Fixed income securities in the enterprise. Analysis of securities transactions with Microsoft Excel
Fixed income securities are debt obligations in which the issuer undertakes to take appropriate action. As a rule, this is a negotiable payment of a cash amount and interest.
There are such types of securities with fixed income: government loan (government loan for the creation of special funds); utility loan (to balance public finances of local governments); utility bonds and letters of pledge (mortgage banks give long-term loans secured by land plots or under promissory notes of partnerships); industrial bond (a fixed income debt of an industrial company).
Somewhat similar to industrial bonds are debentures and option loans. These are transitional forms of securities with fixed income to shares (their purchase is associated with the possibility of purchasing shares in the future).
Option loans and conversion obligations, like industrial bonds, are listed on the stock exchange, their rates are published daily.
A bill of exchange is a security that will attest to the unconditional obligation of the drawer. There are promissory notes and bills of exchange. Each of them has corresponding details. The procedure for the purchase and sale of bills is determined by the Cabinet of Ministers.
Shares are numbered securities, documents that approve membership in a joint stock partnership and give the right to receive dividends. Bearer shares are limited in all countries. As a rule, the shares are kept with brokers or other specialized offices. The owner only has a certificate of the number of shares. Distinguish between ordinary and preferred shares. Ordinary shares give their owner one vote at shareholder meetings. In addition, the owner of an ordinary share has the right to receive a portion of the net profit, which is distributed in the form of dividends.
Upon liquidation of a joint-stock partnership, its ownership claim is the last one. He gets what remains after the payment of debts and settlements with preferred shareholders. Preferred shares give the owner the right of pre-emptive ownership of the profits and property of the joint-stock partnership, sometimes guaranteeing a fixed income (if the partnership has received a net profit) as well as special voting rights (several votes, the right to participate in making relevant decisions at shareholders' meetings) ...
The most common are preference shares with fixed income, but no voting rights. The payment of dividends on these shares is not mandatory for the partnership. Their delay or non-payment does not lead to bankruptcy. The issue of preferred shares is limited by law.
An investment certificate is part of a special securities fund (investment fund), which is managed by an investment company. An investment fund can be composed according to different principles: it can include only shares of large companies or only bonds. The main purpose of the formation of such a fund is to minimize exchange rate dividends and, accordingly, interest rate risks based on a wide differentiation of deposits and payments to owners of investment certificates of maximum income.
A number of securities with new characteristics appear in the sphere of activity of modern stock exchanges. The main reason for this is the need to improve the organizational structure of the stock markets. These new securities include convertible stocks and bonds, futures, options.
Futures are standard term contracts concluded between a seller (issuer) and a buyer for the purchase and sale of the corresponding security at a predetermined price. Options differ from futures in that they imply a right, not an obligation, to carry out a particular operation, which is guided by the option buyer.
It limits the impact on its assets and liabilities of negative market performance by the amount paid for the contract. One of the varieties of options are options that give their owner the right to purchase the corresponding stock values. They are distinguished from options by the longer term, as well as the fact that the option is naturally issued on an existing asset.
In recent years, warrants are increasingly issued with bonds, which has made the latter more attractive in the eyes of investors. Buying a bond, the owner, in fact, issues a loan, which should bring a profit sufficient to pay interest and dividends.
Convertible bonds differ from variant bonds in that the owner cannot sell the right to receive the share at a fixed price in a market separate from the bond.
investment share bond income
To securities with fixed income relate:
Bonds;
Preference shares;
Bills.
Let's look at risk-free securities using bonds as an example.
A bond is a security that certifies the loan relationship between its owner and the person who issued the document (the issuer). The main parameters of a bond are: par or par, redemption price or the rule for determining it if it differs from par, maturity date, rate of return or coupon interest rate, date of coupon interest payments and exchange rate. The par price is printed on the bond and is used to calculate interest. In modern practice, redemption at par is predominant. The bond price is determined by market conditions.
For bonds, you can propose a classification according to the following criteria.
1. By method of collateral:
State and municipal bonds, payments for which are guaranteed by the state or the municipality;
Bonds of private corporations - secured by a pledge of property, income from various programs and projects;
Bonds of private corporations without special collateral.
2. By date:
Bonds with a fixed maturity date;
No specified maturity date or indefinite.
3. By the method of redemption of the par value:
One-time payment;
Distributed in time by the repayment of the agreed shares of the nominal.
By successive redemptions of a share of the total number of bonds, the corresponding bonds are called serial; often this method of repayment is done through lotteries.
4. By the method of payment of income:
Only coupon interest is paid, the redemption period is not stipulated (perpetual bonds);
There is no coupon interest payment, so-called zero coupon bonds;
Interest is paid together with the par value;
Interest is paid periodically, and at the end of the term - the face value, or redemption price, this type of bonds is predominant.
Coupons- these are coupons with an interest rate printed on them. To receive the interest payment, the coupon is cut out and presented to the issuer. Coupon interest payments are made annually, half-yearly or quarterly, and sometimes at the end of the term. The coupon interest rate is usually constant, although sometimes bonds are issued with a "floating" interest rate, the level of which is set depending on any external conditions. In the event that the redemption price of a bond differs from the face value, coupon interest is charged on the amount of the face value, and the investor's capital gain is formed by the difference between the redemption price of the bond and its purchase price.
Consider a bond with a par, coupon interest rate With, maturity n... We will assume that the average market risk-free interest is equal to i. Current value bonds is the current value of the flow of payments generated by this bond
where is the discount factor.
Current value in the case of zero coupons, when the bondholder does not receive the interest payment, it is determined as follows:
In the case when interest is calculated for the entire period and is paid in one amount together with the par, present value is defined by the formula
Full profitability we will call the solution of the previous equations for the interest rate i if the market value is put into the equation instead of the current value.
Example 1.2.1. Find the total yield of a bond with a par value of 1000 rubles, if its market value is 1180 rubles, the coupon rate is 20%, with a maturity of 2 years.
Solution. By condition, it is known that, , , . Then, using formula (1.2.1), we obtain the expression
which is a quadratic equation with respect to v
discriminant
.
The first value does not satisfy the condition of the problem
Since, we have - the total yield of the bond.
Bond coupons may be paid more frequently than once a year. In this case, formula (1.2.1) takes the form
where, a, i- annual nominal interest rate, m- the frequency of coupon payments per year.
Exercises
1. The market value of the bond is currently $ 36. A year ago, it cost $ 33. A coupon payment of $ 3 was recently paid. Determine the total yield of the bond.
2. Determine the current value of a bond with a par value of 1200 rubles, a coupon interest rate of 12% per annum and an average market risk-free interest equal to 8%, if the maturity period is 2 years.
3. Determine the face value of a bond with annual coupons of 15%, a market price of 1,500 rubles, a maturity of 4 years and a full yield of 12%.
4. Ivanov bought in January 2002 a bond with a par value of 1100 rubles. and maturity 2 years for 1195 p. In January 2003, he sold it to Petrov for 1150 rubles. Determine the coupon rate and total yield of the bond.
5. Determine the price of a bond with a par value of 1000 rubles, with a maturity of 3 years, with an annual coupon interest rate of 20%, if the coupon is paid twice a year. The market average percentage is 0.15.
6. Determine the yield of a bond with a zero coupon, if the market value is 850 rubles, face value is 1000 rubles, the maturity period is 2 years.
7. Petrov owns a bond with a par value of RUB 5,000 and a maturity of 3 years. Annual coupon payments are 375 rubles on it, the first will be made in a year. The current rate of this bond is 4877.4 rubles. Average market interest 0.1. Should he keep this bond or is it better to sell it?
8. A small firm approached a local bank with a request to provide the firm with a two-year loan in the amount of 30,000 rubles. at 18% per annum and a one-time return of the entire loan amount with interest at the end of the term. With this money, the company bought 10 risk-free securities with a par value of 3500 rubles, with a maturity of 2 years, with a coupon rate of 15%. The first coupon payment will be made in a year. Determine the capital gain after payment of the loan amount with interest, if the average market interest is 12% per annum? What is the minimum coupon rate for capital gains to be positive?
Risky securities
Some of the most common risky securities are ordinary shares.
There are many approaches to analyzing the stock market, but most of these approaches fall into two main areas:
Technical analysis;
Fundamental analysis.
