Margin Call

Life is a matter of choices as you have to choose what you want but you can’t have both at once. The board of directors from the movie of “Margin Call” were in a hardship of whether to sell the valueless financial products to their customer or to keep their reputations. In the meantime, it is worthwhile to argue that should the company keep their reputation while they are on the verge of bankruptcy? Yet, should the employees keep their professional ethics towards the customers in the situation where they might lose their decent and high paying jobs? In the virtue of moral responsibility and obligations, the answer is yes because the reputation of company would be destroyed if they sell it all to their customers. In contrast, the answer is undoubtedly no because they would have to protect their self-interest in order to prevent the company from bankruptcy. From my point of view, the movie had formed a polarized situation and it is very difficult for the board of directors to make a choice. However, it is understandable that they eventually encourage their employees by providing high bonuses to sell the valueless investment products to the unsuspecting customers. After all, the so called “investors” or buyers of the products were buying it with the assumption of they can purchase it at a cheaper price and make profits out of it without considering the risks nor morality.

Furthermore, I am concerned with the level of job security that reflected on “Margin Call”. In the beginning of the movie, a number of employees including an employee who were with the company for 19years were sacked for the welfare of company. This shows that loyalty of employees towards a company is no longer able to for them secure their jobs. In fact, these miserable events happened not only in the movies, it can be seen often in the real-world situation as well where employees are lay off in the process of company downsizing and bankruptcy. The outcome is that many people are jobless and their living are dramatically impacted.  I personally think that this is quite ironic because it is inverse with the concept instilled by our parents and society since we were born. Most people are told that getting a flying colors results for academic, graduated from university with high prestige would secure a decent job and life would be much more easy. The fact is that unemployment rates of graduates are increasing at an alarming rates and not to mention the unemployment rates worldwide. On the other hand, the 99% of wealth are controlled by the 1% richest people thus the wealth distribution is imbalance severely and it had created a scenario of the rich are getting richer and the poor are getting poorer. Many people are trapped as they worked their ass off just to pay their taxes and debts such as car and housing loans.

Consequently, it is believed that securing a decent job is no longer the priority to pursue for us. A recommended solution from a famous book “Rich Dad, Poor Dad” by Richard Kiyosaki is that employees should start “paying themselves first” as soon as possible. This simply means that employees should retained around 10% of their pay once they receive their salary monthly and when the savings had increased to a certain amount, they then able to generate more passive income using their capital. For instance, they can use their free time to start a business such as an online store or investment like stocks and bonds market. However, starting a new business consists of a high risk thus they must develop a business strategy and risk management in order to sustain and grow their business. In contrast, stocks market also posted a certain level of risks hence they must understand the business and company in order to avoid losses. For example, they can gather and analyze tons of useful information from company’s annual and quarter report, such as the balance sheets, cash flow, profit and loss table as well as company’s future prospects. “Don’t put all your eggs in a single basket”, therefore it is advisable to distribute capital into other financial instruments as well. A great example is to invest 60% of their capital in stocks market and 40% in bonds market.

In short, when the passive income generated monthly from their business or investment is greater than the expenses, employees are no longer depending on their job to survive, they are able to make a living even if they had lost their jobs. After all, it is much more easy to say than doing it realistically, thus we must start carrying out the strategy as soon as possible in order to get out of the trap.

Should Companies Set a Dividend Policy?

Along my path of investing in stocks, I’ve heard that Berkshire Hathaway had never pay out dividend to their shareholders. This is because of the current chairman and also CEO of Berkshire Hathaway, Warren Buffet believes that the cash can be well utilized in investing back into his business instead of paying out to shareholders as dividends. However, the company has a decent shares buyback policy which is an another pipeline to reward its shareholders with cash. Tax implication is one of the difference between shares buyback and dividend as companies are taxed twice when giving out dividends. In fact, the company had only paid dividend once to its shareholders back in year 1967 and Sir Warren Buffet joked that the decision was made when he was showering in the bathroom. The company is now worth nearly $540billions and its share price is current trading at $330,350 which is similar to the price of a house thus it proves that reinvesting cash to the business instead of giving out dividend is indeed an effective strategy to grow the business. Nevertheless, should companies carry out an ideal dividend policy to rewards its loyal shareholders? Or let’s put ourselves in shareholders’ shoes, do they desire dividend payment from the company they invested or prefer the company to reinvest the retained earnings back into business?

