1. Stocks and Bonds Lee Hon Sing NUS Business School Department of Finance

2. 2 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.

3. 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.

4. 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.

5. Company Profits Revenue - cost raw materials - salaries - office rents/expenses/utilities - depreciation - interest expenses - tax = Net Income DividendsRetained 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.

6. Example: SGX

11. SGX Dividends Date12mth DivYield 12/31/20120.273.8516 9/28/20120.273.8571 6/29/20120.274.2789 3/30/20120.273.8905 12/30/20110.274.4046 9/30/20110.27754.1855 6/30/20110.27753.6853 3/31/20110.2753.5032 12/31/20100.27253.2363 9/30/20100.26752.9656 6/30/20100.26753.6198 3/31/20100.2653.4641 12/31/20090.26253.1513 9/30/20090.3954.6912 6/30/20090.3955.5634 3/31/20090.397.6471 12/31/20080.3857.5787 9/30/20080.396.3622 6/30/20080.395.644 3/31/20080.385.0667 12/31/20070.372.7571 9/28/20070.1771.3721 6/29/20070.1771.8061 3/30/20070.1722.626 12/29/20060.1672.9298 9/29/20060.061.3514 6/30/20060.061.7045 3/31/20060.215.25 12/30/20050.217.2414 9/30/20050.27911.0714 6/30/20050.28513.5071 3/31/20050.14086.7024 12/31/20040.13577.5838 9/30/20040.475726.8785 6/30/20040.40524.1071 3/31/20040.40524.3976 12/31/20030.40523.9645 9/30/20030.0744.0637 6/30/20030.0745.3985 3/31/20030.0745.9168 12/31/20020.0746.013 9/30/20020.032.6087 6/28/20020.032.5862 3/29/20020.032.3077 Sum of dividends = $10.7602 It is possible to earn purely on dividends. Second way to “earn” is from capital gains.

12. Example: SGX

15. 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

16. 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.

17. 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

18. Valuing a Stock Valuing a stock involves forecasting the future dividends. The price is the present value of the dividends. 1 D1D1 2 D2D2 3 D3D3 4 D4D4 5 D5D5 6 D6D6 7 D7D7 8 D8D8 … 0 Discount using interest rate r

19. 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.

20. 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.

21. 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.

22. Some Special Events Cash dividend: 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 Announcement dateEx datePayment date Stock price drops by dividend amount

23. 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

24. Preferred Shares: Example

27. Price Movements

28. Valuing a Preferred Stock This assumes that –The company lives or pays forever –The company never skips any dividend payment 1 D 2 D 3 D 4 D 5 D 6 D 7 D 8 D … 0 Discount using interest rate r

29. 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 credit- worthiness of the company – bond rating!

30. Singapore Government Bonds

34. Corporate Bonds: Example

36. Valuing a Bond This assumes that –all the coupons are exactly paid up. –the maturity date is not shortened or lengthened. 1 C1C1 2 C2C2 3 C3C3 4 C4C4 5 C5C5 6 C6C6 7 C7C7 8 CNCN … 0 Discount using interest rate r

37. Thank you Q&A