Alan Cring Productions in association with the Emergent Lights Studio presents
the Illinois State Collegiate Compendium, Academic Lectures in Business and Economics.
This is Business Finance, FIL 240 for spring semester 2024.
Today, financial institutions and then financial statements.
I'm getting caught up, but there's still a little bit of room to run here.
But as always, we look at the numbers to start the day.
And here we have a very quiet day actually in a lot of ways.
But just overall, is this a bull day or a bear day?
Looks bull.
Looks bull. It is bull. It is not a big bull. It is just a very quiet bull.
And you can see that the markets are all in the green, which of course means that it's a bull day.
But that's nothing spectacular.
I guess you could say, well, the NASDAQ is showing some signs of life.
But if you look at the numbers, the Dow is up a barely up 0.03%.
And then, as is typically the case, the S&P 500 will move more strongly in the same direction.
And the S&P 500 is up an unspectacular 0.19%.
And then the NASDAQ, which you should expect to reflect the same direction but more strongly,
because of the higher risk of the stocks, is up 0.45%.
But there's nothing really exciting going on.
There's generally a positive sentiment in the markets right now.
But there's also a wait and see.
Because we have news that is going to be coming out over the next couple of weeks.
For one thing, this is earnings season for some of the heavies on the S&P 500.
They're announcing their earnings for the quarter.
Now, the markets have already formed their expectations of what the earnings will be
based upon the company's estimates, forecasts of what they will be.
And so now, whatever they actually come out to be will sort of either confirm the expectation
or create a new expectation, and you will have either not much movement or something dramatic,
like happened last week with, I think it was Netflix, was just going bananas last week.
And then there's another wild card.
The Federal Reserve is going to have one of its eight meetings a year.
And the general sentiment is they're not going to raise interest rates,
because it appears that inflation has been defeated.
However, there are some who think that the Fed is going to come out with a rate decrease.
Lowering interest rates would stimulate the economy.
But that expectation is not very big right now.
We'll see how it goes.
Crude oil, it has slid a little bit.
We're in that trading range right now. There's nothing dramatic about it.
You can see that it's just kind of bouncing around the 72 to 79,
which it keeps finding its way back into that trading band.
As long as it stays there, gasoline prices, diesel prices, jet fuel prices will tend to stay relatively stable,
which is good for the economy.
We don't need the fuel prices going up, which would increase costs of delivery, transport, and all that.
So we've got that going on.
Gold has been bouncing up and down today.
The gold bugs have a few thrills, and then it slides back down.
It's up about half a percent.
Silver is up really strongly today, for some reason.
I can't say why.
Now, the 10-year bond.
This is the benchmark 10-year treasury bond, which sort of gives us a view of what all bonds are doing,
hence why we call it a benchmark, sort of.
But as you can see, now, these aren't prices.
These are yields.
You see that the yields are falling.
That would mean that the prices of these bonds are going up,
and that would indicate that there is a lot of demand for these bonds.
The demand is surging, so the price goes up, and mathematically, the yield goes down.
That's good news for the economy.
Lower interest rates means that we will get some economic stimulus from that.
Actually, it's dropped about six basis points so far today, six one-hundredths of a percent.
So that's a decent move down.
It's just a sentiment that right now yields are falling,
and if the Fed actually drops the interest rates, the discount rate that it controls
and targets a lower federal funds rate, we'll get into some good economic stimulus.
As a matter of fact, some are beginning to be concerned that the economy is running a little too hot right now.
But we'll see how that goes over the next few days.
I think the Fed's meeting is sometime this week or next week.
Is there some reason why I can't get this to behave itself?
There we go. Good.
Now, let me pull over here and get to the other markets.
The Nikkei had a slow, grinding-up morning that was last night for us, the middle of the night.
And then it kind of topped off and slid back down a little bit.
It was not spectacular, but the market, but the other side of the world,
the Nikkei 225 on the Tokyo exchange, finished up three-quarters of a percent.
Not a bad showing. But then London.
London, the sun set in Japan, and it rose across Europe and rose in England,
and there in Great Britain.
And you can see that there was a bull spike right here.
See the bull spike? Something good news.
But then the bears took over, slapped it back down, and then it bounced around,
and it finally just kind of tailed off and slowly slid down to virtually flat at 0.03%.
That's a flat.
It ended up about the same at the end of the trading day as it did at the beginning.
Although, wait, no, they should still be trading over in London still right now.
Maybe. I can't keep the time right on that.
But anyway, well, then of course the sun rose, went across the Atlantic,
and rose over on the East Coast here, and our markets started out good,
but then they kind of lost their will to live.
They've been bouncing around a lot, although the NASDAQ seems to be doing pretty well.
Now, a couple of stocks just to get that into your blood,
because I ask this every day, I show you these every day,
and I can ask these questions about reading these numbers on a quiz or an exam.
I mean, advanced micro devices, AMD, they make chips.
They are the main competitor of Intel for computer chips,
and we'll see how they look right now.
Down a little bit so far today.
Down less than half a percent, but it's still down.
Let's try a few things. First things first.
Well, those can't be right.