Technical analysis in its simplest form studies the conjuncture of stock market prices in order to predict the dynamics of stock prices of a particular form. Initially, a study of courses over the past period is forecasted in order to identify repeated trends or cycles. Then, stock prices are analyzed for the last period of time in order to identify current trends similar to those previously detected. This comparison of current trends with past trends is based on the assumption that price trends recur periodically.
Fundamental analysis proceeds from the fact that the “true” (current, intrinsic) value of any functional asset is equal to the present value of all cash flows that the owner of the asset expects to receive in the future. Accordingly, it determines the time of receipt and the amount of these cash flows, and then calculates the present value using the appropriate discount rate. Thus, the analyst must estimate the discount rate, predict the amount of dividends that will be paid in the future on shares. The latter is equivalent to calculating the firm's earnings per share and the dividend payout ratio. Once the intrinsic value of the stock has been determined, it is compared to the current market price of the stock. Stocks that have less than market intrinsic value are said to be overvalued. And those shares, the market rate of which is less than the intrinsic value, are called undervalued. Fundamental analysts believe that any material mispricing is subsequently corrected by the market.
Shares have a par, issue, liquidation, market price.
One of the main characteristics of the stock is nominal cost... The par price is indicated on the form, which reflects the share of the established capital per share at the time of the foundation of the company. It must be the same for all ordinary shares of the same type. The nominal value, as a rule, does not coincide with the market value. In a well-functioning joint-stock company, it is usually higher than the market, and in an enterprise experiencing financial and production difficulties, it is lower.
Issue price Is the price calculated from the balance sheet as the ratio of the value of the net share to the total number of issued shares.
Liquid price is valid at the moment of liquidation of the society.
Market price Is the price at which a share is quoted on the secondary market. It is determined as a result of the interaction of demand for shares and supply. In the secondary market, the share price can take on any value.
Income on shares can be presented in two forms - in the form of an increase in market value and as periodic payments -
dividends... Thus, the current value of a share with dividend payment can be determined by the formula
, (1.3.1)
where - dividends paid in k th year.
The market price of a stock is the subject of mathematical modeling. There is a significant number of works devoted to the analysis of fluctuations in the value of shares in the market, the very nature of the market economy makes it impossible to accurately predict market rates.
Mathematically speaking, the market value of a stock S(t) is usually modeled by one or another random process. The first attempt to describe this process is attributed to L. Bachelier, who in 1900 in his dissertation proposed a model of a stochastic process, which was later strictly described by N. Winner for completely different problems. Further research of the stock market led to the refinement of this model. In the Bachelier model, the values could be negative, and in the 60s the American mathematician P. Samuelson proposed a model with only non-negative values.
As already mentioned, a security is characterized by its future value or profitability. In addition, risky securities are characterized by a level of risk - the possibility of not receiving expected future income. This is an integral part of economic reality - as a rule, there is a certain risk associated with every business decision. In the case of financial transactions, the measure of this risk is the unpredictable variability of the profitability of a particular instrument. The formal apparatus for describing such situations is probability theory, the main object of which is the probability space F, R), where Ω = is the set of elementary outcomes, F- a set of subsets Ω that form an -algebra of events, the probability of which it makes sense to talk about in this model, R Is the probabilistic measure of events, i.e. a nonnegative function of sets such that the quantity has the meaning of the probability of the occurrence of an event A, or, in other words, the occurrence of an elementary event.
As applied to the problems of financial mathematics, the model of probability theory assumes that, in particular, the future value of a security is a random variable, i.e. the function of elementary outcomes. Then, according to formula (1.1.2), the profitability
(1.3.2)
is also a random variable, as a function of a random variable. Therefore, in the future we will work with the yield of the security.
Its variability can be characterized by the value of the variance of the return
, (1.3.3)
where is the random yield, M- the symbol of the mathematical expectation, - the mathematical expectation or the average value of the return.
Intuitively, investment risk is something like the likelihood of an undesirable event when the price or yield of a security deviates greatly from the predicted value.
Let us show that this probability can be estimated in terms of the standard deviation. Really,
.
This inequality is known as the Chebyshev inequality. It allows you to estimate from above the probability of unfavorable events. It can be seen that the estimate of the probability of large deviations from the mean is proportional to the variance. Because of this, in financial mathematics, variance or standard deviation is often taken as a measure of risk.
Example 1.3.1. The profitability of a stock is a random variable that takes the values 0.1 and 0.12 with equal probabilities. Make a forecast of the expected return on the stock in the future.
Solution. Let us write the law of probability distribution of profitability in the form
0,1 | 0,12 | |
P | 0,5 | 0,5 |
Then the mathematical expectation will be
dispersion
and the standard deviation
.
Thus, the most probable values of profitability will lie in the interval.
Example 1.3.2. The future value of a share is a random variable evenly distributed over the interval (1800, 2400). Determine the mathematical expectation and standard deviation of the cost.
2. The future value of a share is a random variable evenly distributed over the interval (800, 1500). Find the predicted value of the profitability and the variance of this profitability if it is known that this share is now worth 1000 rubles.
3. Under the conditions of the previous task, determine the probability that the future value of a share will not exceed its current value.
4. Solve problem 3, provided that the future value of the share is a discrete random variable with the distribution law:
X | |||
R | 0,3 | 0,2 | 0,5 |
5. There are stocks with returns evenly distributed over the intervals (), (), where, a- some positive number. Is it reasonable that stocks with higher returns are more at risk? Why?
6. Determine the probability that the absolute stock return will lie in the interval (120, 150), if it is known that it is a normally distributed random variable. Its predicted value is 140, and the profitability variability (its variance) is 36.
7. A specialist in the field of finance has identified potential stock prices worth 1,000 rubles. apiece at the end of the year and the attendant probabilities for the next two years. In the first year, stocks have a 40% chance of going up to RUB 2,000. and 60% chances of falling to 800 rubles. If in the first year the shares rise to 2,000 rubles, they have a 50% chance of going up to 2,500 rubles, and a 50% chance of falling to 1,500 rubles. in the second year. And if the shares fall to 800 rubles. for the first year, then 85% of the chances they will fall to 600 rubles. and only 15% go up to their original price. Calculate the expected value of the shares at the end of the second year.
Each time, when deciding to invest money, one has to ask the question: what securities can bring the greatest income? To answer this question, you need to figure out what profitability is and how to calculate it. Let's try to do it together.
The return on a security is the return that the investor will receive. As a general rule, profitability shows the effectiveness of financial investments. Return on securities and risk are interrelated concepts. Usually, the higher the risk (see), the greater the return on the financial instrument. Fixed income securities rarely generate good returns.
Advice! Remember! Who does not take risks…. he does not go to rest in the Seychelles.
Types of return on securities
The profitability of securities is considered from different angles, with a breakdown into stocks (see) and bonds.
For stocks, the following types of returns are distinguished:
- current profitability;
- dividend yield;
- annual interest rate.
For bonds, the following types of yields can be considered:
- current profitability;
- yield to maturity;
- annual interest rate;
- internal rate of return (IRR (see)).
Advice! Remember that if the profit is received after three months, then when calculating the annual profitability, you need to multiply the profit percentage by a factor of 4, since there are 12 months in a year. If the profit is received after 6 months. Then the annual profit will be obtained by multiplying it by a factor of 2.
There are several types of formula for calculating profitability, the simplest formula for income on securities is presented below:
Where:
- V e - the cost of a financial asset at the end of the period;
- V b - the cost of the financial asset at the beginning of the period
- r - profitability.
Advice! Do not be lazy to make the necessary calculations, they take a little time, but they allow you to correctly evaluate the investment.
Dependence of income and risk on the type of securities
Different types of securities have different risk-reward ratios.
In general, the risk of investing in securities is classified as:
- short: government securities and bank certificates;
- average: mortgages, bonds;
- high: stocks and derivatives.
Return on securities
The yield on government securities is usually not very high, but the risk of losing money in this case is also minimal. The purchase of such securities is recommended for investors who prefer conservative strategies.
The probability of non-payment of income on such securities is low and is associated with very large problems in the economy that do not arise suddenly and even not very experienced investors can predict them. The main form of income on government securities is the receipt of coupon income, since mainly governments issue bonds.
Income from transactions with securities are financial results.
Income, or financial result, can be:
- positive;
- negative.
When selling securities, the amount of income is determined:
- from operations for the purchase and sale of securities (see);
- as a percentage (coupon) on a security.
