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Stocks and Bonds
Lee Hon Sing
NUS Business School
Department of Finance
Speaker Background
Dr Lee Hon Sing holds a Ph.D. and M.Sc. from the Kellogg
School of Management, Northwestern University. He also
holds a First Class Honours degree in Mathematics from the
NUS. Prior to joining NUS, he was Director of Undergraduate
Program for Banking and Finance in NTU, he was a Systems
Analyst with DBS Bank, and with the Private Banking
Department of Union Bank of Switzerland (UBS). His primary
area of research focus is in Credit Risk Modeling, Islamic
Banking and Financial Systems Architecture. He has taught
Financial Management, Financial Markets and Institutions,
Investments, Financial Modeling, Research Methods for
Finance, Alternative Investments, Math Method for Finance,
Business Statistics, and Numerical Methods for Financial
Engineering. He is also the author of three text books.
2
Disclaimer
This article contains the opinions of the author and not necessarily those of the
NUS. They do not represent a personal recommendation of any particular
security, strategy or investment product. The author's opinions are subject to
change without notice. No part of this publication may be reproduced in any form,
or referred to in any other publication, without express written permission.
Information contained herein has been obtained from sources believed to be
reliable, but is not guaranteed. This article is distributed for educational purposes
and should not be considered investment advice or an offer of any security for
sale. Statements concerning financial market trends are based on current market
conditions, which will fluctuate. References to specific securities and issuers are
for illustrative purposes only and are not intended to be, and should not be
interpreted as, recommendations to purchase or sell such securities. There is no
guarantee that these investment strategies will work under all market conditions.
Past performance is not indicative of future results and no representation is made
that the stated results will be replicated. Investors should seek the advice of their
own qualified advisor before investing in any securities.
What is a Stock?
• A stock (shares) represents ownership of a
corporate company.
• Limited liability: no need to pay anything if
company goes bankrupt.
• Ownership allows you to:
– Share in the profits.
– Voting rights in major company decisions.
Company Profits
Revenue
- cost raw materials
- salaries
- office rents/expenses/utilities
- depreciation
- interest expenses
- tax
= Net Income
Dividends Retained Earnings
• May have –ve net income, although CEO still receives salary.
• Sometimes (rare) pays dividends despite –ve net income.
• Decision on how much Retained Earnings is made by CEO. For
reinvestment into business.
Example: SGX
Example: SGX
Example: SGX
Example: SGX
Example: SGX
Date
12mth Div Yield
12/31/2012
0.27 3.8516
9/28/2012
0.27 3.8571
6/29/2012
0.27 4.2789
3/30/2012
0.27 3.8905
12/30/2011
0.27 4.4046
9/30/2011
0.2775 4.1855
6/30/2011
0.2775 3.6853
3/31/2011
0.275 3.5032
12/31/2010
0.2725 3.2363
9/30/2010
0.2675 2.9656
6/30/2010
0.2675 3.6198
3/31/2010
0.265 3.4641
12/31/2009
0.2625 3.1513
9/30/2009
0.395 4.6912
6/30/2009
0.395 5.5634
3/31/2009
0.39 7.6471
12/31/2008
0.385 7.5787
9/30/2008
0.39 6.3622
6/30/2008
0.39 5.644
3/31/2008
0.38 5.0667
12/31/2007
0.37 2.7571
9/28/2007
0.177 1.3721
6/29/2007
0.177 1.8061
3/30/2007
0.172 2.626
12/29/2006
0.167 2.9298
9/29/2006
0.06 1.3514
6/30/2006
0.06 1.7045
3/31/2006
0.21
5.25
12/30/2005
0.21 7.2414
9/30/2005
0.279 11.0714
6/30/2005
0.285 13.5071
3/31/2005
0.1408 6.7024
12/31/2004
0.1357 7.5838
9/30/2004
0.4757 26.8785
6/30/2004
0.405 24.1071
3/31/2004
0.405 24.3976
12/31/2003
0.405 23.9645
9/30/2003
0.074 4.0637
6/30/2003
0.074 5.3985
3/31/2003
0.074 5.9168
SGX Dividends
• Sum of dividends = $10.7602
• It is possible to earn purely on dividends.
• Second way to “earn” is from
capital gains.
Example: SGX
Example: SGX
Example: SGX
Gaining from Price Movements
• Technical analysis: time buy and sell, earn
through price gains.
• Fundamental analysis: analyze what the market
has not priced in yet. Buy undervalued stocks, sell
overvalued stocks.
• In general price rises on:
–
–
–
–
–
Good news on company, industry, economy (global)
Buy recommendation from (influential) analysts
Entry of big investor
Target of takeovers
Rumor
Gaining from Price Movements
• In general price falls on:
– Bad news (or under-expectation) on company, industry,
economy (global)
– Sell recommendation from (influential) analysts
– Exit of big investor
– Acquirer of takeovers, target in failed takeovers
– Rumor
• Need to monitor news every day, frequently.
How to Trade?
• Need:
– CDP account
• Receives dividends, script lending
– Broker: online or through phone
• Pay by internal accounts, funds transfer, cheques.
• Brokerage fees
– Fund manager (?)
• Fund management fees
• Performance fees
Valuing a Stock
0
D1
D2
D3
D4
D5
D6
D7
D8
1
2
3
4
5
6
7
8
…
Discount using interest rate r
P
D3
D1
D2
D4