Yahoo's quotation system, the bid has to be above,
the ask has to be above the bid, so I always say, wouldn't do that kind of stuff.
But as you can see, AMD, this stock price is actually near its 52-week high right now.
It's sometime over the past 52 weeks, it's gotten up to 184.92,
and right now it's at 176.38, so it's near that 52-week high.
But if you look, oh, look at this, the volume, we still got a couple hours left in the trading day,
and the volume on AMD has already almost hit what it is for a full,
on the average day over the last 52 weeks.
Now, a couple things for you.
Let's start this off.
Madam, is this a risky stock or a safe stock?
It's okay if you, you want to take it?
Yes, why do you say that?
Beta, that beta is technically what we call risky AF.
That has a very high risk stock.
1.7, one is the fulcrum, one is the volatility of the world portfolio, the market risk.
Now, this is what 1.7 says, it swings in a well-diversified portfolio,
170% of that, so yeah, this is risky.
This is inappropriate investment for anything but the risk, the biggest risk takers you would want.
Now, that PE ratio is insane.
I'll tell you, right now, 30 would tell us that the price is about at intrinsic value.
Now, if it's below 30, you have some undervaluation, possibly.
Over 30, you have some overvaluation.
And again, 30 is my number.
Some would say 25, some would say 40, whatever.
This is insane.
That price is so far out of line with intrinsic value, you hardly ever see anything that overvalued,
which would mean this is not something that you would want to grab right now
because that price is going to find its way back down so that it's at about 30,
about price divided by earnings per share, price per share divided by earnings per share,
comes back down more realistically to about 30.
As you can see, it's got a long way to drop.
Now, when will that happen?
That's the key.
We don't know.
A stock can stay floating way above its intrinsic value for days, months, even in some cases, years.
And I'll show you one in a minute here, which I showed you the last time, but we can see that here.
Now, the one good thing here, AMD is actually profitable.
That's a lousy 11 cents per share.
But at least, in other words, the net income has to be positive for net income divided by shares outstanding to be positive.
So, yeah, it's profitable, not very, but it's profitable.
It does not, however, pay a dividend.
So the only way you make money on the stock is if the stock price goes up.
See, if there's a dividend, you're going to get a check in the mail for the dividend.
So at least you get something out of that.
But in this case, you're riding this dog just on the price of the stock alone.
Now, moving over, take you on another one, and I showed you this one last time just because it's such a fun example.
Tesla.
I said Tesla.
It can't be that hard to find.
Okay.
Now, the bid-asked spread.
You can sell this stock at $187.68 a share.
You can buy it at $187.69 a share.
The volume is pretty strong on this today, and that's what keeps the bid-asked spread tight.
As long as the brokers can sell a lot of the stock, they don't need to make much money on the spread on any given buy and sell.
Going over now, we'll try this again just to keep this thing rolling.
Madam, is this a safe or risky stock?
Very risky.
I mean, this one's, I mean, this goes as risky as stupid.
At $2.32, you can't find stocks that are much riskier than this.
This goes to one of the guiding principles, and it's a rule in financial advising.
It's called appropriateness of investment.
This is the kind of stock that you would not recommend to the typical investor at all.
We'll think about, you've got a couple, they're retired, and they want to put their savings into a good stock for heaven's sake.
This thing is way too risky for anyone like that.
What makes a stock risky?
One thing is if it doesn't pay a dividend, that increases the risk of a stock right there because you have no underlying check that you can get in the mail.
Another thing has to do with the management is the behavior of the stock based upon the behavior of the management and the prospects for sales.
Risk also has to do with what kind of a product.
You've got more like basic goods, things like cereal, toilet paper, even clothing, stuff like that.
Those stocks tend to have lower betas simply because they are stuff that people won't stop buying even if times get bad.
And with a stock like this, another factor in it is competition.
Tesla has competitors, and Tesla is also, the reputation of the cars is getting dinged all the time in social media these days, and it's getting a bad reputation.
Those things go into the behavior of the stock when you have the bulls and the bears, and there are fewer and fewer bulls holding on to this stock and trying to get people to buy it.
Then you have bears saying, get the hell out of it.
Now, in that regard, if you look at the P-E ratio, you see that P-E ratio? See overvalued?
In other words, this thing has a lot of room.
If you've got price divided by earnings, and it's about two times what it should be, that would tell you this stock has a lot of room to fall.
As a matter of fact, a couple of analysts that were former students of mine a long time ago were DMing me on LinkedIn last night talking about the scuttlebutt as $90 a share, 90 to 80 a share, half of what it is now.
And that would bring the price down by half, so the P-E ratio at 90 to 80 would be more like about 30.
So there's your risk factors, all in a nutshell right there.
Definitely not even something for a lot of younger investors.
We think that they tend to be more risk taking because they have more time to recover if stock goes south.
However, when we look at their actual investing behaviors, we see the folks your age a little older in their early professional years.
They're not risk takers at all, so this would not be an appropriate investment for them.
The question is, well, who would be investing in this?
Probably the companies that already have put a lot of money in, and they can't afford to do anything but keep plowing forward.
And that's where we talk about how the banks are quietly, very carefully, without much fanfare, slowly shedding it.