To calculate the financial result, the following documented expenses related to the following are deducted from the received amount:
- purchase of securities;
- sale of securities;
- redemption of securities;
- custody of securities;
- the use of borrowed funds when performing transactions with securities;
- depositary fee
- exchange fees, etc.
The textbook "Corporate securities as an instrument of investment attractiveness of companies" offers the following classification of forms of payment of dividends. As can be seen from the diagram, the forms of payment of income on securities are varied.
The most common payment of dividends in cash, but in some situations, and now other forms of income on securities are used. The return on risk-free securities is never very high.
Such profitability can be obtained on the basis of using the following financial instruments for comparison:
- bank deposits;
- government securities;
- foreign government securities;
- the key rate of the Central Bank of the Russian Federation;
- rates on interbank loans.
Let's consider all these options. The easiest way to determine the risk-free rate is to compare it with a bank deposit. For example, if most reliable banks have an interest rate of 9%, then this will be the risk-free rate.
The calculation of the rate for government securities, the key rate and the rate for interbank loans is similar. Information on Russian securities should be found on the Central Bank's website in the section “GKO-OFZ market rates”. Information on foreign government securities can be viewed on the websites of international rating agencies. The key rate and the rate for interbank loans are also published on the Central Bank website.
Advice! Countries for assessing the rate on foreign government securities are best chosen from the list of the most developed, such as the USA, Germany, Japan. It is these countries that are the foundation of the stability of the world economy.
The characteristics of income on securities shows in which of the following methods it can be obtained:
- dividend;
- loan winnings;
- discount (discount) when buying a security;
- indexation of the par value of securities;
- fixed interest payment;
- floating rate of interest income;
- step interest rate.
Perpetual securities are the most common in the financial market. Perpetual securities are securities that can circulate in the market forever, until they mature.
These include:
- bills of exchange (see);
- checks;
- certificates of deposit;
- investment shares;
- securities, etc.
Bills and checks in Russia are not very popular.
Usually, the security gives permanent income from the interest rate. For example, there is a government bond with a face value of 2,000 rubles and with an annual interest rate of 8%. For the year, the investor's income will be 160 rubles. But, if this bond can be bought on the exchange market for 500 rubles, then its yield will be 16%, and, accordingly, 320 rubles.
Advice! A perpetual security is such until the moment of its redemption and the investor must follow the information on it. In the event that a decision is made to repay it, you must complete all the mandatory actions for its presentation for payment. The owner of the paper can set specific terms for its redemption.
Perhaps Warren Buffett is best known in the financial world for his equity investments. He became famous for his attitude towards stocks of companies such as Coca-Cola, American Express, Washington Post and Gillette. The essence of his position is to "buy and hold" the shares of such outstanding companies. However, Warren Buffett's activities are not limited to ordinary shares only. He also buys short-term and long-term fixed income securities, which include money certificates, bonds and preferred shares. Investing in fixed-income securities is one of several areas of Buffett's investment activities. As in other cases, he engages in this type of investment when there are opportunities that have not been properly exploited by other market participants. This is Buffett's approach to investing: he is simply always looking for investment opportunities that can provide the highest post-tax return. In recent years, Buffett has occasionally traded in the debt capital markets, including corporate and government bonds, convertible bonds, convertible preferred shares, and even high yield junk bonds.
A close look at his hard-earned securities deals reveals a strong resemblance to equity investments, as Warren Buffett adheres to similar investment principles. He is looking for such financial instruments that would provide a margin of investment safety and would be available at a low (favorable) price. As with buying common stock,
Buffett insists that any issuer of securities attractive to him must have such characteristics as strong and honest management, optimal capital allocation, and the potential for future profit. Buffett's decisions do not depend on "hot" trends in the market, nor on the calculation of good times for buying and selling securities. The wisdom of the investment decisions Buffett makes is that he looks for opportunities to profit from buying undervalued financial assets.
This aspect of Warren Buffett's investment activities has not received widespread coverage in the financial press, although fixed income securities account for a significant part of the company's total investment portfolio. Berkshire Hathaway. In 1992, they accounted for 20% of the investment portfolio Berkshire. Nowadays, 14 years later, this share has increased to 30%.
Reason for including hard-interest securities in an investment portfolio Berkshire hathaway simple enough. At the time of purchase, they had a very favorable price. There are two reasons why Warren Buffett often resorted to buying entire companies and buying fixed-rate securities. The first reason is a significant increase in the company's investment resources Berkshire Hathaway. The second is the changing investment environment, including the lack of stocks that could be of interest to Buffett. In his address to shareholders Berkshire hathaway in 2003, Warren Buffett wrote that it is becoming increasingly difficult for him to find stocks that are well below their true value, and that this problem is compounded by the rapid increase in capital that needs to be used.
He also explained to shareholders that the company Berkshire will continue to adhere to the capital allocation practice that was used in the past: “If a situation arises when the shares become cheaper than the market price of the entire company, we begin to actively buy them. If the price of bonds becomes attractive, as it was in 2002, we actively buy such securities as well. In any market or economic environment, we are happy to buy companies that meet our standards. If such a company is located, then the larger it is, the better. The capital of our company is not used efficiently enough. This is an unpleasant situation, but it is better than taking rash actions. (I know this from my own experience.) ".
To a certain extent, investments in fixed income securities will always make up a certain part of the investment portfolio Berkshire hathaway due to the dominance of insurance companies in the structure Berkshire. In order to meet their obligations to policyholders, insurance companies must invest a portion of their earnings in hard-earned securities. Nevertheless, the share of securities of this type in the investment portfolio of insurance divisions Berkshire less than other insurance companies.
Basically, Buffett tries to avoid investing in fixed income securities (beyond the amount of this type of investment needed to keep insurance companies going) if there is a threat of inflation that could weaken the future purchasing power of money and therefore decrease in the value of bonds. And while interest rates roughly matched the returns on most stocks in the late 1970s and early 1980s, Buffett did not focus exclusively on buying long-term bonds. In his opinion, there is always a possibility of rapid growth of uncontrolled inflation. Under these conditions, even common stocks would begin to lose their true value, not to mention bonds, which would suffer even more. An insurance company that has invested most of its funds in bonds during a hyperinflationary period may face the problem of depleting its investment portfolio.
While it might seem odd to even mention Warren Buffett's name and bonds in the same context, it comes as no surprise that he uses the same methods to value fixed income securities as he does to value a company or its stock. Warren Buffett is an investor who is guided in his activities by certain principles and invests money only when he sees opportunities for profit and when he manages to provide compensation for possible risk in the terms of the transaction. Even when entering into a deal to buy hard-interest securities, Warren Buffett's commitment to always acting from the position of the owner of the company means that he pays special attention to the quality of management, the value of the issuer of these securities, as well as its economic efficiency. This approach to bond pricing is unusual, but served Buffett well.
Bonds
Washington Public Power Supply System
In 1983, Warren Buffett made the decision to purchase bonds from the Washington state energy company - Washington Public Power Supply System (WPPSS). This deal is a prime example of Buffett's analysis of the feasibility of making a profit from buying bonds versus buying an entire company.
July 25, 1983 power supply system management WPPSS(ironically referred to as "Whoops") defaulted on $ 25 billion in municipal bonds that were used to finance the unfinished construction of two nuclear reactors known as Project 4 and Project 5. By a state decision, the heads of local energy distribution companies were not required to pay WPPSS for electricity, which they had previously undertaken to buy, but ultimately did not demand. This decision led to the largest municipal bond default in US history. The size of the default, and the ensuing crisis, worsened the bond market for utility companies for several years. Investors began to quickly sell utility bonds, which led to lower prices for these bonds and an increase in their current yields.
The threat looming over projects 4 and 5 in progress WPPSS, cast a shadow on projects 1, 2 and 3. However, Warren Buffett felt the difference between the situation in which projects 4 and 5 found themselves on the one hand, and the situation with projects 1, 2 and 3 on the other. The first three projects were operational plants with direct obligations to the state-owned Bonneville Power Administration. Yet the problems with Projects 4 and 5 were so severe that some projections could have weakened Bonneville Power's creditworthiness.
Warren Buffett assesses the risks of owning municipal bonds WPPSS, issued for the implementation of projects 1, 2 and 3. Of course, there was a risk that these bonds could be defaulted, as well as the risk that interest payments on these bonds could be suspended for a long period. However, there was the problem of caps on the value of these bonds. Even though Buffett could buy bonds WPPSS at a price below par, by the end of their maturity they could only have a value equal to their par.