          

             

           From my point of view, a company with a dividend policy that giving out dividends between the range of 20%-40% from its retained earnings is desirable. This is because when the share price of the company is not performing, dividends play an important role to safeguard shareholders’ value. Even though shareholders are making loss on the declining share price, they would still receive dividend as a “compensation” for their investment and the risk that they are taking. For instance, when the bear has take over the market and the overall market sentiment is bad for a certain period of time, companies with a high dividend yield are very defensive and preferable for shareholders to invest because the share prices will generally decline at a high range hence dividends are able to guarantee shareholders’ investment as a passive income. In contrast, it is advisable that growing companies do not implement a dividend policy because they can expand their business by investing the retained earnings in projects and other investment. In this case, companies are able to growth at a high pace and the share prices would eventually increase due to the rising future earnings. Therefore, shareholders can enjoy a “yummy” capital gains out of the stocks yet companies fulfilled their obligations by maximizing its shareholders’ wealth.

             Speaking of dividend, I recall that I had a best friend back in high school who came from a wealthy background. I was admired by his wealth and one day when we were eating lunch at canteen, I asked him about what do his family do for a living out of curiosity, specifically his dad’s career. He answered: “my dad is jobless.” I was terribly shocked by his answer and asked him immediately after: “Then where are all the wealth from?!” He said he only knew that his family would receive money regularly but had no idea where was it from. I was desperate to figure out the answer then I asked my best friend to inquire his parents. On the next day, he then told me that it was stocks, stocks that his grandfather bought many years ago. At the time being, I barely know what stocks really is and it turned out that his grandfather bought a large amount of blue-chip stocks and later on transferred to his dad which stated on his will that the stocks are prohibited to sell, the family could only receive dividends for their lifetime. Therefore, his father receives these dividends regularly and lives a wealthy life. As a matter of fact, there are quite a number of shareholders are aiming at stocks with high dividend yields in order to increase their passive income and eventually achieve the so called “financially freedom”, where passive income is higher than the expenses.

            In short, it is not mandatory for companies to implement a dividend policy because every companies are different in terms of their assets, liabilities, cash flow and etc. However, companies can set their dividend policy using various Dividend Relevance Theories as a reference whichever best fit their criteria. For example, the theory of Bird-in-the-hand implies that companies should pay high dividends to their shareholders in order to maximize share price because investors prefer the certainty of dividend payments to the possibility of substantially higher future capital gains. In contrast, Firm life-cycle theory shows that company should implement dividend policy based on its life cycle thus when a company’s growth rate and profitability rate are expected to decline in the future, company should pay out dividends and vice versa.

Blog 3- Capital Structure

Coca-cola has been my favourite soft drinks since I was a kid, and it still is now. Imagine one sip of it went into your mouth, it just feels so great, sort of like an explosion in the mouth many thanks to the “secret recipe” of coca-cola. Another of my favourite drink, is of course the coffee! I can never go on a day without a cup of coffee in the morning, it sorts of like “a coffee a day, keep the sickness away” to me. So why are we talking about these two of my favourite drinks in this blog? It is because the main topic today is about one of the shocking acquisition happened in the late August this year, which is Coca-cola is buying the business of Costa from Whitbread.

Coca-cola has offered an £3.9 billion all cash for the business of Costa, the UK’s favourite coffee shop. Nevertheless, the area that we are focusing in this blog is the capital structure of Coca-cola funding the acquisition. In order to fund the acquisition solely through cash, Coca-cola would have to issue new debt, I mean, who would have carry so much cash in their pocket? Right? Debt financing has a lower cost than equity financing because it is tax deductible thus the company do not have to worry about paying large sum of taxes throughout the acquisition. By doing so, the weighted average cost of capital is actually lower if Coca-cola were to fund it through debt financing instead of issuance of new shares.

Consequently, the shareholders of the company would not face a dilution of their ownership without issuing new shares. In this case, the company can also maintain the earnings per shares which is actually beneficial to the shareholders. However, there is always a good side and a bad side in everything. The disadvantages for the company to finance through debt is that the credit rating might affected or downgraded due to the increasing debt and trigger a bad cycle such as the drop of share price or whatsoever.