The Wall Street brokers, the bankers on Wall Street though, they're stuck, and they're wondering how the hell they're going to get out of this without taking a major hit to their balance sheets.
But that's their problem.
Let me show you one more, a more normal stock.
Okay, look at AT&T.
Okay, here we go.
AT&T, and this goes to the point that you were making about risk and all that.
This is a basic service.
AT&T provides telecommunication services, not just mobile phones, but a whole gamut of stuff.
It's an old, old company.
And that's another thing too.
The old companies tend to be more conservative in their investments, in their management styles, and that tends to bring down the beta of a stock.
As you can see, below 1.72, that's a conservative investment, something you put in a conservative portfolio, or maybe something, if you had a riskier, a high beta security, you put that in there to tone down the overall beta of the portfolio.
And PE ratio, there's something interesting with this one.
This one is saying undervalued.
So in other words, even if you are not a day trader, you don't buy and sell stocks all the time, this is one of those, putting, when the PE ratio is this low, you know, at least over a period of time, it's going to find its intrinsic value.
We saw that in the book in that chart of undervalued and overvalued.
You can see it here.
This is one of those, no, you're not going to make a fortune tomorrow off it, but putting this into a portfolio when the PE ratio is low gives you the idea that, yeah, it's probably going to be rising over the next months or possibly a couple of years.
It will work its way back up to a PE ratio of 30, which means that the price will increase over the next couple of years.
That's not a guarantee, but it's a good trading strategy that doesn't take a lot of math and a lot of genius and that people make it sound like you need.
Just look for these.
And when you see a stock, you've got a nice portfolio and you see a stock, well, now the PE ratio is up well above 30, that's when you want to maybe shed some of that from your portfolio.
Not all at once, but just as a normal practice, you add to your portfolio when the stocks are undervalued and you ease back off those in your portfolio when they're overvalued.
And it doesn't take day trading.
This is long-term strategy, which is, again, as I said before, this is what responsible finance is all about.
And in the world you'll be in, which is the corporate world, it's not about making the kill of the day.
It's about long-term survival of the company and prospering to increase the shareholder wealth, that is, increase the stock price over a long period of time.
And that's what we talk about in finance.
We all have our fun little side portfolio.
I do, where I take side bets like a casino. You'll see a short video that I did for the College of Business about what the difference is between a casino and the stock market.
And you'll hear me say this over and over again in that video that they're going to release in a few days, I guess.
But anyway, as you can see, AT&T is a profitable company, respectable, $2 a share, almost $2 a share positive, which is good news.
And happy times, that is a really good dividend yield.
That dividend yield is the dividend, $1.11 here, divided by the price you pay.
It's sort of like I put $17.18 in the bank, and the bank is saying, well, we'll give you a dividend, we'll give you an interest rate on it of 6.42%.
You can't beat that. That's a pretty decent.
For $17.17, you're going to get a check for $1.11 every year.
Well, that's not guaranteed, obviously. It's a dividend.
But still, that's decent right there.
So this is one of those that would be a recommendation for a long-term position.
Not necessarily to win you some big bucks over the next week or two.
It's not a casino. Not when you do it, it's the way we do it in the professional world.
It sounds boring, but that's how we do it.
But anyway, is there any other stock that's on your mind right now?
Yeah, I think we'll see.
But like I said, this is earnings seasons.
So look right here.
You see AT&T missed it.
Every company gives a forecast of what the earnings for the quarter will be, and the investors react to that.
And then the company releases the actual numbers.
And if they release numbers that are better than what they estimated, well, the stock markets go to boom.
We've got new information.
If it releases information that they overestimated, well, the stock market is going to punish them right that day, right there.
Now, you see here that AT&T is going to be releasing its next quarterly earnings on April the 18th.
And it's going to say that its earnings for the quarter will be about zero.
Now, if AT&T comes in with positive earnings, well, that's going to get the market all kinds of excited within minutes.
If it releases negative earnings, well, the market's going to beat the heck out of the stock.
But you can keep that in mind when earnings reports are coming out, because a lot of times the rumors will drive the market.
Oh, it's coming out two days from now.
I think they're going to be above, or I think they'll be below.
So there'll be a lot of activity in the days running up to it.
There's an old saying, and I'll give you a lot of the old sayings from the folks from my time.
The saying was, buy on the rumor, sell on the news.
In other words, when there's rumors, that's usually going to jiggle the price up.
But when the news comes, well, that was disappointing, and it drops it.
But the earnings were good.
But if everyone thought they were good before they came out, then the rumors were going to have already put the price up.
You're not going to gain anything if you buy on the day that the earnings are released,
or if you sell on the day that the earnings are released, because they'll already have reacted to it as quickly as they can.
You can't get in there before the heavy market players do, unfortunately.
Enough of that for a while.
Let me drop that down.
Grab my soul back in here.
Let's try to find somebody who looks like he or she needs to be harassed for a while.
No, you sir, I'm ready to bother you.
Now, suppose you need $20 for a couple of weeks.
Well, the fact of the matter is that I have $20.
We would call you a deficit economic unit.
Deficit economic unit.
And we would call me a surplus economic unit.