Shortly after the announcement of the default of bonds issued to finance projects 4 and 5, the agency Standard & Poor "s has downgraded its ratings of bonds issued to finance the implementation of projects 1, 2 and 3. The price of bonds WPPSS for projects 1, 2 and 3 with the lowest coupon rate fell to forty cents per dollar of par. This resulted in the post-tax current yield on these bonds being in the range of 15 to 17%. The bonds with the highest coupon rate fell to eighty cents per dollar of par, with the bonds yielding the same current yield as the low coupon bonds. This situation in no way worried Warren Buffett, who actively bought bonds from October 1983 to June of the following year. WPPSS, issued for projects 1, 2 and 3. By the end of June 1984 the company Berkshire hathaway owned bonds WPPSS, issued for the implementation of projects 1, 2 and 3 in the amount of $ 139 million (these were bonds with both low and high coupon rates). The par value of these bonds was $ 205 million.
According to Buffett, buying bonds WPPSS meant for Berkshire hathaway the acquisition of a business that could be expected to generate profits of $ 22.7 million after taxes (this figure represents the total amount paid on annual coupons of bonds WPPSS). This profit was to go to the company. Berkshire hathaway in cash. Buffett points out that there were very few companies listed for sale at that time that would sell below their book value and generate a 16.3% post-tax return on leveraged capital. Buffett calculated that it would cost the company if he decided to buy a low-leverage, going concern that generates $ 22.7 million after tax ($ 45 million before taxes). Berkshire hathaway in the amount of 250 to 300 million dollars, provided that such a company could be found. If, among other things, the business of such a company were strong enough and understandable for Buffett, he would not hesitate to shell out such a sum for it. However, the company Berkshire paid only half of this amount for bonds WPPSS, to get the same amount of profit. Moreover, the company Berkshire purchased bonds WPPSS 32% below book value.
In hindsight, Warren Buffett admits that buying bonds WPPSS turned out to be much more profitable than he expected. The profit on these bonds was higher than most of the companies bought in 1983. Buffett later sold the bonds. WPPSS with a low coupon rate. They doubled in value and at the same time brought the company Berkshire hathaway tax-free profits of 15 to 17%. “Despite the positive experience with the purchase of bonds WPPSS, we haven't changed our negative attitude towards long-term bonds, Buffett said. "All we have learned from this experience is the hope that someday we will again face bonds that, for one reason or another, will be significantly underestimated by the market."
RJR Nabisco
In the second half of the 1980s, new financial instruments appeared on the financial market, which were officially called “high yield bonds”. However, most investors have called and still call them junk bonds.
According to Warren Buffett, the new high-yield bonds were different from their predecessors, the "fallen angels" - as Buffett himself called high-yield bonds, which lost an acceptable rating level for investors during a difficult period and were transferred by rating agencies to a lower category. Bonds WPPSS belonged precisely to the category of "fallen angels". Buffett described the new type of high-yield bonds as the worst form of "fallen angels" and said they were junk before they were issued.
Wall Street securities traders have promoted the attractiveness of buying junk bonds, citing a recent study that found higher interest rates offset the risk of default by investors. Buffett argued against this point of view, arguing that the use of statistics on defaults for the previous period is meaningless, since these data are based on analysis of another category of securities, significantly different from the current junk bonds. According to Buffett, it was illogical to assume that junk (high-yield, but unreliable) bonds are identical to "fallen angels" - high-yield bonds that have lost a rating level acceptable to investors. "It would be as wrong as analyzing the death rate from Kool-Aid using data on mass suicide in Johnston, whose residents drank it before death."
As developments in the stock market in the 1980s showed, as the market flooded with new offerings, high-yield bonds became increasingly junk. Buffett said the following about this: “Junk bonds in huge quantities were sold by those who did not care about everything, those who did not think about anything. And there was no shortage of either sellers or buyers. " In the midst of the general psychosis in the debt market, Buffett suggested that some financial services companies would inevitably go bankrupt when it became clear that heavily indebted companies were struggling to meet the challenge of paying interest. In 1989 the company Southmark Corporation and Integrated Resources defaulted on their bonds. Even the company Campeau Corporation, The American retail empire, which relied heavily on the issue of junk bonds to fund its businesses, announced it was struggling to meet its interest-bearing obligations. After that, the following events took place. Company UAL Corporation, which in the near future was supposed to go into the hands of its workers by buying out a controlling stake in the amount of 6.8 billion dollars, for which it was supposed to issue junk bonds, on October 13, 1989, announced its inability to raise the necessary funds. Arbitrageurs sold their positions on common shares UAL, which led to a fall in the Dow Jones Industrial Average by 190 points in one day.
Frustrated with a failed deal UAL and bond losses Southmark Corporation and Integrated Resources caused investors to question the value of high yield bonds. Portfolio managers began to get rid of junk bonds. In the absence of buyers, prices for high yield bonds began to plummet. At the beginning of the year, junk bonds brought in high yields, but later the index of their yield, calculated by the company Merrill Lynch, dropped to 4.2%, while the current investment grade bond yield was 14.2%. By the end of 1989, junk bonds were out of favor in the market.
A year before these events, the company KohlbergKravis & Roberts bought the company RJR Nabisco for $ 25 billion. For this, the company used mainly bank loans and proceeds from the issuance of junk bonds. Company RJR Nabisco fulfilled its financial obligations to service bonds, but when the market for junk bonds collapsed, the rate of bonds RJR began to fall along with junk bonds of other companies. In 1989 and 1990, with a downward trend in the junk bond market, Buffett began buying bonds. RJR Nabisco.
During this period, most junk bonds lost their attractiveness to investors, but Buffett realized that bonds RJR Nabisco do not deserve such a fate. The company provided a stable output of products that brought in enough cash to pay off debt. Moreover, RJR Nabisco successfully sold some of its business units at very competitive prices, reducing its debt-to-equity ratio. Buffett analyzed the risk of investing in bonds RJR Nabisco and concluded that the company's actual reputation was better than that perceived by other investors who decided to sell their bonds. Bonds RJR Nabisco provided a current yield of 14.4%, so the purchase of these bonds at a lower price opened up the possibility of earning a return on invested capital in the future.
Thus, during 1989 and 1990. Warren Buffett bought bonds RJR Nabisco in the amount of $ 440 million. They were sold at that time with a significant discount. In the spring of 1991 the company RJR Nabisco announced the redemption of most of its junk bonds by repurchasing them at par. As a result, the bond rate RJR Nabisco grew by 34%, which brought Berkshire hathaway$ 150 million in profit.
Level 3 Communications
In 2002, Buffett bought large blocks of high-yield corporate bonds from other companies, increasing his holdings in this type of securities sixfold to $ 8.3 billion. Sixty-five percent of the bonds Buffett bought were bonds of energy companies, and the remaining bonds were the amount of $ 7 billion was purchased through the insurance divisions of the company Berkshire Hathaway.
Explaining the train of thought in addressing shareholders Berkshire hathaway for 2002, Buffett wrote: “Top management Berkshire does not believe in reducing the degree of credit risk associated with the issuers of these investment instruments. " These are the words of a person who never assumes unaccounted for risks (in other words, risks, compensation for which is not provided for in the terms of the transaction). On this occasion, Buffett also said the following: “Charlie and I are disgusted by the very idea of taking even the smallest risks, unless we are confident that we will receive adequate compensation. In this case, we are ready to take risks to the same extent as we are from time to time ready to eat cottage cheese the next day after the expiration date indicated on the package. "
In addition to assessing potential risks and ensuring that they are adequately compensated for, Warren Buffett generally bought securities at a significant discount to their fair value, even at a bargain price, and held these securities until he had the opportunity to sell them at par value.
The most intriguing aspect of all of these bond purchases is that Buffett probably would not have bought the common stock of most of the companies he bought bonds. However, by the end of 2003, Buffett's investment in high-yield bonds had fully paid off and generated $ 1.3 billion in profits. Berkshire hathaway this year was $ 8.3 billion. As the high yield bond market surged, some bonds were redeemed or sold ahead of schedule. Buffett’s comment on this was extremely simple: "Yesterday's weeds are sold today for the price of fresh flowers."
In July 2002, the three companies invested a total of $ 500 million in convertible 9% bonds with a conversion price of $ 3.41 and a maturity of 10 years issued by the company Level 3 Communications, which is based in Brumfield, Colorado. This was supposed to help the company make large-scale investments and improve its financial position. The buyers were: Berkshire hathaway($ 100 million), Legg mason($ 100 million) and Longleaf partners($ 300 million).
