The Book of Bond

Transcription

the hello and welcome the course want you to lesson one plays upon in his lessons we've learned about the wonders who uses bonds appointments and wise bond investments of this so let's get started the person understand uh... argues that it's nothing more than a one says i describe the following scenario just kato mine this weekend throughout this lesson okay so let's start off with a high representative from a large business that will call the business realestate empires this is the c_f_o_ his name is jack and has the chief financial officer checked is responsible for making sure that any table financing that goes through the business all runs through jackson jack's responsible for that and so jack was given admission from the c_e_o_ the chief executive officer that he did that come up with financing for five hundred million dollars in order to do i'm construct the company's new headquarters building so here's the new uh... rules the umpires headquarter building bet jack is going to be financing and this building cost five hundred million dollars uh... jackson have to get out the and try to find out my so how does jack finance a building of that size if into come up with that much money for his corporation and like anything else he would start at the back so jack would go to the bank and sit down with uh... personal backing obviously be meeting with uh... some pretty high level people for alone of that size what they do is they sit down and they'd look at all the things that we review torrent unit one we're assessing the value of the stock of the bank would do a very similar thing with the people looking at the health of the company that would that'd be the first step at the banquet didn't even see if they could lend that amount of money to uh... corporation like this so would say that after chapin sat down with representatives of the bank and they determined that unit jack's company it was healthy enough to spin order take on alone of that size of five hundred million dollars which is enormous uh... the bank decides they're going to go ahead and facility that one how the bank is going to is you that money to jack's businesses they're gonna do it through for bonds and so what ideas i just created kind of generic bond here and what the best thing to do is they're going to make five hundred thousand bonds and each one has apartheid thousand dollars and what the bank's refusing to take these slips of paper these bonds and they're gonna sell these bonds to investors and the money that their investors pay them through the sponsors can be to save money but the bank hamesha reject so the bank reach five hundred thousand bonds each bonds thousand dollars when you multiply those numbers together you get the five hundred million dollars to check would be uh... going after built the headquarters building so what the bank does is the bank comes up with the rough coupon rate much to say that it's five percent uh... based off of the risk and the interest rates that are all happening during the time when jack could have gone to try to get the loan answer based off of that they're gonna go ahead and issue they uh... bonnet five percent so is jack comes in he's we come back to the bank in the banks and sit down the back gate at this point has issued an annual budget but they're still gonna facilitate the land they're gonna go ahead and get jacks company dot five hundred million dollars that they need order to absurd financing bill in the building thingy after they do that after they give japanese five hundred million dollars there now sitting on this five hundred thousand bonds that they're not distributed start selling to investors so let's go to the next step here skaters are investors answer the bank after jackson equation jackpot is five hundred million dollars from the bank and now the bank is going to go ahead initiated start selling these five hundred thousand bonds to all all sorts of investors how one investor might buy it you know if alyssa bonds the next person might buy a hundred bonds bit the bank is going to be selling each one of the response and the bank instead of charging thousand dollars they might charge per thousand five dollars for each bonds sold and that difference uh... that five dollar difference will call it will is what's called the underwriters fee and that's how it that makes them on because they're selling off all the sponsor uh... because of some five hundred thousand bonds let's say a market for about five dollars that's how the banks making their money so the investors get their bond and they pay a thousand five dollars to get into that bond and money all that slip of paper but they're actually gunnery cdcl says the coupon rate is five percent and so they're going to receive five percent of thousand dollars katie in five percent goes off apartheid not the price that they pay for the bond gets really important to technet so they're gonna make five percent a year on the thousand dollars so every single year at fifty dollars and bonds are typically pay two times a year so that these investors if you give one of these investors have one bond day bc twenty five dollars after six months of owning it meant next six months to get another twenty five dollars and they keep getting this twenty five dollar payments for the total term of the bond to be thirty years and then this is also a very important part at the very end of that thirty years they've received there are thousands all her par value investment back and that would be paid by checks company so jack's jack's company would also be making that coupon payment about five percent each each paying so after the bank sells off that bond the relationship at that point is now between jacket investors so let me go ahead and recap this real fast you can see how the flow of money whitaker uh... during this transaction needed the five hundred million dollars the bank supply and that five hundred million dollars so you can see uh... might get on reports chair after jack received the five hundred million dollars the bank now has five hundred thousand bonds that they now need to start selling to investors now if they don't sell all the bonds