Archive for the ‘Level 1’ Category

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Rule of 72?

Tuesday, February 23rd, 2010

The Rule of 72 is a simplified method for calculating approximately how long it will take for an investment to double. In order for the rule to work, you have to know the rate of return on the investment, the rate of return has to stay constant, and you can’t add or take away any money from the investment.

The rule is simple: just divide 72 by whatever your rate of return is and you’ll get the number of years it’ll take the investment to double. For example, if your rate of return is 3%, you divide 72 by 3 and get 24. So your investment will double in about 24 years, assuming the rate of return doesn’t change and you leave the investment alone until then.

What’s the difference between stocks and bonds?

Wednesday, January 13th, 2010

When you buy stock, you own equity – that is, you are actually buying partial ownership of a company in the form of shares. The percentage of the company’s total shares that you own is how much of the company you own – for example, if the company has 100 shares and you buy 50 of them, you own 50% of the company. This means that you share the company’s ups and downs: if the company does well, your stock becomes worth more than what you paid for it, and you make a profit, but if the company does badly, its stock decreases in value, and you suffer a loss. Equity holders are last in line among creditors if the company’s value goes to zero. This is why the stock market always has a certain amount of risk attached: you can never know for sure what’s going to happen to your stock.

With bonds, on the other hand, you virtually always know exactly what you’re going to get. Bonds are not shares, so they don’t give you any ownership. Rather, when an institution wants to raise money, it sells bonds, which are like IOUs; they’re basically promises to pay your money back later, with interest in the meantime. The interest rates are usually fixed, so you can calculate your profits. For example, a company could sell you a bond for $1,000, and under the terms of the agreement, you’d get 5% of that $1,000 every year for the next ten years, and then your original $1,000 back at the end of that decade. Of course, this means you’re only going to make a profit of $500 over ten years, but you are guaranteed that money.  If the company goes bankrupt, bond holders are usually first in line to be paid among those owed money. So people who prefer bonds like the security they offer, and people who prefer stocks like their potential to make their owners an incredible profit in the future.

One final note – there are three main types of bond: government, municipal, and corporate. Government bonds are sold by the government, municipal bonds by cities, and corporate bonds by companies. Government bonds are the most secure, followed by municipal, then corporate (because a company is much more likely to go bankrupt than a government is). However, because corporate bonds are the most risky, they also offer the highest rates of interest.

What is the routing number on your checks?

Monday, January 11th, 2010

There are a ton of numbers and information on a check that can make it confusing to use or even to understand. One of the most important things to know about your check is the routing number. If you are looking at a check, the routing number is the 9-digit code in the bottom left corner.

The routing number is important because it is used to set up direct deposits and other electronic transfers into your checking account. It identifies the banking institution where your money is held, as well as your specific account.  This can be getting a paycheck directly deposited into your account (as opposed to having to deposit it yourself… manually… at a bank…) or having someone (like your parents) transfer a monthly allowance. In essence, it is the number that makes sure the money gets to the right place!

Why are so many companies incorporated in Delaware?

Friday, January 8th, 2010

More than half of the Fortune 500 companies are incorporated in the great, tiny state of Delaware; but how is this possible? Certainly most of these companies are not based in Deleware, but there are a number of reasons why a company would choose to become a corporation there:

  • Delaware is one of the states with the least expensive incorporating fees.
  • Whether you are a shareholder, officer, or director, you do not have to be a resident of Delaware.
  • Just because your company is incorporated in Delaware, that does not mean you actually have to do business in Delaware, and if you don’t do business there, then you do not have to pay the Delaware state corporate taxes.
  • In Delaware, one individual can have all the officer positions and be the only director, which is particularly advantageous to smaller business.

Basically, the laws in Delaware make it cheaper and easier for a company to be legally incorporated there than anywhere else. It is business friendly, plain and simple.

Why does the price of a plane ticket change so much?

Friday, January 8th, 2010

Have you ever gone online to find that the price of an airline ticket has doubled since last night? Airline prices remain a mystery to most, but there are basically three major factors that influence the variable price tag:

Yield Management - This is a complicated computer-based model that constantly adjusts the prices of the remaining inventory of tickets to yield the greatest dollar amount for the remaining seats. (Pretty smart, huh?) The program uses many inputs including historical booking patterns, demand, market competition and events in the market to squeeze as much revenue as possible from every seat.

Competition - If American Airlines is competing against U.S. Air, or Delta, their prices will stay similar because all of these major airlines use similar yield management software. But if they’re up against a low-cost provider like JetBlue, they’ll have to adjust their prices for the effected flight routes in order to stay competitive.

Cost - This is lowest priority in setting prices since the going rate for seats, availability of aircraft, and customer demand are all ultra-sensitive to fluctuating markets. Often, airlines are not able to pass their costs onto customers because, well, there are always other means of transportation if flying is too expensive.

While airline prices are going to fluctuate dramatically, understanding the fluctuations can help you book the best plane ticket, and get a good deal. You can also try sites like kayak.com and others, which show you the average prices over time for the flight you’re planning.

Why does your mocha frapp cost more in New York than in Pittsburgh?

