Basic Financial Securities - a very basic quick lesson in Finance

Let us say Alice and Bob want to start a business. Alice contributes $3,000 and Bob $5,000. Let's say for sake of argument they work equally hard at the business and make $800 in profits at the end of the month after taxes. So what is each person's share? Fairness dictates that the profits be split among the parties in the ratio of their contributed capital (or risk they took going in). Thus, Alice makes $300 and Bob gets $500. This is the basic idea of a Partnership.

Stocks
Now let's say Alice and Bob's business, ACME, needs more capital to expand. They need to raise it from other sources. They could ask friends and relatives. They could go to a bank. Let's say for argument that they issue shares or equity in the business. These shares would normally be placed by a bank or a group of banks that a. advice ACME on what a suitable price should be for the shares, and b. do a roadshow to market ACME to potential clients to informally see what price ACME shares can command given its growth prospects. This process of investment banks marketing a new company that is coming to market to issue shares is called a roadshow.

After the roadshow, the investment banks advice ACME what a suitable share price might be, how many shares they can issue, and how to go about selling them. Typically, selling shares involves listing the company on a stock exchange and then letting shares start trading (ACME may keep some shares for themselves, and the banks may do the same, per their agreement with ACME). The rest of the shares are sold on the agreed upon day on the stock market in an exchange in a process called the Initial Public Offering or IPO. ACME shares start trading on that day. This is also called the primary market.

After the IPO, ACME shares may be bought or sold on the exchange. This is the secondary market. And prices of these shares may go up or down based on ACME's revenues, sales, margins, future prospects and a whole host of other factors.

So why do people buy ACME shares? They buy these shares because owning a share means owning a part of ACME's business. Let's say ACME was worth $8M when they floated shares, and they have a total of $2M in shares outstanding, havng sold 500,000 shares at $4 each. Then each share owns $4 of ACME's business. If ACME is later worth $8M due to increased sales etc, then the share prices rise proportionately, and the owners of these shares profit.

People may buy shares for another reason as well. ACME may periodically distribute extra income from sales, after all investments in its business and expansion plans are met, as dividends to shareholders. So not only do shareholders accrue capital gains from holding stock, they get a periodic dividend as well, if the company gives one.

Bonds
But what if ACME didn't want to issue common stock? ACME could have financed their business growth by issuing debt, called bonds instead. The way this works, ACME (again through banks) approaches the market and says "give us $2M now, and we will pay you back $2M after 10 years, and interest at 5% semi-annually in the mean-time on the principle".

Here, the $2M is split into 2000 bonds each worth $1,000 say, and sold in the debt capital market. The 5% coupon is something the banks consult with rating agencies (who determine the credit-worthiness of ACME and its ability to pay back the loan), that they think the market will bear at the level of risk. Then the bonds are sold in the debt markets, to bond owners called bond-holders.

Let us say for sake of argument the prevailing interest rate is also 5%. These bond holders are each paid $1,000 for a bond, and receive $25 two times a year (semi-annually), and receive at the end of the 10th year, a final payment of $25 and their original principal of $1000.  Of course, if ACME goes bankrupt sometime in these 10 years, then both the coupons (interest payments) and the principal are forfeit by the bond-holders. This is called credit risk. So bond-holders are careful to only buy bonds for good companies, and demand a hefty premium over the prevailing interest rate as at least some compensation for this risk.

... more to come. will keep it very basic for the complete novice.


Interest rate, tax rate

Syndicated Loans


Bonds - maturity, coupon, duration

Treasuries/Sovereigns

Quasi Sovereigns

Corporate Credits

Commodities

Derivatives

Options

Forwards

Futures

Swaps

Zen Stories

The goal of this post is to capture insightful, interesting, inspiring, and uplifting stories. None are composed by the author himself. He simply recounts from memory and past readings, sources long forgotten. Apologies on missing attribution. All errors in the story-telling remain mine alone. I will add more as I find time.


1. "Before I studied Zen, the mountains were just mountains, and the rivers were just rivers. After the first taste of Zen, the mountains were no longer just mountains, and the rivers were no longer just rivers. Now that I understand more of Zen, the mountains are once again mountains, and the rivers are once again rivers."

                                                                                                                                             -- Unknown

2. A traveler approached a monk seated, eyes closed in meditation, prostrated before him, and asked him how long it would take him to get to the next village. "Walk", the monk replied. "That's what I am asking you", the impatient man countered, "how long till the next village?". "Without seeing how you carry yourself, how can I answer?" was the wise reply.

3. Two monks were traveling on a pilgrimage when they came to a small river to be crossed on stepping stones. On their bank, they noticed a shoddily dressed lame woman who appeared to be wanting to cross but unable because of her difficulty. One monk ignored her and crossed the river himself. The other, with some difficulty, carried the woman across and put her down on the other side. The monks then resumed their journey. After going a distance, the first monk asked, "given your vow of celibacy and never to touch a woman, why did you carry her across over there?". The second monk replied, "yes, I did touch her, and yes again, I carried her. But I left her there, while you are carrying her still."

4. As I walked up a beach I saw a girl in the distance doing an odd kind of dance. As I got closer I saw she was picking things up and tossing them back into the sea. Then I noticed that several thousand starfish had beached and she was tossing them one by one into the sea. I asked her what she was doing - "they'll die if they don't get back into the water" she said, "I'm only doing my bit".  I asked her what possible difference it could make when there were so many lying around. "To this one it does" she said, tossing yet another into the sea.

5. A little girl was lost in a small but busy marketplace. When a stranger tried to help her find her mother, she said "my mother is the most beautiful woman in the world". The stranger then took her towards all the beautiful women present, and each time the girl said it wasn't her mother. They then find a rather plain looking woman searching desperately for her child. The girl runs to the woman and hugs her. "We do not love people because they are beautiful. People are beautiful to us because we love them".

6. God promised me he would be with me always. In a dream he showed me my footsteps through my past life, and there were always two pairs of feet walking, except for the most difficult times when there were only one set of footprints visible on the sands of time. I asked Him about this. "My son, these were the times you were not able to go on and I carried you".