initially offered investors in the banks continued tahoe or the bonds open the bank would receive the coupon payments is five percent coupon payments but if the bank does sell the bonds off to the investors which they want to do because they'll ultimately don't want to be responsible for that sizable on they want to push that responsibility off onto the investors that after the bank would go ahead and start selling those response off to the investors now investors have all the pawns the relationship is now between jack in the investors and so jack's company is going to continue to make the five percent uh... coupon payments to those investors and they're gonna make it every six months make another payment keep making this payments clear up to the thirty years so those investors who can pay five percent that initial investment author point for thirty years and then after thirty years the ball in the constitution or and that's important trim on the constant reference for net and jack's company now has to pay all those investors are whoever's hole in the bond whoever holds the bond after the term comes up they all received thousand dollar payment for the part are you every seat at the house in dollar payment out to the point becomes chore and that's it that's really all there is too okay so who is she responds but it is really just to divisions for this and one is corporations and the others government so the model that i just walked in three was a was a corporation for corporation the to raise money that's one of the options that they have in order to research funds is to can look back at the bank issued bonds uh... so you understand that model and when you're talking to the government beholden to you the exact same thing to go through the same steps they'll don't go to the bank to bank will look at the uh... the capability that the government actually has to repay the bonds uh... when you get into it the state and local level they don't have the luxury of the federal level that they can just print more money because they don't have state dollars that they don't have world colors they're using federal dollars at the state and local government have to remain within the boundaries of watch their balance sheets and make sure that the revenues that they bring in or exceeding via expenses that they have so when they go to the bank to bank sent to the same thing they're gonna assess their ability that local government of state government's ability to repay the loan in the interest rate that they would make the bond for would-be corresponding to there to their ability to pay that off when you get into the federal level uh... warren buffett considers this is your risk investment simply because the federal government has the ability of a luxury just print more money if they need to now that causes inflation and low long-run but uh... will talk about that later on speaking to you of some of the working its lessons in and second course of this website bit uh... all you really need to know is but generally speaking the federal government's upon is considered zero risk because they can just print more money in order to fulfill via coupon payments so speaking about the risks associated with bonds uh... the thinking that i really think about her these three things of the first one is whether the company of the government would have a failure because if that company let's say we go back to jack's company although he might have got a really good interest rate because maybe whenever he went in for his initial uh... screening everything looked like the company pet for billy to pay back their loans that's a long long that's thirty years logs of fifteen years later maybe you got a new management may be a new board of directors and the direction of the company is taken has become a whole lot riskier and which we find is that that company that risk associated with the company and that made either inability to continue making a coupon payments search showing up in the market and people start trading that bond much lower because there's no anticipation that the coupon payments are going to be sustained the next first that's associated with bonds is that when interest rates change the bond of value the market value that bonds also been a change let's assume that you just went out and you bought five percent federal pond and two years later interest rates went down to four percent to hear you are holding that five percent bonds in two years later the best people can get when they go out and buy bonds four percent so there's a there's an enormous advantage that you have holding up on that is paying a higher interest rate than what people can go out get at four percent incident valued your bond market goes up significantly based off of that change in the last thing that uh... is a risk associated with the parts inflation if you would go out and you buy a five percent bonds and inflation throughout the term about on is four percent all more money you're going to make relatively speaking as one percent so when you're figuring out the value of a pond uh... you absolutely have to subtract out the inflation that occurs to me that duration that you got the bond that something very important understand we'll talk about all those factors much more in the second course that this is just a general overview okay so i briefly talked about uh... company that would start performing poorly and let's assume that you have you're holding a bond for a company that actually does fail goes through bankruptcy online in two thousand two thousand nine time frame this was uh... real for general motors they went through the bankruptcy and uh... when something like this happens the work distribution for the equity it remains that company whenever they go bankrupt in order of presidents is that the bondholders receive their money first then the preferred shareholders than the common shareholders now in the first uh... unit but we were talking about were common shares so you the last in order there to receive distributions of what was written in the company if it would fail so that's one of the things that truly great about paul insist that level risk has a lot lower than dealing