Friday, January 8th, 2010

It just seems to make sense that a drink from a chain like Starbucks should cost the same amount no matter where you are when you order it. The menus are the same and the coffee all comes from the same place — so what’s the difference? To understand, you need to realize that you’re paying for much more than just espresso and the Barista’s snazzy signature green apron. While some operational costs are the same for all stores in a megachain like Starbucks — the coffee itself, for instance — other costs vary depending on the location of the individual store.

The cost to hire the best Baristas, or wages, varies from state to state. Taxes are much higher in some states than others. The cost of renting space in a city like New York is simply much higher than renting space in Pittsburgh. Even the price of milk varies greatly depending on where you are. When you pay a few cents or a dollar more for your drink in New York than you would Pittsburgh, you’re really paying for the heightened costs of running a business there.

Paul McCartney is involved with PETA?

Thursday, January 7th, 2010

Yes, that is right, the former Beatle is a spokesperson for PETA (People for the Ethical Treatment of Animals).  There are many reasons why celebrities would get with a involved a charity, foundation, or organization.

The most important reason is that celebrities can bring attention to a cause that may otherwise be ignored – ordinary people tend to notice when famous people do things, including an advertisement or a commercial for a specific charity. Charities will often ask a high-profile individual to attend a benefit or a function for these purposes.

The celebrity has his or her reasons also. Any PR rep would tell you that having your name attached to a charitable cause is good press and good exposure.  Additionally, a lot of celebrities do not want to seem one-dimensional, and being part of a charity or foundation shows their multi-dimensionality.  Finally, for some it is a personal issue: Sheryl Crow, a survivor of breast cancer, is one of the main proponents for the nonprofit Stand Up To Cancer.

Does anyone use paper checks anymore?

Tuesday, December 22nd, 2009

While the ten-pack of free checks might seem a bit much, don’t throw them away just yet. Checks are playing a diminishing role in everyday life, but they still have their uses.

In the past, paper checks were the preferred method for paying for large purchases, getting paid, sending money, paying bills, etc.. But now when you walk into a store, the most likely thing coming out of your wallet is your debit or credit card. Getting paid? Companies can now directly deposit into your checking account without you ever having to go to the bank. The reason for the shift away from paper checks is simple – ease of use. Writing a check can be a hassle: it takes time to fill it out, you have to go to a bank to deposit one, and you always have to order more. For these reasons and more, banks have mostly transitioned to electronic forms of check processing and even utility companies are now accepting credit/debit card payments.

Even though paper checks are definitely on their way out, they still serve some vital financial roles. Checks are a great way to securely send large sums of money to individual people. If you are renting an apartment, for example, you’d be very lucky to find a landlord that would accept a credit card to pay rent. It’s not hard to imagine though, that soon this process will be replaced by an easier electronic method.

While paper checks will probably one day become extinct, you’re still likely to find yourself digging them out once a month or so.

Who is watching the banks?

Tuesday, December 22nd, 2009

Since banks play such an important role in the economy and in your life (assuming you’re not keeping your money under a mattress), they are are heavily watched by several government agencies.

The government wants your money to be safe and to ensure that any business calling itself a bank subscribes to a very high operation standard – you shouldn’t worry if the local bank on the corner is legit. That being said, there are three main federal organizations along with individual state agencies that regulate banking on both a national and local level.

The main federal organizations focus on different areas, but work together to ensure that the banking system runs smoothly:

  • Comptroller of the Currency – approves new banks, issues banking laws, and makes sure banks are following the law
  • Federal Reserve Board – provides financial services to banks, watches out for risky behavior, and maintains stability of banking system
  • Federal Depositors Insurance Corporation – insures people’s money against any possible bank failures

State agencies act in similar capacities (regulation, enforcement, and oversight), but only for banks within their borders. All in all, these federal and state agencies are carefully monitoring and analyzing every bank to make sure your money is safe.

Who says Facebook is worth $10 billion?

Tuesday, December 22nd, 2009

Valuation, the process of determining how much a corporation is really worth, is always partly objective and partly subjective. There are several different methods commonly used, but there’s going to be some guesswork involved no matter what.

The most common way to value a company is according to its earnings, which are usually calculated according to earnings per share: you simply divide the company’s net profit by the number of shares it has. (You want the earnings per share value because that makes it is a standard measure to reflect each piece of ownership in the company). You can also value a corporation according to its assets – that is, if a company paid off all its debts and added up everything of value it had left, how much money would that amount to? Another technique involves measuring cash flow, or how much money passes through a company in various transactions over the course of a quarter or fiscal year (not counting predetermined expenses like taxes and interest).

Investors compare “like” companies, as defined by industry, growth rates, or geography, based on their Price to Earnings (PE), Price to Cash Flow, or Price to Growth (PEG) ratios. Price to Growth is used for companies like Facebook, that are yet to have earnings! Higher quality companies get higher ratios, or valuations, versus lower quality earnings.  Historically, the average PE within the S&P 500 since 1936 is a PE of about 15.8x.

These are the most basic techniques, but there are many alternative techniques that are used or that some people claim are more effective. And ultimately, no matter which method you use, the “true value” of a company is only something that can ever be approximated; it’s more of an ideal than a calculable number.

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