Day 99

The risk and return

The risk and returns are probably the most common concepts acknowledged by financial decision makers. These two factors are contrary evaluations but work mutually on the assessment of financial assets. As a matter of fact, the trade-off between risk and return would normally reflect a positive pattern. Where the riskier the investment is, the higher return can be expected by the investor to receive. Hence it is the fundamental knowledge for financial participants on balancing the risk and return over a financial asset.

So how do we define the term ‘ risk’ in finance? In my opinion, the risk is the uncertain difference between the expected outcome and the actual result. It should be the deviation that diversifies the output. The risk itself must be uncertain, has a considerable impact over the outcome and may generate either positive or negative effect. Therefore, it is crucial for financial decision-makers to understand the actual influences of the risk. People may react differently corresponding to the severity of the risk. Generally, all of us are risk averse, since no one would prefer to lose control on the outcome. However, the correlative better return induced many groups to be risk takers. For instance, the average real return for the 10-year bond during 1999 to 2009 was 4.43%. On the other hand, the mean return on share market investment provided by the All Ords index was 9.95%. Thus that risk premium at 5.67% was sufficient for many financial participants to take the risk.

After the explanations of risk, the tricky part is how do we ‘hedging’ it with the return in order to achieve the maximum efficiency on our fund's utilization? It involves the study of statistics. We should calculate the standard deviation on the return, and consequently, we will be able to identify the extent of the possible return. For example, there are 68% of probability that the actual return will occur between the sectors of expected return plus/minus the standard deviation value. The investors can easily observe the possible return distribution, thereby the measurement over risk and return will be amplified for following decisions.

Although the higher risk may lead to better gain on investment, we need to balance between them so un-anticipated loss can be avoided.  

Day 98 Ideas of the Chinese stock market

Ideas of the Chinese stock market

There are two shares I would like to evaluate today. I am going to proceed with both technical and political evidence and hopefully this article will assist you on investing relevant securities.

Let’s start with China Minmetals Rare Earth Co. Ltd.(sz.000831). Through reading the candle stick chart of the last four trading days. We can realize the share price was expressing a bearish trend. However, on the prior trading day(27th), a reversal hammer shape appeared. The upper wick of the body indicates at some point of the day. The buyer force pushed the price up but the consistent selling pattern dragged the price down at the end of the day. This possible bullish reversal pattern was emphasized by today’s hammer pattern, which the price was retained at a high level by the bulls. The committee of the share is 29.24% today, and the turnover is about 4.99%. These ratios justified the positive trend of the price, since the rapidly turnover plus the prevailing purchasing power in the market. At the policy level, the recent announcement of the Silk Road Economic Belt development immensely stimulated the infrastructure market. In addition, the consolidation between the CSR CO. Ltd and CNR Co. Ltd. was considered as the signal of amalgamation on government-owned corporations. China Minmetals Rare Earth Co. Ltd.(sz.000831) as the leader government owned enterprise was expected to reform along with other corporations in the industry, in order to eliminate over capacity problem and increase competitiveness in the world. As a consequence, the share can be held to obtain the future substantial capital gain.

Another share would be the Sichuan Tianqi Lithium Industries, Inc. (002466.SZ). Which is the major market participant in the lithium production business. We shall still focus on the technical analysis first. According to the candle chart, there was a tremendous bullish engulfing pattern appeared on 24th. Where followed by a robust upward trend. Although the price was dragged down a bit in the last two trading days (which can be predicted via the hanging man pattern on 27th), the increased proportion of the candle stick body indicated the buying and selling power tended to be balanced in today’s market. This is backed by the committee today at -28.17%, which defined the bears had a trivial advantage in the market. The turnover was at 3.86% today, corresponding to a large amount of main capital withdrawal, which also caused the temporary bearish pattern. On perspective of policy level, the National People’s Congress proclaimed the future government support towards new energy area. The Lithium is the core material for the lithium battery that is anticipated as the new power source for vehicles. Therefore, the future expansion of the market will definitely benefit the market leader Sichuan Tianqi Lithium Industries, Inc. (002466.SZ).

Even though this is not a sophisticated analysis, I hope it explained the idea of the two common approach that we used to assess financial asset.  

Day 97 Compound interest

Compound interest

The time value of money specifies that the money today will not be worth at the same value tomorrow. Technically speaking, this hypothesis is created to outline the importance of investments and other financial activities. Actually, the value of our investment can be quite different after a long-term. And what stimulates our return is the power of compound interest. As a financial participant, it is the fundamental knowledge for us to comprehend, since it determines the benefit carried out by our investment. Therefore, it is one of the most important figures that would affect out investment decisions.