with common shares because of something that happens you're the first person to receive payment if their space there is any money left said something else you to consider on a lot of times when you're talking bankruptcy there's not really too much left so this is something else to think about so why would you invest in a bar in a lot of people they baber we don't see the value in it because they see maybe a little coupon rate of maybe five percent want to do is on a show you wife investing in bonds is absolutely just as important as investing in stocks and this is so fundamental to warren buffett's investment approach in this is something that really want to pay close attention to it when i got here is the dow jones industrial average uh... through our last market crash in two thousand eight you can see the timeline about there and what ideas and looked up what the thirty year federal laundry was back in beginning at two thousand set nap on rate was around five percent no one else i did and if you can't eat gone through the first unit you understand what the price earnings ratio isn't it if you don't i recommend you go back in definitely watch the that first unit before you jump your second in texas will make a whole lot more sense that during that same time and and two thousand seven beginning in two thousand seven the average price earnings ratio on the dow jones was twenty seven as you remember if we take the reciprocal overpriced earnings ratio that that gives us a the preaching a rain uh... rough estimate of what our return will be and so taking the reciprocal which just means one divided by a price-earnings ratios would be one divided by twenty seven are returned as three point seven percent so looking at the bond a federal quan which we've already established system you know misses your risk investment and it's making five percent and if you would do it invests in the dow jones industrial average and your pisa twenty-seven and you can only expect the three point seven percent return it's pretty obvious which investment you're is the better choice mandates that the bond is because you can't make a five percent oppose the three point seven percent and so when you look at this chart you can see how stocks will prolly training like wildfire back in two thousand seven and everyone in their kid was involved in the stock market the yet the bond is where warren buffett and really smart uh... value investors would have been because they know that they're gonna get a better return on that and so what that does and they were predicting anything they're not predicting anything here that all altered to resist and simply reacting to put to better value and at this point was the bond now as we look over to the right side let's go to two thousand nine can look at how the numbers change so now in two thousand nine thirty-year federal pauline is now at two twenty three percent because the federal government china stimulate the economy to drop the interest rates and now we look at the average price earnings ratio for stocks ten to fifteen so when we take the reciprocal of fifteen which is one divided by fifteen our return is six point seven percent almost double where it was two years earlier so now let's look at that return soon bonds are now up to twenty three percent and stocks are at six point seven percent on average across the board which ones that are investment will of course the stocks of the better faster and of course that's what we were both in old billionaires were doing was a whereby a police talk soon thereafter cheap prices never unit minimizing and they were buying companies that had very little that and so what they knew it was there that they were always on the right side of the equation they're always investing and bonds when they should have been there investing in stocks and they should have been because they were simply making that comparison and that is so vitally important to understand so let's have some fun here let's assume that we bought a thirty-year federal blog back in two thousand seven because we saw it was a five percent and the price list at the thousand dollars per points let's just by one point four thousand dollars back then so that we hold onto that bond okay and now in two thousand nine interest rates dropped on the two twenty three percent and when there is interest rates dropping your holdings remember we bought the five percent bonds were holding that five percent ball and now it's two years later and the best that anybody can go out and find a street when he three percent but what are you holding on to your holding on to the five percent bond who doesn't want by five percent bond when interest rate to that level so that your bond becomes more valuable on the market because you want to five percent bond when everyone else can we get two twenty three percent and so the value-added changed approximately upto one thousand four hundred eighty dollars and then when you add in two years of coupon payments that actually goes up to five hundred eighteen dollars you've made in a two year period so that's about twenty five percent return precluding that bond in just two years so that's why uh... investing in bonds is so important and just it's equally important to warren buffett's investing approaches as much as stocks that unfortunately a lot of people don't talk about that nate really don't understand how he's doing that but this is what he's doing so why invest in bonds then what i just said you know understanding pause just as important as understanding stocks which are gonna find is that a lot of times let's talk to really high the bond prices are really load of great value and vice versa years see the exact opposite whenever uh... the bond prices when interest rates really well and no one st stops that's when you really want be involved stocks so that includes the first lesson unit to we've learned what is upon we learned uses bonds we've learned about four hundred wise bombastic said and i really hope that this uh... might be the will to faster discussing with things i wanted to get everything out on the table so that you can understand where i'm going with this picture at sea and let's assume