2
3
4
1  r  1  r  1  r  1  r 
P
D1
if we assume dividends growth at constant rate g
r  g 
• Valuing a stock involves forecasting the future
dividends.
• The price is the present value of the dividends.
Portfolio Theory
• Do not invest in only 1 stock. Buy a few stocks so that they
diversify each other
– Because of covariance diversification, the return per unit risk (r/) is
higher when there is diversification.
• Keep a stock in your portfolio only if you are positive about
its future, not because you hope the price will rise back up
to recover your cost.
• Penny stocks are dangerous stocks. They may drop to $0.
• Lagging effect: by the time everyone think it is a good buy,
the price is probably too high. By the time everyone wants
to get out, it is probably time for bargain hunting.
• You must have holding-power to let your beliefs enact out.
Don’t use short term funds for long term investing.
IPO’s
• In an oversubscription, the allocation is pro-rated.
• Very often, but not always, the stock price rises on
the first day.
• If you buy on the first day, you will usually make a
loss. The first day price is usually too high.
• Research shows that usually in the long run, e.g. 6
months to 2 years, the stock price will be a loss
compared to the first day.
• Some companies buy back all their stocks and
delist when the price is low, so you’ll never get to
recover your purchase price.
Some Precautions
• Margin trading is dangerous
– Margin calls are possible
– You may lose more than your initial investment
• Contract for Difference (CFD) is like margin
trading.
• Warrants are leveraged investments
– Offer high profit magnification
– Has much greater chance than stocks to reach $0.
Some Special Events
• Cash dividend: announcement date, ex-date,
Stock price drops by
payment date.
dividend amount
Announcement date
Ex date
Payment date
• Share dividend instead of cash dividend.
• Rights issue: company issues more shares to raise
funds
• Stock split, e.g. 2-for-1
Preferred Shares
• Like common shares but fixed dividend
• Higher precedence than common dividends, but
may be skipped as well
– Cumulative / non-cumulative
• Look out for special conditions
– callable
Preferred Shares: Example
Preferred Shares: Example
Price Movements
Valuing a Preferred Stock
0
D
D
D
D
D
D
D
D
1
2
3
4
5
6
7
8
Discount using interest rate r
P
D
D
D
D




2
3
4
1  r  1  r  1  r  1  r 
P
D
r
• This assumes that
– The company lives or pays forever
– The company never skips any dividend payment
…
Bonds
•
•
•
•
Fixed regular coupons (interest)
You are a creditor, not an owner.
You are paid off even before tax!
If company defaults, you can sue them into
bankruptcy. On bankruptcy, you have higher
precedence than shareholders.
• In general quite safe, but need to check the creditworthiness of the company – bond rating!
Singapore Government Bonds
Singapore Government Bonds
Singapore Government Bonds
Corporate Bonds: Example
Corporate Bonds: Example
Valuing a Bond
0
C1
C2
C3
C4
C5
C6
C7 … CN
1
2
3
4
5
6
7
8
Discount using interest rate r
P
C3
CN
C1
C2





1  r  1  r 2 1  r 3
1  r N
cF
P
r
  r  Mn 
F
1

1






Mn
n



  r 
1  
 n
• This assumes that
– all the coupons are exactly paid up.
– the maturity date is not shortened or lengthened.
Thank you
• Q&A