Now, I wouldn't know anything about you.
I might not ever meet you.
But you see, there are these institutions that this is their job.
They find surplus and deficit economic units, and they put them together.
This is called financial intermediation.
It is the matching of surplus and deficit economic units.
Financial intermediation is the matching of surplus and deficit economic units.
Oh, but there is more to it than this I should point out.
You sir, you need $100.
But I have only $20.
So even if there was a way that we could get together, it wouldn't work.
So financial intermediation relies, number one, on level,
which is a fancy word of saying amount.
I'm a surplus unit, you're a deficit unit, but we don't have the same level of need.
We don't match on the level.
So that one would have to be covered.
So I realized, oh wait, I do have $100.
So let's go on.
Well, you want to pay me back next year, and I said, no,
I need this money back for cheeseburgers tomorrow.
So no match, because the timing is off.
Timing must be matching.
But there's one more.
I'm thinking about, okay, fine, year from now, it'll work, fine, we're good.
But then I find out that you sir are a scoundrel.
You are a creature from the Black Lagoon.
You do not pay your bills.
In fact, you have a reputation on social media.
He does not pay his bills.
Someone else says, IKR.
Okay, screw that.
Not going to do it.
The risk must be compatible.
I must have the same risk tolerance as you have risk.
If that doesn't work, then there's no match.
So in other words, financial intermediation is a matching of surplus and deficit economic units
based upon level, timing, and risk.
So those three factors must be part of it.
As a hint, I usually do this on a quiz or an exam, which is the following.
I'll give you like six.
You have to find the three that are the criteria for the financial intermediation to work.
Now in this example, I've made a point here that this was just you and me.
Financial intermediation doesn't have to be some financial institution.
It can be you know both of us, you know he needed money,
and so you could be the financial intermediary between us.
You're not a bank, but you can do it.
Now we usually think about it though in terms of financial institutions doing this kind of thing.
And there are all kinds, when I say financial institutions, there are all kinds of these out there.
And truth be told, it's getting really confusing.
You see, a little before your time, before you were born,
we had a law or a set of laws that kept one type of financial institution
from doing things that were supposed to be done only by another type of financial institution.
Those laws were passed in the early 1930s in response to the crazy wild west free market activity of the 1920s.
But that law expired in 1999, and I'll get into that more.
You don't need to know the dates here or anything like that right now.
And then it just turned into a crazy quilt.
And to this time now, it's just like madness.
Literally in some of the courses, advanced courses I teach, I have to have this sheet.
Okay, this can do this, this, this, this, and this.
Now, oh, this one started doing this, and they should be doing that, but they're allowed to now.
It's just like a crazy quilt.
So I'm giving you a little bit of a brighter distinction that really exists out there in the real world.
Now, the first one that everyone always brings up is the IB, the investment banks.
The investment banks are very specialized kinds of banks.
If you want a career in finance or actually in a couple of other subjects related, the IBs pay really good money.
I mean, insanely good.
I took my students up to a regional investment bank in Chicago in the financial district.
And I mean, the jobs that they offered had salaries that were probably, starting salaries, probably twice what I make here.
So that gives you an idea.
Now, here's what IBs do.
I think I said something about this last time.
Investment banks, okay.
You are an investment banker.
I am Mark Zuckerberg.
I know I'm better looking than he is, but, fine, whatever.
Okay, so I say I want to do my initial public offering of common stock.
I want to go public.
Well, that's a big process.
And I want to raise a billion dollars.
Well, I, Mark, could just go out there, hey, everybody, want to buy some stocks from me?
Not efficient, not efficient at all.
Not even the companies, anything about what the company is all about.
They wouldn't know what to do.
But you're an IB.
You say I shall buy that one billion dollars of stock.
Really?
Yes, I will.
So you and I have a long negotiation where, for the price that we'll open at, how many shares it is,
and all the consulting fees and the requirements of what documents you'll need and all that kind of stuff.
And you do all the legal paperwork for the SEC and for the states and all that.
Now, you're not going to buy it all on your own.
You will put together a syndicate of investment bankers.
You'll take maybe $600 million of it.
You'll take $100 million, $150 million.
So the syndicate, it's allocated.
The issue is subscribed through these.
That's a primary market transaction.
Because I, Mark, am going to get the money.
Actually, Facebook will get the money.
So in other words, this stock is not going to everybody.
And that's kind of a myth.
Well, I bought Facebook on the IPO.
No, you didn't.
You most certainly didn't.
Not one person in this room will probably ever participate in the primary market.
What you'll do, you investment bankers, you'll buy it and then you guys will pump it up,
make sure that your favorite rich clients get there, get some of it,
and then you'll pump that through the roof to get the stock price up there.
And then it will be dumped out into the secondary market to us.
That's how it always works.
That's how it works.
That's an investment banker's job.
They subscribe, and I'm using some terminology here, and I'll use this over and over.
You'll get used to it.
It doesn't do any good just to give you a stupid definition right off the bat usually.
Helps if I just keep using the terms.
They subscribe the issue, and then that was the primary market,
and then the secondary market got it when the IB sold it to suckers like us.
That's how it works.
And there's nothing illegal about it.