Tech companies tend to be of little interest to Buffett as potential investment targets. He frankly admits that he does not know how to correctly determine the value of such companies. The bond issue cost the company Level 3 Communications quite expensive, but it allowed her to raise the necessary funds and increased her creditworthiness. For his part, Buffett made the investment at a lucrative rate of interest (9%) by getting his share of the share capital. According to Buffett himself, during that period, investors could count on a 7-8% level of annual return from operations in the stock market. Therefore, receiving his 9%, he was again ahead.
This whole story has another side characteristic of Buffett's work: the strong influence of such aspects of the investment process as the integrity of the company management and personal connections. Company Level 3 Communications was formed as a result of separation with the transfer of part of the assets from PeterKiewit Sons, based in Omaha construction company. Buffett's friend, Walter Scott Jr., serves as honorary chairman of the board of directors Peter Kiewit Sons, and the chairman of the board of directors Level 3 Communications. He is recognized as an Honorary Citizen of the City of Omaha and has supported the City Zoo, Museum of Fine Arts, Institute of Engineering and Technology, and the Nebraska Game and Parks Foundation. Close friendship and business ties have developed between Scott and Buffett: Scott is on the board of directors of the company Berkshire hathaway and the offices of these two businessmen are located in the Kiewit Plaza building, separated by only two floors from each other.
Warren Buffett knew Walter Scott very well and had a high opinion of him. However, Buffett wanted a deal with Level 3 Communications be honest and transparent and that there are no questions about the undue influence of the relationship between them on the terms of the transaction. Thus, Buffett proposed to O. Mason Hawkins, chairman of the board of directors and CEO of the company Southeastern Asset Management, who advises Longleaf Partners, help with the conclusion of the transaction and with the definition of its terms.
In mid-June 2003, a year after the deal was concluded, the company Berkshire Hathaway, Legg Mason and Longleaf partners exchanged their convertible bonds Level 3 Communications in the amount of $ 500 million for common shares worth $ 174 million. They also received additional shares in the amount of $ 27 million as an incentive for the decision to convert the bonds. (Company Longleaf partners already converted some of its $ 43 million in bonds in the first half of 2003, and converted the remainder for $ 257 million in June)
As a result, Warren Buffett received 36.7 million shares Level 3 Communications. In June, he sold 16.8 million of these shares for $ 117.6 million, and in November sold another 18.3 million shares for $ 92.4 million. Obviously, the company Level 3 Communications successfully paid off its promissory notes, and by the end of 2003, in just 16 months, Buffett's initial investment in the company's bonds had doubled. Among other things, these bonds brought him $ 45 million in interest income, and remained at his disposal 1,644,900 ordinary shares. Level 3 Communications.
Qwest
In the summer of 2003, Buffett bought hundreds of millions of dollars worth of bonds issued Qwest Communications- a troubled telecommunications company based in Denver and formerly known as US West, as well as its operating subsidiary Qwest Corporation. During that period, the company Qwest was in arrears of $ 26 billion and was in the midst of revising its 1999, 2000 and 2001 financial statements. There were rumors about the possible bankruptcy of the company. Corporate bonds Qwest were sold in the market at a price of thirty-five to forty cents per dollar. Some of these bonds provided 12.5% yield and were backed by specific company assets. Other, more risky bonds did not have such collateral. Buffett bought both types of bonds.
According to most analysts, at that time the assets Qwest were of a high enough value to provide cash coverage for Buffett's investments, even at this price level for her bonds. In addition, if it were not for the need to pay interest, the company Qwest would receive a fairly large cash flow. The company's most valuable asset was its franchised network of local telephone services spanning 14 states. Buffett believed that under the leadership of the former CEO Ameritech Richard Notebert, the company can solve all its problems.
Amazon.com
In July 2002 Jeff Bezos, CEO of the company Amazon.com, announced that the company's cost of issuing management stock options would be expensed. Buffett wrote to Jeff Bezos a letter in which he paid tribute to this decision. Just a week after writing this letter, he bought $ 98.3 million worth of high yield bonds. Amazon.com.
Warren Buffett values managers who demonstrate integrity and high moral standards in their operations. It is known that Buffett has long advocated the idea of including the cost of rewarding employees by selling them shares at fixed prices as an expense item. However, his decision to buy bonds Amazon.com was not dictated solely by respect for the position of Jeff Bezos. Government Employees Insurance Company, subdivision Berkshire Hathaway, the car insurance company should have earned a $ 16.4 million return on its investment in high yield bonds (17% yield in nine months) if the company Amazon.com bought back 10% of high priority short-term bonds for a total of $ 264 million, issued in 1998. A little later, in the summer of 2002, Buffett bought another $ 60.1 million of convertible bonds Amazon.com with a fixed income of 67.8%. At the rate of $ 60 per $ 100 par, the yield on these bonds was 11.46%, and the yield to maturity would have been even higher.
It is common knowledge that Buffett is keen to make investments in companies whose business he understands, and that he avoids the need to deal with companies with a high technology business in every possible way. His communication with the Internet is limited to three types of activities: he buys books through online stores, reads Wall street journal and plays bridge. In his 2000 address to shareholders, Buffett ridiculed his fear of high technology: "We entered the 21st century by embracing modern industries like brick, carpet and paint, so try to contain your excitement."
Why then bonds Amazon.com caught Buffett's attention? First, as he himself said, they were selling "at an extremely low price." Second, he believed that the company Amazon.com will achieve great success in his business area. In addition, Buffett may have noticed a certain similarity in the company's profile to other retailers in which he has invested. Company Amazon.com generates its profits on the basis of huge sales volumes at low prices, and even with a fairly low rate of return, it manages to provide an acceptable level of efficiency and profitability. Buffett loves the way Jeff Bezos built this mega-brand and the way he got his company out of some very difficult situations.
Arbitration
Arbitration, in its simplest form, involves buying securities in one market and simultaneously selling them in another market. The purpose of such an operation is to make a profit on the price discrepancy. For example, if a company's shares are quoted at $ 20 per share on the London Stock Exchange and $ 20.01 on the Tokyo Stock Exchange, then the arbitrageur can profit from the simultaneous purchase of those shares on the London Stock Exchange and the sale of those shares on the Tokyo Stock Exchange. In this case, the capital invested in the purchase of shares is not exposed to any risk. The arbitrageur simply benefits from the ineffective functioning of these two markets. Since such an operation is not associated with risk, it can be called risk-free arbitrage. However, risky arbitrage involves the sale or purchase of securities with the expectation of making a profit at the announced price.
The most common type of risk arbitrage involves buying securities at a price below their future value. Risk arbitrage generally occurs in connection with mergers, liquidations and reorganizations of companies, as well as in connection with offers to acquire a controlling stake in a company. The risk that the arbitrageur assumes in this case is that in reality the stock price may not rise to the announced level.
According to Buffett, to assess the possibility of risky arbitrage, it is necessary to find answers to three basic questions: “What is the likelihood that the promised event will actually happen? How long will the company's funds be frozen? What is the likelihood that a more attractive event will occur - for example, an offer to take over a competing company will be received. What happens if the promised event does not take place as a result of an antitrust litigation, financial hardship, etc.? " ...
Faced with the problem of excess cash over the possibilities of their investment, Warren Buffett often resorted to arbitration as one of the ways to profitably use the excess cash. An example is the 1981 deal with the company Arkata Corporation, according to which Buffett bought 600 thousand shares of this company at the moment when it was undergoing the procedure for the buyout of a controlling stake by another company at the expense of a loan. Other arbitrageurs enter about fifty of this type of trades annually. However, Buffett, for all his interest, has only made a handful of major arbitrage deals. He limited his participation in arbitration to deals that were open and friendly, and refused to speculate on potential mergers and acquisitions or extortion based on the purchase of large quantities of shares in a company in order to resell them to the same company at an inflated price.
Buffett has never counted the results of the arbitrage deals that have been concluded during his entire career. However, according to his estimates, the arbitrage operations brought the company Berkshire hathaway on average 25% of pre-tax profitability per year. Since arbitrage is often used instead of buying short-term Treasury bills, Buffett's interest in arbitrage fluctuates depending on the amount of funds the company has at his disposal. Berkshire.
