Profit Margin -- Apple Analogy

There are 2 types of Profit Margin, Gross Profit Margin and Net Profit Margin. Here's my analogy used to explain it to one of the graduates at MIP today:

I bought an apple at $0.60 and my staff sell it at $1.

So my gross profit is $0.40, hence the gross profit margin is $0.40/$1 * 100% = 40%.

I paid my staff $0.10 to sell that apple. So my net profit is actually $0.30. Hence, my net profit margin is $0.30/$1 * 100% = 30%.

I'm glad that it helps in her understanding. :)

Borrowings / Debts

Borrowings/Debts refers to the money owing to the banks and other members of the public (through the use of bonds - long term / notes - short term). In the event that the company is unable to pay off these borrowings / debts on time, the company is very likely to end up in a highly undesirable position.

The ability to pay of borrowing / debts are especially crucial to the survival of the company. Hence, we must always ensure that the company is able to pay off their borrowings within the time frame stipulated, to protect ourselves. By protecting such downsides, we will be able to lower our risk exposure. :)

Just imagine, in the aspect of owing the loan shark money and we can't pay them. So there's a chance that loan shark might spray / splash paint on our wall, write our unit number at the lift, threaten us, hit us, pose danger to us or our loved ones etc but we won't be declared bankrupt. Just that our life will be more miserable and might be in danger if we can't pay up. Which is pretty scary right?

But when we owe bank money, and we can't pay up, there's only 2 results, either we become bankrupt and continue to slog and work so that we can pay back the money, or the mortgaged item will be possessed by the bank and they will sell it off to cover our debts.

Put this in the company's view. If the company can't pay up, there's also only 2 path, either it close down, or the bank will possess the item on mortgage and sell it off for money to cover the company's debt. But there could be a 3rd case that the government may want to save the company but this only applies if the company one that the government can't afford to let it close down.

Reference: Investopedia - Debt

Protective Put Vs Covered Call

Options when traded the usual way as a form of leverage to make money through the current trend of your stock is very risky in my personal opinion. However, options can also be used in a way that you can either protect your downside or make money with it. But before you implement any of these strategies, you've got to analyse your stock's fundamentals before purchasing to minimize your risks further, and of course for the amount of put or call option that you purchase, you should have the equivalent amount or more of the underlying stocks you wish to protect.

The protective put is like buying an insurance to guarantee the value of your stock. You pay a premium to buy the put option in order to ensure that no matter what happened, you can always sell your stock at the specified price.

The covered call allows you to make money when the value of your stock drops but you will make less money should the value of your stock appreciates (increase in price). You receive the premium for selling a call option on the stock that you are currently holding at a price that you think the stock should be valued by the end of a specified date. This price must of course be higher than your purchase price so that you do earn a profit from selling the stock. So in the event that the stock price really drops and the call option was never executed, you makes that premium. But in the event that the stock price increases to a price more that what you specified in that call option, you might need to sell your stock to the person that buys that call option. Which means, you will make less money in the process.

Normally, I won't use either but I would prefer protective put as it's best to protect the downside and let the upside take care of itself rather than limiting the upside and making money during the downside.

Call & Put Options - The creative explanation :)

Basically, there are 2 types of options, namely, call option and put option. For both type of options, it is worth more money only when you can make money out of it and it becomes rather worthless when you can no longer make money from it. When it expired, it's worth nothing at all.

Call Option

This is a contract that allows you to buy a specified stock at a specified price before it's expiry.

Let's take McDonald's for example. Supposed, McChicken is for sale for $3, and there's a McChicken coupon that can buy it at $2.60 instead. This analogy, the coupon is the call option and the McChicken is the stock. The coupon is worth $0.40 as it allows you to buy McChicken at $2.60 instead of $3.00.

But this coupon has an expiry date. Once it expires, it's totally worthless.

Supposed, McDonald's now come up with a special offer that sells McChicken at $2 instead! Then that coupon you hold will become almost worthless, but it's still of some value as it hasn't reached the expiry yet and we don't know when this special offer will last. So people may still trade the coupon at certain values, but much less than in the earlier example. :)

Put Option

This is a contract that allows you to sell a specified stock at a specified price before it's expiry.

Let's take Singtel and iPhone as an example. Supposed Singtel has this trade-in promotion where they intend to buy back iPhone at $200, but you must show them the promotion flyer before the promotion ends. In this analogy, iPhone is the stock, the flyer is the put option. Supposed another shop M1 is selling 2nd hand iPhone at $180. So the flyer is now worth $20 as it allows you to sell iPhone at $200 but you only need to pay $180 for the phone itself.