This is just how it's done.
And this makes these offerings of common stock work.
Now, the initial public offering is the one where a company goes public.
It has to do a lot of paperwork for the SEC and for any state's divisions of securities
in which the stock will be offered and sold.
But it's a process, and it's a grueling process.
In my consulting years, I did very small IPOs.
Even at the small level, it was just like, oh, my God, this is way too much like work.
But anyway, what was I going to say?
So we go to the primary market, then it gets to the secondary market,
and investors buy and sell it from each other.
That's what these stock markets I show you.
This is secondary market activity.
Buying investors, buying and selling investors, selling.
That's the way it works.
Okay, that's IB, investment banks.
They're not normal banks.
Not what most people would even contemplate would be a normal bank.
Now, IBs also will participate in seasoned offerings.
In other words, after a company goes public,
maybe it wants to sell some more stock a few years later.
Or maybe it wants to issue bonds to borrow money.
That's how companies borrow money, is they issue bonds.
Okay, an underwriter underwrites.
In other words, the IB underwrites the offering, and that one goes out later.
So there's not just one public offering.
A company can go through its life through a number, first an IPO,
and then afterwards through seasoned offerings every now and then.
In fact, some companies, and I think Microsoft does this,
they will register, do an offering of an insanely large amount of stock,
but they won't do anything with it right away.
They will put it on a shelf, and as they need some equity capital,
they'll pull some of it off the shelf and sell it.
That's called a shelf registration.
It's another way that it can happen.
But anyway, now, banks.
I have the investment banks, the IB.
Now the next type I might mention is a commercial bank.
A commercial bank is what most people would think of as a bank.
They take deposits, and they make loans.
Now, there's another thing that is sort of like a commercial bank.
It's called a credit union.
They take deposits, and they make loans.
Here's the difference.
If you've got a checking account at a bank...
You, sir, you have a checking account.
Yes, sir.
At...
Second.
Yeah.
Huh?
Second year.
No, that's a credit union, the CU.
No, you're a real bank.
You're a big bank.
And I come in, and I've got a check.
You've got a checking account there.
You pay me with a check.
I walk in there, and you have to pay me on demand.
They call checking accounts demand deposits, on demand.
It's not that I produce proper ID.
However, if I've got a check from a credit union, and you are a credit union,
you don't have to give me that money right away.
Now, you probably will, but those kinds of checking accounts are not demand deposits.
They can delay it.
I think the rule now is up to 30 days.
If I came in with a $100,000 check, you could tell me you have to wait 30 days
if you're a credit union.
So that's a big difference between a credit union and a commercial bank.
Commercial bank, its deposits for checking accounts are called demand deposits.
Now, I'll use the next term.
I'll define it more later.
But the ones that look like checking accounts at credit unions are technically what are
called negotiable order of withdrawal, now accounts.
You don't have to know that term yet.
I'll define it later in the semester.
But just know that.
But commercial banks, they make loans, they take deposits.
That's how they work.
Now, there is another animal which is broader, a financial services company or corp,
corporation.
They offer a range of services.
Now, this is where it gets after the time when that law I was talking about expired.
You see, it used to be the case that a bank couldn't do anything but be a bank.
Now, a lot of banks offer you more than just banking services.
They offer you a sort of like a smorgasbord.
In some cases, of banking, of financial services.
So they're a little broader.
And truth be told, and this is where the blur is getting in there, a lot of what we think
of as just plain commercial banks actually do have financial services that they offer
too.
So more and more banks are becoming more than just banks.
It's just the way, and there are some of us old timers who say, oh, down this road is
real problems.
Because if I'm a bank and I take your money as a bank, the old idea was you should not
be able to be like an investment banker.
You shouldn't be able to sell me stock that's right out of an offering.
You shouldn't be able to do that because you have an incentive to profit at my expense
from doing that.
You shouldn't be able to offer me financial planning services because then you're going
to recommend your bank to me instead of looking at all the possible investments out there
for a family looking for investment advice.
But you can do that now in a lot of these financial services firms.
They can be banks, but then they can work in their own interest to promote other services
that maybe they shouldn't because they're not objective about it.
But that's, we're past, that ship has sailed.
We're there now.
So anyway, enough of that.
Now, financial intermediaries.
Well, actually, I should have told you, financial intermediaries.
These are the institutions that do this stuff.
Now, there are other ones too out there.
And they kind of, there's kind of a garden variety.
And you can see a list in the book, but I'll cover some of the noticeable ones out there.
Now, remember, not all financial institutions have anything whatsoever to do with you.
Investment banking, investment banks don't have anything to do with us, even though they
impact our lives.
And you need to know about them.
Now, here's some other ones.
Here's one.
These are generally surplus economic units that interact with some type of deficit economic unit.
Like in an IB, the surplus economic unit is the IB.
The deficit economic unit would be Facebook, which needs the money, and commercial banks.
Financial services.
Okay, here's a couple.
Here's one, life insurance companies.
We are a huge player.
I mean, it's almost incomprehensible the amounts of money that they use.
I'm going to have to tell someone something that's pretty upsetting.
You, sir, you're going to die someday.
Did you know that?