Application of the compound interest method is pretty straight-forward. We have to accumulate the interest earned in each period along with the principal amount, and the interest revenue for the next period is calculated on this value. The common pitfall we need to avoid is that we have to calculate the value on the same time frame. For instance, if the deposit is compounding monthly, then the annually interest rate is required to be transformed into monthly interest rate. In addition, if the cash are invested repeatedly in a series manner, it becomes multiple cash flow investments. Because of the time value of money, we cannot simply collectively work out the expected return. Hence, we must define the future value of every single transaction and add them up. Distinguished by their features, there are four main categories of multiple cash flow investments. To illustrate, the ordinary annuity is with series of standard cash flow investment over a fixed period, and based at the end of a solid interval; On the other hand, the only different on the annuity due is the cash flow appears at the beginning of the interval; The infinite or perpetuity cash flow deposit will continue forever, thus it has an unlimited time period; At last, the varying compounding investment has the characteristic of the erratic amount of cash flow occurs in each interval.

To understand the calculation process of this compounding interest investment is critical. Due to financial decision makers must assess the present value and future value of the investment. Typical issues include taking the cash now and invest it for the return, or accept an offer to be paid in the future. Besides that, evaluations of financial assets such as bond price will rely on the present value as well. Nonetheless, it is rather simple mathematic knowledge, but like I said, it is the keystone of many other profound financial problems.  

Day 96 Decision-making and the directors

Decision-making and the directors

As we discussed before, the company is guided by the internal governance rule, which is in accordance to its constitution or replaceable rules. Therefore, all the decision made in a body corporate should comply with it. There are two ‘organs’ in a company that take decisions corresponding to the internal governance rules: the board of directors and the general meeting of members. Each of them is specified with certain powers on decision making. It is crucial for us to remember that the powers of two groups are sovereign and cannot interfere/override each other’s decisions. 

Under Section 198A(1) & (2) Corporations Act(2001), the board of directors has been granted with the general management power. So the company should be managed or directed by directors unless the terms specified in the company constitution. This power makes the directors become the most important character in company the decision-making process. As a consequence, the Corporations Act regulated that private company must have at least one director (S.201(a)), and public company need appoint at least two directors(S.201(b)). Section 9 defines the director as the person who is validly appointed to the position or on the general grounding act in accordance to that position. Hence these shadow/ de facto directors who are not literally described as ‘director’ will still undertake the similar obligations. Commonly, the company constitution would regulate the process of appointing a director. However, if the replaceable rules apply, the director should be appointed by ordinary resolution of members. The board may also appoint directors, but only with the agreement by the shareholders. The removal progress of the director is performed by the ordinary resolution as well. Due to the importance of this occupation, there are series restrictions that prohibit the disqualified person to be elected. For instance, the candidate must be over 18(S.201B (1)), did not convict certain offences(S.206B(1)), or are not experiencing bankruptcy(S.206B(3)). In order to manage the company more efficiently, directors tend to delegate their powers to certain committees and S.198D provides justification of it. If the delegate breaches the law or obligations, the director is held responsible for these actions(S.190(1)). Unless reasonable grounds, in good faith after proper enquiry delegate reliable and competent in relation to power delegated is performed S.190(2). 

All directors must be diligent to bring the company towards the shareholder’s best interest, and all these regulations are created to maintain this basic purpose.  

Day 95 Internal governance complies with Replaceable Rules and Constitution

Internal governance complies with Replaceable Rules and Constitution

The internal governance is the instrument that defines the structure and management procedure of a company. It relates to the appoint, removal and distributing powers of officers, as well as disclosure of share classification plus rules regarding dividend payment. The Corporations Act(2001) S.134 states that the internal governance rule in a company consists of the replacement rule set by the C.A., the company’s own constitution or the combination use of both.

The replaceable rules are the model regulations spread out in the Corporations Act, and the section 141 provides a table to list all the terms. It is rare to see company that adopts these rules since they are rather rigid and unsuitable for diversify situations.

On the other hand, the constitution is the company own set of regulations, which is the collation of all internal governance principles. Under S.135(2), the replaceable rules can be replaced or modified by company constitution. More importantly, applying the constitution grants the company much flexibility to satisfy other requirements such as ASX listing rules. In addition, it also helps the company to avoid the unfavorable legislative adjustment towards the replacement rules. Section 136(1)(2) proclaims the requirements to adopt an constitution, where obtaining the written consent of all proposed members on registration, or generated by the special resolution process. Such process involves the pass of the resolution by at least 75% of entitled members’ votes. The special resolution is also the necessary proceeding to alter the constitution, justified by S.136(2). However, there are several limitations over the alteration to the company constitution for the purpose to protect the right of shareholders.

To illustrate, under the Corporations Act(2001) S.136(3), the constitution cannot be modified unless it passes the special resolutions and the entrenching provisions. Moreover, the alternation on constitution will lead to the compulsion on shareholders to buy more shares(S.140(2)) or the variation of class right on shares(S.246B) is not valid. At last, the section 232 espoused that the change must be fair and without oppression to a specific group of members, otherwise it will not be a legitimate alternation. Furthermore, the common law also provides restrictions on the variations of constitution, but only in the scenario involves expropriation of shares. The high court advocates that the adjustment made to constitution is valid if the expropriation is for proper purpose and fair(procedural and substantive).

Although the replaceable rules are part of the Corporations Act, the non-compliance of it will not breach the Act. The relevant party may refer to the contravention of statutory contract if necessary.