However, Buffett is not actively involved in arbitrage at this time, but prefers to keep excess cash in Treasury bills and short-term liquid instruments. In some cases, Buffett has favored medium-term, tax-free bonds as an alternative to monetary instruments. He understood that replacing short-term Treasury bills with medium-term bonds would entail the risk of significant losses if he had to sell these bonds at an unfavorable time. However, since these tax-free bonds provide higher yields than Treasury bills, Buffett knew that potential losses could be offset by gains.
Arbitration has always been a success for the company Berkshire hathaway so it might surprise the shareholders of the company that Buffett began to avoid them. It is common knowledge that the return on investments made by Buffett was even higher than he expected. However, in 1989, the arbitration conditions began to change. The surplus of funds circulating in the market for buyout transactions by managers of controlling stakes in their companies at the expense of a loan created conditions for unrestrained enthusiasm among the participants in this market. Buffett did not know when lenders and buyers would regain the ability to think sanely, but he himself always acted with caution in situations in which others acted frivolously. Even before the collapse of plans to acquire a controlling stake UAL in October 1989, Buffett began to withdraw from active participation in arbitration transactions. Another reason, in all likelihood, was simply the lack of opportunities to close deals on a scale comparable to a huge investment portfolio. Berkshire.
Anyway, Buffett's withdrawal from arbitrage transactions coincided with the emergence of convertible preferred shares, which made the process virtually painless.
Convertible Preferred Shares
Convertible preferred shares are hybrid securities that have the characteristics of both stocks and bonds. Typically, these securities provide investors with a higher current rate of return compared to common stocks. This increased profitability, in turn, provides protection against the risk of a decline in the stock price. During a period of decline in the common stock, the higher yield on the convertible preferred shares protects them from falling to the level of common stock. In theory, convertible stocks fall in value until their current yield approaches the price of non-convertible bonds with the same yield and maturity.
Convertible preferred shares also offer investors the opportunity to benefit from the appreciation of the common stock. Since shares of this type can be converted into ordinary shares, their rate begins to rise along with the rise in the rate of the latter. However, convertible shares provide a high level of return and can lead to capital gains, therefore they are priced higher than the price of ordinary shares. This difference, expressed as a percentage, is the conversion rate at which the preferred shares are converted to common stock. Typically, the conversion rate ranges from 20 to 30%. This means that the common stock must rise 20-30% before the convertible can be converted to common without losing value.
In the same way as in the case of investments in high yield bonds, Buffett invested capital in convertible preferred shares whenever their return outperformed other investment projects. In the late 1980s and 1990s, Buffett acquired convertible preferred shares in companies such as Salomon Brothers, Gillette, USAir, Champion International, American Express and etc.
Some companies have been targeted by so-called takeover invaders, and Buffett has gained a reputation as a "knight on a white horse" who is saving companies from hostile takeovers. However, Buffett himself did not see himself as a savior acting solely for the good of others. He perceived the purchase of shares in these companies as an opportunity to profitably invest capital and thereby seize the opportunity to generate large profits. In addition, the preferred shares of these companies provided Buffett with higher returns than he could get from investments in other financial instruments.
Some of the companies issuing convertible preferred shares were familiar to Buffett. However, for other companies, Buffett didn’t know enough about their business, nor could he predict with a reasonable degree of certainty the size of the future cash flow in these companies. Buffett believed that it was precisely the impossibility of such forecasting that was the reason that the company Berkshire hathaway invested capital in convertible preferred shares of the companies mentioned above, rather than their common shares. Despite the potential for profit from converting shares into commons, the real value of preferred shares, according to Buffett, is to provide a fixed income.
There is one exception to this rule - MidAmerican. The multilateral transaction with this company covered convertible preferred shares, common shares, and debentures of the company. In this case, Buffett became interested in convertible preferred shares, not only because of their ability to provide a fixed income, but also because of the ability to obtain a share in the issuing company.
MidAmerican
March 14, 2000 the company Berkshire acquired 34.56 million convertible preference shares and 900,942 ordinary shares MidAmerican Energy Holdings Company(a gas and energy company based in Des Moines) for approximately $ 1.24 billion, or an average of $ 35.05 per share. Two years later, in March 2002, the company Berkshire bought another 6.7 million convertible preferred shares for $ 402 million. As a result, the company Berkshire received ownership of 9% of shares MidAmerican, giving the right to vote, and slightly more than 80% of shares that do not give this right, but are of interest from the point of view of their profitability.
After 2002 the company Berkshire and some of its subsidiaries bought about $ 1.728 million in non-transferable preferred shares, some of which were redeemed in August 2003 for $ 150 million. He invested another $ 300 million in shares MidAmerican David Sokol, chairman and CEO of the company, and Walter Scott, the company's largest investor. In fact, it was Scott who first approached Buffett with an offer to buy the stock. MidAmerican. It was the first major deal Buffett and Scott had worked on together for the first time in their fifty-year friendship.
The price Buffett paid for the stock MidAmerican, was close to the lower end of the possible price range - from 34 to 48 dollars per share. Consequently, Buffett bought these shares at a bargain price. In addition, Buffett, as well as the shareholders Berkshire Hathaway, I was confident in the development prospects MidAmerican so much that it financially supported this company in the acquisition of pipelines worth about $ 15 billion. As one of the elements of this growth strategy, the company MidAmerican(with Buffett's help) bought pipelines from troubled energy companies.
One of these deals was concluded quite recently. In March 2002, Buffett bought the pipeline Kern river gas transmission at the company Williams Company, located in Tulsa. This pipeline transported 850 million cubic feet of gas daily over a distance of 935 miles.
Buffett paid $ 960 million for it, taking on existing debts, and also spent $ 1 billion in capital expenditures.
A little later, in the same 2002, the company MidAmerican also acquired a gas pipeline Dynegy "sNothern Natural at a negotiated price of $ 900 million, plus debt coverage. Subsequently, at the beginning of 2004, the management Berkshire announced that the company will invest 30% of the costs, or $ 2 billion, in the construction of a new gas pipeline, designed to transport natural gas from a field in Alaska, in the North Slope region; this would increase US gas production by 7%. Chairman of the Board of Directors MidAmerican Sokol said that without Buffett's help, the company would have been difficult to make such an investment.
In the process of another transaction of a similar plan, a subsidiary Berkshire MEHC Investment Inc., bought preferred shares of the company for $ 275 million Williams. Preferred shares of this type generally do not give the same voting power in the election of board members as ordinary shares. However, under the terms of this deal, the company Berkshire hathaway received the right to elect 20% of the board of directors MidAmerican, as well as the right to approve decisions regarding the conclusion of certain important transactions.
In the summer of that year, Warren Buffett and company Lehman brothers provided the company Williams a loan of $ 900 million to be repaid first. It was provided for a period of one year at 19% per annum and was secured by almost all of the company's gas and oil assets Barret Resources, which company Williams at one time bought back for $ 2.8 billion. It was reported that the loan provided by Buffett was part of a package of agreements to ensure the company Williams, still an investment-grade company, with cash and loans totaling $ 3.4 billion. The purpose of this funding was to help the company prevent bankruptcy. The terms of the deal were very tight and included fees for lending that, according to some reports, could raise the interest rate on the deal up to 34%. However, the following argument can be made in defense of such tough conditions: Warren Buffett not only helped the investment-class company overcome the difficulties that had arisen, but also protected himself from possible risk.
Deal with MidAmerican was not Buffett's only attempt to invest in the energy industry, which was facing various challenges at the time. Nevertheless, the investments in this company were complex and affected many aspects of its activities. Buffett was convinced that the company's true value was higher than its current market price. He knew that senior executives of the company, including Walter
Scott and David Sokol acted openly, honestly and intelligently. Among other things, the energy industry has all the opportunities for stable operations, which is why Buffett expected to increase the level of stability and profitability of energy companies.
In a situation with MidAmerican Warren Buffett made investments in fixed income securities with the prospect of exchanging them for common shares. As in all other cases, he acted as the owner and took responsibility for the further development of the company. He made some money off the company's hard-earned securities Williams, while ensuring the protection of their investments by contractual obligations, high interest rates and assets (in particular, assets Barret Resources). As it turned out, the company MidAmerican became the third largest electricity supplier in the United Kingdom Great Britain, and also provided electricity to 689 thousand Iowa residents, and pipelines Kern river and Nothern Natural provided transportation of about 7.8% of natural gas in the United States. In general, the company had at its disposal assets worth $ 19 billion and received an average of $ 6 billion in annual revenue from 25 states and a number of other countries. Company Berkshire hathaway received from its securities MidAmerican about $ 300 million in profit per year.