You'll be ugly.
You'll be in pain.
You'll bitch, and you'll fuss, and you'll finally shut up and be dead.
But that will...
Well, that kind of sucks, man.
But that's not going to happen today.
Probably not tomorrow.
Unless an asteroid hits or you skateboard out into traffic while you're watching your smartphone.
No, no, no.
You won't die.
You will probably...actually, you'll probably live maybe to 100 years old.
So if you have a life insurance policy, you're putting premiums in.
I'm the life insurance policy.
You're giving me money every month.
And so are hundreds and millions, hundreds of thousands and millions of other people.
I am accumulating huge amounts of funds that I won't need to use to pay a death benefit for many, many years.
Decades, in fact.
And so these life insurance companies are swimming, actually swimming in oceans of money.
They need to do something with it.
Well, yeah, they will.
They'll probably find...they will be surplus economic units that will find deficit economic units with a very unusual...
with an unusual kind of timing.
If I'm a life insurance company, I don't want to put money into an investment that's going to pay me off in a year or five years or even 10 years.
Maybe not even 20 years.
So these would be a vast source of capital, long-term funds, for a company that was issuing 30-year bonds
or a school district that wanted to do a 20-year bond to build a new high school or a couple of elementary schools.
So these are long haulers in the financial intermediation world.
They fund long-term projects.
And there are even longer-term projects.
There are some projects that could go on 50 years or even longer in some cases.
The funding that will be needed for...we need money right now to fund the preliminary work on...I can't believe I say this.
It sounds like science fiction.
On mining of asteroids, on building of colonies on the moon and on Mars, of space stations that will be permanent residents to thousands,
possibly tens of thousands of people, on projects for the fusion reactors that are just starting to light up.
Those are really long-term things.
But it's happening now.
And I've seen some of these funding needs that are hauling out there 50 years.
I think these are past anyone's lifetime, and the company's starting them.
No one will be alive when these are actually come to the point where they are bending metal or lighting fire.
But there you are.
Strange century we're living in.
Here's another one. Mutual funds.
These are accessible to just about anyone who's got some funds.
Essentially, a mutual fund is a company that you can pay to become a part of.
The company buys stocks and bonds on behalf of its owners, which could be you.
And there are mutual funds of all kinds out there.
Mutual funds that invest in international stuff, or maybe in mutual funds that invest in broad portfolios of domestic stocks,
or healthcare stocks, or environmental green stocks, or drug industries, pharmaceutical industry stocks and bonds.
You can pick something and a beta, and there are tens of thousands of these mutual funds, they are in what we call families.
Different investment houses offer their own family.
You can get a lot of different funds from Fidelity, PIMCO, Investco.
I mean, there are all kinds of these out there.
And you just decide, okay, well, I kind of like Fidelity.
Let's see what Fidelity has.
Oh, heavens to Betsy.
Fifty different funds that I could invest in, choose a risk level, a beta, choose sort of your cause maybe if that's what you want to do.
It's world's open.
Now, as long as you're in the family, you can move your funds from one, move your money from one fund to another.
But generally speaking, you can't just flip your funds any time you want.
There's something else that you can do that with.
But mutual funds, and when the fund earns you money, you can either get a check or you can just use that to buy a larger piece of membership in the mutual fund.
So you could actually have sort of a force multiplier effect over time if you just say, yeah, whatever I get in dividends from the stocks in this fund, you know, all that kind of stuff, or if you sell that stuff, just put it back into the fund.
And over time, you can see your membership go from like, a good example was when I had like 10 years ago, I had 50, I went in 50 shares, and now I've got 62 shares, 62 pieces of this mutual fund.
So it's kind of cool.
They're available to just about anyone.
Now, caution.
Well, two cautions.
One is that there are no-load, low-load, and high-load funds.
Now, the load is how much you pay just for the privilege of membership.
It's not an investment.
You just pay to, it's like a membership application fee.
Now, anyone who would pay the money for a high-load, you're out of your mind.
There are all kinds of incredibly good no-load funds.
You just join low-load or even kind of silly when, well, we charge you $100, and then we'll decide if you can be a member.
No, I'm not going to do that.
So that's something you always want to watch out for.
See if it's a no-load or a load fund.
Another thing, and this is going to be for something else I'm going to show you here in just a minute.
It's, well, it just went out of my mind.
Good grief.
This is a bad day.
I need what's in this coffee cup.
Coffee.
Oh, God.
Oh, okay. We're good.
Okay. We're good.
Management fees.
See how fast that came to me?
Okay.
Now, you look, and I'll show you this in just a minute with another kind, but the people who run the fund, they are experts.
They do all the work for you deciding on investments, keeping the portfolio in balance from day to day, week to week, and all that kind of stuff, doing all the analytics.
You don't have to do any of that, but they will charge a fee.
It's a percentage of the take of the fund.
Now, my rule is.3% should be the maximum I would see for the management fee.
You'll see some that are lower.
I'll show you some that are lower, and you'll see some that are just insane, like 5% fee.
No, no, you're not going to do that.
A well-run fund doesn't need to have managers that are making a fortune off you.