Of course, as usual, once the promotion deadline on the flyer expires, the promotion ends and the flyer will be worthless.

On the next day, M1 sold all it's iPhone. Only Starhub is selling iPhone at $210. But the flyer of the trade-in promotion still has minimal value although quite worthless as it is not expired yet, because we never know when Starhub will come up with a promotion to sell iPhone at a price less than $100 before the flyer's trade-in promotion ends. So people may still want to buy the flyer but at a much lower price of course, maybe just $0.01 per flyer.

Intrinsic Value

Basically, intrinsic value of a company / asset is the estimate of the true underlying value of the company / asset based on fundamental analysis. It's usually calculated using the discounted cash flow model and / or valuation of the underlying net asset (all valuable assets such as cash, deposits and good properties, less all borrowings). Usually this value is different from the company / asset's market value as the market value is depending on market sentiments (aka mood swings).

Reference:

1. Investopedia - Intrinsic Value
2. Wikipedia - Intrinsic Value 

Do let me know if there's anything I can do to simplify the explanation further. Let us all improve together. :)

What is Warrants?

Warrant is an investment tool that enables the holder to gain exposure to a security at a fraction of the stock price. It is tied to the exercise price, a price at which you can have the right to either buy or sell the underlying stocks at, before the pre-determined date tied to the warrant, depending on the type of warrant. Hence, it can be used to profit from both a rise and fall in the stock price itself. It has this leverage feature. However, as we all know, leverage cuts both ways, when it goes in your favour, you may earn twice, when it goes against you, you may also lose twice.

The main downside of warrant is that its holders are not entitled to share dividends and they have an expiry date so they can't be hold over long term period. The good thing is that warrants can be bought or sold in a similar way as compared to shares.

Although the underlying issuer is different, it functions in a similar way as compared to options.
Read more about options.

Unit Trust

Unit Trust (also known as a collective investment scheme) is a pool of money managed collectively by a fund manager. The pool of money usually comes from retail buyers, such as you and me. Unit Trust is started with investors buying units in a particular trust / fund, e.g. usually at least $1K per investment. All these money are pooled together to buy a portfolio of assets such as other unit trust, stocks and shares, bonds, or treasury bills, etc. The portfolio of assets purchased by the fund depends on the investment objective of that unit trust.

Usually, there are 3 types of unit trusts:

1. Equities (consists mainly of Stocks and Shares, most risky)
2. Bonds (consists mainly of bonds, treasury bills, notes, least risky)
   
3. Balanced (a balanced mix of the 2 types mentioned above, risk level is in between the above)

And these basic type of unit trusts are then further dividend into various categories:

1. Money Market Fund
2. Global Fund
3. Sector Fund
4. Country Fund
5. Income Fund
6. etc..

For all unit trust, past performance are not indicators for future performance and there's always a chance of losing all your capital. So please ensure that you do know what exactly are you buying and make sure that the sales personnel do countersign your application form with the claims they mentioned if they claim that the returns is guaranteed. If they don't dare to countersign with their name and ic no as well, with all the claims they've made, do reconsider your decision in the purchase.

The risk factor varies between the various type of funds, which is not covered under this article. Alsoe, I need to mention about the sales charges. There are basically 2 types of sales charges, front end and back end. Most of the time, it's either front end or back end charges for a particular fund but rarely both. So it's best to check with the person that you buy the fund from or read the information carefully.

Front end sales charges are deducted from your initial investment amount upfront, the moment that unit trust is purchased, as a result, you will be purchasing less units. Usually, the sales charges varies with the mode that you purchase a fund. If you buy it over the internet such as POEMS, fundsupermart, etc, the sales charges is lower, it may varies around 1 - 2.5% depending on the fund. If you purchase it through agents from the bank, it's usually about 5%. If you purchase it through agents from NTUC income, it's usually about 3% but the funds available are quite limited and I personally won't do that ever again due to the low returns and high charges. If you purchase it through agents from various financial consultant, the sales charges may varies, there's a slight chance that you might be able to negotiate the sales charges.

Back end sales charges are deducted when you sell your investments, usually this will be waived or decreased gradually when you hold the investment over a period of 5 years or more. For this case, do take note of the details before purchasing but it can be negligible if you intend to hold it for long term, e.g. more than 10 years, but still check about whether the fees will be waived or not as well.

Switching Fees may or may not be applicable depending on the policy of the particular plan that you've purchased and depending on the company itself. Usually it varies from 0-2.5%. Anything higher does not really makes sense.

Do take note of all the fees / charges that may be involve and the risk level of the unit trust should you purchase any. :)