When analyzing this area of investment activity Warren Buffett, it is important to remember that he regards convertible preferred shares, first of all, as securities that bring fixed income, and only then as a means of profit from capital gains. Consequently, the value of the preferred shares owned by the company Berkshire Hathaway, may not be less than the value of similar non-convertible preferred shares and may even exceed this value due to the existence of rights to convert preferred shares into ordinary shares.
Warren Buffett is widely recognized as the greatest investor in the world, using the principle of comparing the value and the price of acquired objects (the principle of "price / value") when investing. The strategy of such an investor is to buy stocks, bonds, other securities, as well as companies in general at a price that is significantly lower than their actual value, and wait for their price to rise. Thus, Buffett adheres to the same principles whether he invests in high-dividend stocks or high-yielding corporate bonds. A price / value investor is active wherever there is an opportunity to conclude a profitable deal.
Warren Buffett is considered to be an investor with a preference for long-term investments in common stock. However, he has enough talent, vitality and capital to include problem sectors in his sphere of activity and find “rough diamonds” there. Buffett is targeting companies with honest, smart managers and cash-generating products as potential investment targets. In addition, Buffett gives preference to those financial instruments that are most appropriate at the moment. Warren Buffett makes the right decisions most of the time, but when he makes mistakes, he openly admits them. As the numbers show, Buffett's decision to get serious about investing in fixed income securities in 2002 and 2003. turned out to be correct. In 2002, the total amount of profit received from investments in fixed-interest securities amounted to $ 1 billion.In 2003, this figure tripled to $ 2.7 billion.
Classification of securities according to their investment opportunities
The essence and classification of securities
Investment activity using securities
Due to their specific features, securities allow implementing various investment strategies.
The main difference between securities and other objects of civil transactions, which is that securities provide 2 types of rights.
First, there are real rights on the securities, primarily property rights. This makes it possible to carry out any legal transactions with securities, including purchase and sale transactions. Proprietary rights to a security provide such properties of securities as convertibility (the ability to buy and sell on the market, as well as act as an independent payment document), accessibility for civil circulation (securities can be the subject of any legal transactions - pledge, gift, inheritance, encumbrance, etc.).
Secondly, there are rights arising from possession of a security - the right to a part of the profit, to unconditional return of the borrowed amount, to manage the issuing company, etc. It is this set of rights secured by this or that security that determines its value and market value. Reliable exercise of rights under a security is facilitated by such properties as standardness (the law establishes standards for the issue and circulation of securities, rules for recording and fulfilling obligations, types, types and forms of securities, etc. seriality (issuing securities in series simplifies the procedure for confirming and exercising rights), regulation and recognition by the state (only a financial document that is registered as a security in accordance with the procedure established by law and / or is recognized as such by the law is considered a security), compulsory execution(refusal to fulfill obligations secured by a security is prohibited, except as otherwise provided by law).
General classification of securities
The classification of securities can be carried out according to many criteria. First of all, securities must be subdivided into 2 type- emission and non-emission.
Emissive security are characterized by the following signs:
Secures the totality of property and non-property rights subject to certification, assignment and unconditional exercise in compliance with the form and procedure established by law;
Posted by issues;
Has the same volume and terms of exercising rights within one issue, regardless of the time of purchase of the security.
Typical representatives of equity securities are stocks and bonds.
Non-equity securities do not have a combination of these three features. Non-equity securities include certificates of deposit and savings certificates, bills of exchange, checks.
In the legal aspect, the most important is the fact that the Federal Law of April 22, 1996 No. 39-F3 "On the Securities Market" regulates the relations arising from the issue and circulation of only equity securities, regardless of the type of issuer (circulation of other securities is regulated by this Law only in cases provided for by federal laws). This means that the norms specified in this Law (for example, on licensing the activities of professional participants in the securities market) are applicable primarily to transactions with bonds and shares.
Another way of classification is the division of securities into classes depending on the subjects of rights certified by the security. On this basis, there are:
registered valuable paper- the rights certified by the security belong to the person named in the security. Information about the owners of registered securities should be available to the issuer in the form of a register of owners of securities, the transfer of rights to which and the exercise of the rights assigned by them require mandatory identification of the owner. According to the Law, in Russia all shares of joint-stock companies must be registered;
securities on bearer- the rights belong to the bearer of the security; the transfer of rights to such securities and the exercise of the rights enshrined in them does not require identification of the owner. An example of such a paper in Russia was the government savings loan bonds (OGSZ);
order securities - the rights belong to the person named in the security, who can exercise these rights himself or appoint another entitled person by his order (order). A classic example of an order security is a bill of exchange.
The investment potential of a security is a complex characteristic that reflects a set of certain qualities of a security that makes it attractive to a particular investor. The most significant qualities that determine the investment attractiveness of securities include their profitability, liquidity, risk, method of providing income and the duration of the security.
The combination of these qualities of securities makes it possible to conditionally subdivide all securities into three kind:
1. Fixed income securities.
3. Derivative securities.
Let us dwell separately on these types of securities and identify those investment qualities that distinguish them from each other.
Together, these securities have a number of specific properties:
1. As a rule, these are debt securities that secure the loan relationship between the borrower (issuer of the security) and the lender (investor, owner of the security). Such securities include bonds, certificates, bills of exchange, checks, etc. According to the law, all payments on securities of this type are the obligations of the issuer and do not depend on its financial and economic condition. The evasion of the issuer from the execution of the declared payments on securities with a fixed income is a sufficient reason for the holder of such a security to initiate the procedure for the enforcement of obligations.
2. For them, the issuer introduces a certain maturity date. This date is understood as the day when the borrower (issuer) must pay the investor, first, the borrowed amount, which is par value (par) security, and, secondly, interest (if it is stipulated by the terms of the security issue).
3. They have a fixed or predetermined payment scheme for par and interest (coupon) amounts. You can specify different payment methods for fixed income securities, but the most famous are three such schemes:
a) individual securities are placed by the issuer on the primary market at a price below par, the so-called discount price. Payments on such financial assets are carried out once a day of redemption, when the issuer pays the nominal value of the security to the investor. Such securities are usually called discount, coupon-free. An example of a discount: securities can serve as domestic government short-term bonds (GKO). Such bonds are placed by the Central Bank of the Russian Federation during auction trading at a discount price (say, RUB 970), and after a specified period (3, 6 or 12 months) they are redeemed and the nominal value of RUB 1,000 is paid.
One property of discount securities should be noted: up to the moment of redemption, their market price is always below par (the opposite would imply the existence of negative nominal interest rates, which theoretically cannot be);
b) other securities with fixed income can guarantee the receipt of fixed interest (coupon) amounts and par at strictly defined intervals. Russian practice knows two schemes for the payment of fixed coupon amounts:
- constant coupon - in this case, the amount of the interest payment is fixed 1 time and does not change until maturity. For example, the issuer of the corporate bond Alrosa 19 guaranteed a constant coupon payment of 16% of the face value until maturity. A similar scheme is laid down in foreign currency bonds of the state internal foreign currency loan (OVVZ), for which coupon payments are constant 3% of the face value;
- fixed coupon income- in these cases, the issuer fixes the amount of the coupon payment, which remains unchanged over several coupon periods. Then the coupon rate changes and is fixed again for several coupon periods, etc. For example, on March 20, 2002, the RF Ministry of Finance placed federal loan bonds with a fixed coupon yield (OFZ - PC) with maturity on September 14, 2005. The following coupon payment scheme was established for these bonds: for the first and second coupons - at a rate of 15% per annum, for the third - sixth coupons - 14% per annum, for the seventh - fourteenth coupons - 12% per annum (for these bonds, coupon payments are provided for 4 once a year);
c) in recent years, securities have become widespread in the world, for which the paid interest (coupon) amounts are not fixed, but dependent, associated with other economic indicators - the profitability of other financial resources, the rate of inflation, the state of the stock market, etc. An example is the government savings bonds issued in Russia. According to the Terms of issue of these bonds, the coupon yield on them is determined as the sum of two components: first, the product of monthly consumer price indices (CPI) expressed in fractions of a unit for the 6 months preceding the month during which the coupon yield is declared, and, second, a fixed rate determined by the issuer in the decision on the issue (no more than 0.35% for the coupon period).