If they're good at what they do, that fund will be earning enough money that.1% is plenty for them to have their three martini lunches.
So keep an eye on that fee.
And like I said, I'm just about to show you that here in a minute.
But before I go to that, let me introduce you to one of the evil, this is dark stuff, private equity, private equity funds.
They are nasty, ill-willed, destructive.
I'm thinking of getting one set up in Central America, but that's just me.
Here's how it works.
Somebody, I think I'm going to pick on you.
You are a company.
You have gone into bad times, bad management maybe, but market trends turned against you.
The economy hit you bad, and you're on the brink of bankruptcy.
You can't pay your next interest payment.
Now remember that if you don't give your stockholders a dividend, all they can do is cry and bitch.
But if you don't pay your bondholders, when you owe them an interest payment or when you owe them the principal, they can shut you off.
They'll just turn you off.
You're done.
That's it.
So you're on that brink right now, and you get a phone number.
Call him.
He's with a private equity firm.
Hello?
Why yes, I can save your company.
What I'll do is we'll sit down.
We'll work it all out.
Well, first we're going to stop buying American.
We're going to move your production facilities over to Guangzhou province.
We're going to get rid of all these American workers.
We're going to slash your sales staff in half, and we're going to – you're going to get – and then here's what's in it for you.
You give us stock in your company, and then we'll hype the stock.
We will also lend you enough to wipe out your debts, and you'll owe just us.
But you'll also sign a consulting agreement with us to keep an eye on you to make sure everything works okay.
That's the upfront of a private equity firm.
And then you'll die anyway.
First we're going to pump the stock up, and then we're going to sell ours to drive the stock, and that will drive the stock price back down.
It will turn out that what we did didn't fix the fundamental problem that the market conditions had changed.
And you will be in trouble, not with all those former bondholders, but with us.
Can't make your payment.
You can't pay that interest payment on that loan we gave you.
Well, I guess we're just going to have to shut you down.
So we kick you out the door.
We take that company.
We liquidate it, and we give it to all of our friends.
That's how private equity works.
Sears, Staples, rumors are that Panera is next on the block.
They stepped into it in 2017 with the P.E.
Okay.
This is how we work in that business.
Private equity.
It is a financial intermediary.
It takes care of itself.
And no one else.
Now, there's a version.
It's not a private equity firm, although they do some P.E. work, but that's not what they're made for.
This is called a hedge fund.
Now, as the name implies, their job is to provide hedges for risks that companies or trusts or families or people don't want.
And I can't remember whether I already did this or not.
You, sir, are a farmer.
You grow corn.
Somehow that just doesn't work for you.
I'm sorry, bro.
Okay, we'll just say you're a corn farmer.
You are in the business of corn.
Okay?
That's what you do.
You are not in the business of corn price volatility.
Now, most people would say, well, the price of the corn, they're like the same.
They're a completely different thing.
You are not a speculator in corn prices.
You just want to go out to your field.
I grow corn.
Look at all that corn.
I grow corn.
You understand what I'm trying to get at here is that you don't want the corn.
You see, when the corn prices are high, you're going to make a lot of money.
Hell, you can buy your kids new clothes, for God's sake.
I've been wearing the same one for 10 years now.
Bubba just got grown out of his.
But then in another year, corn prices are low and you are being, you're in misery.
You have to, you actually tore down the shed so you'd have some heat in your fireplace.
You know, everybody's wondering where the dog went and you know damn well where the dog went.
That was on the dinner table.
Yeah, well, I told you to make Fido some, make Fido dinner and I've been making him some dinner with dog food, not making him the dinner.
Okay, wait.
So, you see, I come in.
You come to me.
A co-op of a bunch of farmers come to me.
And I say, okay, I know what to do here.
I can buy a, I can buy on your behalf a type of security.
When corn prices are low, you lose on the corn but you make a fortune on the contract, on the security.
When corn prices are high, you make money on the corn but you lose on the security that I do.
But what that means is that you've created a hedge.
No matter what corn prices do, your income is fairly predictable.
You get rid of the volatility that you don't want.
That's how a hedge fund works.
You're a, okay, let's try it.
You are the owner of a trucking company.
Your name is Earl.
Earl's trucking company, not surprisingly.
Now, you see, you're in the business of moving things.
Matter of fact, that's your company logo.
We move things.
You're not in the business of diesel prices.
You see, when diesel prices are low, you have a lower expense so you have a higher profit.
But when diesel prices are high, you have a high expense so you have a low profit.
But you should not be doing in the business of diesel prices.
You're in the business of moving things.
Don't forget your core motto.
We move things.
It's not we speculate in diesel prices.
You sure as heck don't.
So you see, I'm a hedge fund.
I can help trucking companies.
Because when diesel prices are low, you'll lose on the diesel's contract,
but you'll win on the price of diesel.
But when diesel prices are high, you lose on the diesel price,
but you win on my contracts that I created for you.
These are types of futures contracts.
I can set it up any way you want and move a risk that is not part of your core business model off you.
I make a little money.
It costs you a little.
It's like an insurance policy.
You pay car insurance.
Do you have a car accident every month after your, well, damn, I paid my insurance premium.
Watch out.
No, you don't.
