income investments. I'll run through the specifics of a typical bond with an example of a bond I personally own.
023139AA6
AMBAC FINL GROUP INC DEB 9.37500% 08/01/2011
The first set of letters and numbers is the CUSIP, a 9-character alphanumeric security identifier. It is similiar to a stock ticker symbol. Use of it ensures the identification of the precise security (bond, stock). Many companies have bonds with different maturities and interest rates, so using a CUSIP saves time in identifying a particular bond. To say "I want to buy a General Electric bond" to a broker would be very inexact as GE has hundreds of bonds outstanding with different maturities and interest rates. A CUSIP would direct the broker to purchase a particular bond with its set maturity and interest rate.
In the example above, the bond I purchased is issued by AMBAC, the infamous municipal bond insurer who dabbled in the MBS/CDO universe and lost billions. Another great reason to use CUSIP is because different databases have different names and designations for bonds and it is sometimes impossible to find the bond you are looking for. For example, one database could have the bonds of the utility company, Consolidated Edison, as "Con Edison," while another could have it with the full name. Using the CUSIP can be a time-saver as it is universal.
What is not mentioned in the example is the par and the market price. Par is the bond's notional value (generally, 1 bond unit is $1000). I bought 1 bond and paid $970. A multitude of market factors (which could be a whole seperate discussion) explains why I paid below par. Market dynamics aside, as long as the bond is not in default, the bond operates at the par-value. Most relevant here is the interest calculation, which is based on par. 9.37500% is the interest or coupon rate of the bond. This bond will pay an annual interest rate of 9.37500% on the par amount. Since I bought 1 bond, I will receive 9.37500% x $1000 = $93.75 a year.
08/01/2011 is the maturity date, i.e. this bond matures on August 1, 2011. On that day, if there is no default, the final interest payment is paid and the par-value ($1000 per bond) is paid to the bondholders. The corporate debt is then paid-off and the bond ceases to exist. This bond, like most bonds, pays semiannually. So the annual interest payment of $93.75 is actually split into two equal payments per year: every August and February. You can always use the maturity date to as a reference as to when the interest payments will be paid.
Rationale for my investment:
I wanted to invest in something more stable (versus equities), but was willing to accept greater risk (for a higher return) in the corporate bond market. I bought this bond in June of 2008 and at that time, I felt that AMBAC would survive the financial mess at the time (I may be totally wrong). Assuming I am right, on August 1, 2011, I will receive $1000 for my $970 investment in principal and have collected interest at a rate of 9.375% on $1000 during the time I held the bond.
Universal risks applicable to this and any other fixed-income instrument:
1) Interest rate risk: the bond earns interest at a fixed rate; any drastic increases in interest rates diminishes the value of the bond
2) Inflation: the bond earns interest at a fixed rate; any drastic increases in the rate of inflation diminishes the value ofthe assets. The "real" return (after adjusting for inflation) can be negative should the compounded rate of inflation exceed that of the coupon rate.
3) Currency risk: the bond is denominated in US Dollar; any depreciation of the dollar will diminish the value of theassets. While the obligations of the bond may be met, your resulting cash flow has reduced purchasing power.
4) Default risk: the performance of the bond depends on the financial stability and viability of the underlying company, the bond is at risk of defaulting if the company is unprofitable for too long and unable to "break-even." Generally, an instrument is in default when any obligation is not met, e.g. interest payment isnot paid in full or not paid at all.
In the case of Washington Mutual Bank, its assets were seized by the FDIC and sold to J.P. Morgan Chase. The supermajority of bondholders and equityholders were given nothing in compensation. The interest (and principal due) on Washington Mutual bonds will remain unpaid and as a result are in default.
FDIC take-over of Washington Mutual Bank
On September 25, 2008, the Federal Deposit Insurance Corporation (FDIC) seized all of the deposits and assets of Washington Mutual Bank and sold them to J.P. Morgan Chase for $1.9 billion USD. Such a deal gave the consumer banking arm of J.P. Morgan Chase highly sought after markets in California, Florida, and Washington state. With it, J.P. Morgan Chase assumed an estimated $296 billion in assets and $265 billion in certain liabilities (any debt below secured debt in priority of payment was not included), for a net gain of approximately $31 billion. In a presentation to shareholders, J.P. Morgan writes that the deal is financially compelling as it is immediately accretive to earnings. This shouldn't be a surprise as J.P. Morgan can leverage off of Washington Mutual's large retail deposit base, which they got for a pittance.
The purpose of this blog entry is to express my outrage that debtholders were wiped out in the deal. It would have been better for debt investors to have had Washington Mututal gone bankrupt so that they would have recovered some (if not all) of their investment back. Contrary to media hysteria, such a bankruptcy would have been benign with respect to most Washington Mutual customers. The FDIC had increased deposit insurance to $250,000 per individual. Almost no customer would have lost a cent of their deposits.
What was also surprising was the timing of the take-over. That same week, the then CEO of Washington Mutual, Alan Fishman, had just declared that the bank was financially sound. When the FDIC deal had been made public, he was on a plane returning to corporate headquarters. According to news reports, he had no knowledge whatsoever of this back-room dealing with the FDIC and of the imminent take-over.
I think it is unfair that J.P. Morgan Chase paid so little for Washington Mutual Bank. The shareholders and especially the bondholders got nothing. It took a lot of investment (debt, equity) to build the franchise and with a quick back-room deal with the FDIC, J.P. Morgan got the business for free. I can accept the equityholders of Washington Mututal Inc. who held the greatest risk, to be wiped out, but to let the bondholders (the creditors) be wiped out when the business was still intact and with hundreds of billions of dollars outstanding in assets is unfair. The creditors loaned the money to Washington Mutual. Without such a loan, Washington Mutual would have never been able to acquire the assets which J.P. Morgan Chase now owns. J.P. Morgan's payment for a net gain of $31 billion in assets: $1.9 billion.
The purpose of this blog entry is to express my outrage that debtholders were wiped out in the deal. It would have been better for debt investors to have had Washington Mututal gone bankrupt so that they would have recovered some (if not all) of their investment back. Contrary to media hysteria, such a bankruptcy would have been benign with respect to most Washington Mutual customers. The FDIC had increased deposit insurance to $250,000 per individual. Almost no customer would have lost a cent of their deposits.
What was also surprising was the timing of the take-over. That same week, the then CEO of Washington Mutual, Alan Fishman, had just declared that the bank was financially sound. When the FDIC deal had been made public, he was on a plane returning to corporate headquarters. According to news reports, he had no knowledge whatsoever of this back-room dealing with the FDIC and of the imminent take-over.
I think it is unfair that J.P. Morgan Chase paid so little for Washington Mutual Bank. The shareholders and especially the bondholders got nothing. It took a lot of investment (debt, equity) to build the franchise and with a quick back-room deal with the FDIC, J.P. Morgan got the business for free. I can accept the equityholders of Washington Mututal Inc. who held the greatest risk, to be wiped out, but to let the bondholders (the creditors) be wiped out when the business was still intact and with hundreds of billions of dollars outstanding in assets is unfair. The creditors loaned the money to Washington Mutual. Without such a loan, Washington Mutual would have never been able to acquire the assets which J.P. Morgan Chase now owns. J.P. Morgan's payment for a net gain of $31 billion in assets: $1.9 billion.
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