4. As a rule, the quotation of securities with a fixed income is carried out not in monetary units (as is the case with the quotation of shares), but as a percentage of the par value. For example, on February 22, 2005, at the close of trading on the MICEX for bonds "Alrosa 19", the bid price was 106.7% of the face value, and the offer price (asked) was 106.95% of the face value of the bond.
Classification of fixed income securities. There are various ways to classify fixed income securities, however, in the most general terms, they fall into three categories:
Perpetual (demand) deposits and time deposits;
Money market securities;
Bonds.
Perpetual and term deposits. At present, in Russia, securities of this category are mainly found in certificates of deposit and savings. Certificate of Deposit and savings certificate - this is a written certificate of the credit organization - the issuer about the deposit of funds, certifying the right of the depositor ("beneficiary") or his successor to receive, after a specified period of time, the amount of the deposit (contribution) and interest on it. Both bank and non-bank credit institutions can issue certificates of deposit, and only banks can issue savings deposits. Deposits can be issued both on a one-off basis and in series, there are registered or bearer deposits. Both deposits are urgent. Calculations with a certificate of deposit are carried out only by bank transfer, with savings certificates cash payments are possible.
An example of a demand deposit can be checking accounts. In the West, they are offered to clients by many financial institutions - commercial banks, savings, loan and credit institutions. The owner of the checking account is paid an annual interest of 3 to 5% of the balance of the account; as a rule, the interest payment is made, its balance amount for the year has not dropped below the established level (usually in the range of $ 500-2500). Since the owner of a checking account is given the right to withdraw money on demand, checking accounts are called demand deposits.
Let's give examples of other securities of this type, found in financial markets, for example, the United States. Money market investment deposits (MMI deposits) are a type of certificate of deposit. The main distinguishing feature MMI deposits is that the annual interest paid on them is not strictly fixed, but is set at least 0.25% higher than the income of treasury bills ( Treasure bills) with the same maturity. Minimum deposit amount for MMI the deposit is 10 thousand dollars, and the maturity is set above six months. So, an investor can purchase MMI deposit for 10 thousand dollars with a maturity of 6 months. If treasury bills with a maturity of 6 months provided at that moment a yield of 4.2%, then by MMI the percentage of the deposit will be at least 4.45%; in the event of an increase in the yield of treasury bills to 4.34%, the interest on MMI the deposit increases to 4.59%.
Indexed CDs appeared in the United States in 1987. The main difference between these securities is that the interest paid on them is "tied" to the indicators of the stock market, i.e. is indexed. Usually an investor purchasing such a certificate can choose the minimum interest rate, let's say 4.5%. If during the period of the deposit the stock market indicators went up, then the owner of the deposit will receive an increase in the interest paid. Thus, these deposits guarantee their owner a certain minimum income and provide the possibility of additional benefits in the event of an increase in stock prices on the stock market.
Eurodollar deposits are international time deposits. They are denominated in dollars and issued by commercial banks located outside the United States. Eurodollar deposit accounts generally carry higher interest rates than comparable term deposits provided by American banks. This is due to a higher level of risk on Eurodollar deposits due to different conditions of deposit insurance, a floating exchange rate, and political instability.
An important positive quality is inherent in deposits - high reliability. This is explained by the fact that in many countries (at present - in Russia), deposits of individuals in banks on time and term deposits are provided with state insurance (in the United States, deposits up to $ 100 thousand inclusive are insured; in Russia, deposits up to 125 thousand rubles). In this regard, the risk associated with investing in deposits is low. However, deposits have a number of disadvantages: due to the low level of risk, the return on deposits is the lowest of all fixed income securities. In addition, deposits do not provide an adequate degree of liquidity, since there is practically no secondary market for these securities. Therefore, many investors prefer to invest in money market securities.
Money market securities have distinctive features:
Usually their maturity does not exceed 12 months;
They have a fairly high liquidity, since they can be freely sold and bought by investors in the secondary securities market;
As a rule, they are placed by the issuer at a discount price. Money market securities allow borrowers (the state, and on
The West - and large corporations) to obtain borrowed funds from individual and institutional investors by selling the latter short-term securities, which are, in fact, unsecured promissory notes. The most common type of money market security in Russia is short-term government bonds (GKO).
Bonds are called securities with a fixed income, securing the right of its owner to receive a bond from the issuer within the specified period of its par value or other property equivalent. A bond may also provide for the right of its owner to receive a fixed percentage of the par value of the bond or other property rights. The yield on a bond is interest, or discount. There are 2 main differences between bonds and money market securities. First, a significant number of bonds are sold at par with subsequent interest payments. Secondly, the maturity of bonds is more than a year and may last for several decades. Bonds can be classified according to various criteria. In particular, it is important to divide bonds depending on the type of their issuer. On this basis, bonds are divided into the following types:
State - the issuer is the state (in Russia - represented by the Ministry of Finance).
Bonds government agencies(represented by ministries and departments). As a rule, these institutions issue bonds and use the funds received to lend to small businesses, the education system, housing construction, and support for farms. On the Russian securities market, bonds of the Bank of Russia are an example of government bonds.
Municipal - the issuer is regional and local authorities. Usually, investing in municipal bonds carries a higher risk than purchasing government bonds and government securities. This is due to a number of circumstances: firstly, practice shows that the issuer (local government) is sometimes unable to fulfill its bond promises, that is, investing in local government bonds is associated with credit risk (risk of bankruptcy, default) ; secondly, despite the fact that many bonds are insured by private insurance companies, there have been cases when, in the event of the bankruptcy of the issuer (local authority), the insured was unable to cover its debts; thirdly, due to the fact that a significant number of bonds of this type are circulating on the financial market, often the investor has difficulties with their sale, that is, investing in municipal bonds is associated with the risk of illiquidity.
Corporate - the issuer is legal entities (more often open joint stock companies). The rules and peculiarities of the issue of bonds by joint stock companies are given in the Federal Law of December 25, 1995 No. 208-FZ "On Joint Stock Companies". Corporate bonds are usually classified according to the degree of risk associated with their purchase. The most reliable are considered collateralized bonds. If the bonds are secured by the firm's real estate, then they are classified as mortgage bonds. The company's financial resources can also be used as collateral.
Another category is unsecured bonds. In recent years, in the West, bonds of firms borrowing money for very risky projects have become widespread - if successful, they provide higher interest rates than on other bonds. Such bonds are classified as "Second-rate, junk" (junk bonds).
In order to attract investors, companies are going to introduce additional benefits for bond buyers. For example, many Russian corporate bond issuers stipulate in their decision to issue offer- the possibility of the owner of the bond to return the bond to the issuer within the specified period at the redemption price (offer price). This can be beneficial for potential bond buyers if interest rates rise and the market price of the bond falls. The offer increases the liquidity of bonds.
Russian law allows corporate issue convertible bonds, which can be converted either into shares or into other bonds of the same company. The convertibility of the bond allows firms to enter into the terms of the issue a clause on early recall of bonds, according to which the firm has the right (but not the obligation) to recall (redeem) its bonds before the specified maturity date. This right allows issuing firms to more flexibly respond to financial market fluctuations in the event of a decrease in interest rates. Indeed, if the coupon payments on the Alrosa 19 bond are 16% per annum, then the owner of the bond receives 80 rubles in interest payments. every six months (for this bond, coupon payments are made 2 times a year). Imagine that the inflation rate decreases and market interest rates fall to 8% per annum. In this case, it is unprofitable for the issuing firm to pay the annual interest on the bond, which is 2 times higher than that established in the market. Therefore, she will repurchase the bonds ahead of schedule and issue a new loan at 8% per annum, thus saving millions of rubles. on interest payments.
Foreign - the issuer is government agencies and corporations of other countries. These bonds are widespread in the West, since they allow you to get a higher return. Investing in bonds of other countries has another attractive feature - the change in their prices is not associated with fluctuations in the prices of domestic financial resources, which makes it possible to achieve greater diversification of the investment portfolio.
So, the investment opportunities of fixed income securities are determined by the combination of the following qualities:
a) they are debt securities, and any payments on them represent the obligations of the issuer;
b) the owner of such securities knows in advance the dates and amounts of upcoming coupon payments on them;
c) the securities are redeemed within the specified period when the issuer pays the owner of the security its face value;
d) after maturity and full settlements with their owners, fixed income securities cease to exist and cease to bring income to investors.