But it's still there for you.
Got the idea?
Not my roommate on the other hand.
No, you mean the one that drives like a blind trout?
He would be fooled if he wasn't.
You know, I found out here in Illinois on those back country roads,
the speed limit signs are one of the things where people see and they say, hold my beer.
Anyway, where the hell is it?
Okay, so that's a hedge fund.
And they actually do good because if you're in a business,
you do not need uncertainties that aren't part of your core model.
You do not need uncertainties.
You can't even mitigate yourself.
What are you going to do?
Go to the diesel station and beat the crap out of the gas station manager if the diesel prices are high?
No, you can't control it.
Just like you can't enter the corn markets of the world and move the price of corn to what you want it to be.
They're beyond you, but you can just set them aside
and put them somewhere where they're no longer your problem.
Now, some people accuse me of going way off topic, but whatever I do, there's a reason.
Until the COVID lockdown, I had an RSO here that actually did ghost hunting.
We hunted ghosts.
Now, there were times I had some people who went with me and we ran into some ghosts.
And they're running around screaming, why, what, does, and I said, you didn't have to do this.
You could have stayed out here instead of going in there.
Even when you opened the door and you heard something like, get out, you didn't have to do it.
But you see, that's the thing is, you don't do what you don't have to do unless you're on YouTube and you're an idiot.
You understand?
So hedge funds, if you have to do something, it helps you so that you don't face the consequences of it.
Where the heck was I?
Okay, now.
Good.
Okay, now, the last one of these.
This is one that is particularly relevant to investors like you or like a lot of wealthy people, too.
These are called ETFs, electronically traded funds.
Now, at first glance, they sound like a mutual fund, but they are, excuse me, wait.
Oh, that Grand Slam breakfast is coming back.
No, seriously, noobs.
That was the eggs.
Shut up.
Man, I didn't know that he'd get so hard.
Oh, when I get that double stack of pancakes and I put the hot sauce on it.
Four hours later, we're back.
Okay, ETF.
Now, an ETF is a company that is just a portfolio of stocks.
You could have a company, it owns the S&P 500, all 500 stocks, and then you buy a share of that company.
So you actually own the portfolio.
Imagine this, you, sir, are going to a finance singles bar.
Now, someone comes up to you and says, so what do you invest in?
And you say, well, I invest in a couple of stocks.
I've got some Tesla.
You're going to go home lonely.
Swipe left?
I think so.
But if you say, well, I own the S&P 500, well, you will go home with a friend.
You actually own the stock portfolio.
Now, I'm going to show you a couple here, but there are thousands of these.
And you can do like index portfolios, famous ones like the Russell 2000 or the Dow 30 or all kinds of different ones in different sectors, different betas.
And it sounds like a mutual fund, except that you're not a member of a mutual fund.
And this is a stock.
You just go order some from your broker, order two shares, five shares.
Let me show you a couple here real quick.
My favorite is, of course, the S&P 500.
Its trading symbol is SPY, the spider.
That's $489, so obviously it's not something you want to buy, grab a round lot, 100 shares.
But still, $489, you have the action of the S&P 500.
It's not like the S&P 500.
It is the S&P 500, all in one share of stock called spider, and its trading symbol SPY.
Now, look down here.
Remember I was telling you about, first of all, notice this.
See the beta of it?
1.00.
It is the market portfolio.
I mean, those 500 stocks are like two-thirds of the world market.
So of course it's going to have a beta that's approximately the world market.
It's perfectly hedged.
It's managed by professionals day and night.
And as you can see, their expense ratio, their management fee, is 0.09%.
You can't beat it.
It is for a small-time investor who is thinking, I get this all the time.
I've got to find cheap stocks.
No.
Buy a share of the spider.
When you can afford another share, buy another share of it.
Now, let me show you another one.
This is pure stock.
Let me show you one that's pure bond.
As a matter of fact, this one is so famous that it's used as the benchmark for any other bond portfolio.
AGG.
It's a bond portfolio.
So notice here, right here, beta 1.00.
You're riding the world.
Not more than the world, not riskier than the world, not less risky than the world.
You're riding the world.
It has a really modest fee of 0.03%.
Really good stuff.
Now, let me tell you how you do it.
If you're a smart investor, you think, okay, the economy is going to do really well.
You say 80% SPY, 20% AGG.
If you think that the economy is going to suck, maybe 25% SPY, 75% AGG.
In other words, you have only two pieces that you need to move against each other based upon your judgment about the direction of the economy.
If you're kind of on the fence, maybe 50% AGG, 50% SPY.
You don't need to go through nightmares of portfolio allocation and the portfolio control theory, which I'll show you later in the course.
You can just do it this way and you've got well-diversified portfolios professionally managed day and night.
You don't have to sit in front of stock screens worrying.
They sit there looking at you and you buy them as stocks.
They are stocks.
You just order it from, put it in the trade order with Robinhood or TD Ameritrade or Fidelity or whatever, and you've got your instantly well-balanced portfolio.
And you can honestly say you own the S&P 500.
No swipe left for you tonight.
Got it?
I'll pick up Chapter 3 on Wednesday.
That's all I have for you, I think.