In addition, the increasing debt level would also cause the interest rate to rise, and eventually pull up their cost of debt. In this case, it might offset the reduced in WACC that we discuss earlier. During the bad days, cash plays an important role for any company to settle their problem like the liquidity, hence there is a hidden risk for Coca-cola to turnover if there is any unwanted event happens. Overall, I personally think that this is a pretty good deal because Coca-cola get to involve in other business besides its core business as it could generate a decent continually revenue and contributes to its bottom line, not to mention the large market shares of Costa in the UK.

In short, this is a smart move by the company as coffee is considered as a necessity for all the coffee lovers. Exaggeratedly, I bet many of the coffee lovers couldn’t survive a day without a cup of coffee, even they were lucky to make it, they would be probably half-dead already.

Assessed Blog 2 -The last days of Lehman Brothers Moral Hazard 2008

The last days of Lehman Brothers 2008

       I’ve gained a lot of insights on the financial crisis of year 2008 after watching the finance documentary of “The Last Days of Lehman Brothers Moral Hazard 2008” that produced by BBC. On top of that, I had a better understanding of the development of the world economy, its development is closely related to the judgment and decision-making of policy makers, hence the mistakes of policy makers may cause financial crisis within the country and worldwide which makes the economy extremely fragile. The documentary also emphasis on the difficulties of making decisions by the bankers and minister of finance in the U.S whether to save Lehman Brothers from bankruptcy especially when they were running out of time and it gave me a mini heart attack while watching it.

          

             

                 

                  The main reason that causes Lehman Brothers to bankrupt is the human nature of greed. The CEO at the time of 2008, Dick Fuld could have sold Lehman Brothers with decent price few months before the collapse happened, but the price was never high enough to fulfill his greed. Lehman Brothers was burdened by too much of toxic assets and no other banks would want to buy it or bailout the drowning bank. In my opinion, the credit default swap was a very clever and profiting financial instrument derivatives which made the banks tons of profits. However, they neglected the risk behind it and could only see the profits where they were giving out credits rating on the CDS which they didn’t even analyzed the value of it. In addition, the subprime mortgages had created a giant bubble back then and it eventually burst when the borrowers were not able to repay their loans. It reminds me a saying of “You reap what you sow”, thus risk management is very important which not only for banks, individuals like us must manage risk carefully in order to prevent any unwanted events.

           

“Someone has to fail”, a sentence fill with sorrow but truthful from Paulson in the documentary. Lehman Brothers had to fail, Dick Fuld had to fail in order to curb the terrible situation from going worst. Perhaps it explained why the Barclays Bank did not bailout Lehman Brothers in the end. From my point of view, if the acquisition were to succeed, it was only to extends the life of Lehman Brothers but the problem wouldn’t be solved and it might lead to a more powerful crush towards the financial world. Besides, are banks like CitiBank, JP Morgan, HSBC Banks too big to fail? If I were in the situation which before the financial crisis of year 2008, I could never imagine that Lehman Brothers, with a history of 150 years in banking industry would have end up like this, and I personally think that 95% of people couldn’t see that coming as well. However, the fall of Lehman legacy had proven that a bank was never too big to fail. Even with the size of Lehman Brothers, a bank would still collapse if the risks are not properly managed by the directors.

           

To conclude, the collapse of Lehman Brothers is a very useful example and warning for the financial world. Banks regulators are now more stringent on the minimum capital requirement as well as emphasizing on liquidity risk. Besides, leverage is a “double-edged knife” as it could generate decent profits for banks but over-leveraging would hurt the banks. Countless of people had suicided, went bankrupt, and vary tragedies happened during financial crisis of year 2008. Nevertheless, ten years has past and the economy is on the track to recover. According to rumors, there is a curse saying that financial crisis would happens once in every ten years which shown by the financial crisis of Southeast Asia in 1997-98, the collapse of Lehman Brothers in 2008. However, would there be another financial crisis occur in year 2018-19? I have no idea, and I am certain that nobody has an accurate answer because it is not predictable, but I am sure that it would happen in the future due to the human nature of fear and greed, which is said by one of the greatest investor of all time, Sir Warren Buffet. In fact, that are many issues rising globally which are harming the economy system such as the trade war between US and China, currency crisis on emerging markets due to the increasing interest rate, fluctuation of oil prices due to the sanctions against Iran and the case of reporter killed in Saudi and etc. Even though we are unable to predict the next financial crisis, but we are able to prepare and take cautious action to minimize the impact it could bring to us by managing risks and diversify out portfolio effectively.