Global Edge International Consulting Associates, Inc.: investing

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Sunday, October 4, 2015

Investment Protection Using A Zero-Coupon Hedge

PROTECT INVESTED PRINCIPAL USING A ZERO COUPON BOND HEDGE

Article By Douglas Castle Of The Global Futurist Blog And The Taking Command Blog

Written for Publication in The GLOBAL EDGE INTERNATIONAL Blog


A thoroughly uninteresting picture of a mathematical formula for zero-coupon bond computations.

A remotely relevant picture with more "eye appeal" than the above mathematical formula.

IMPORTANT NOTICE: THE INFORMATION CONTAINED IN THIS DOCUMENT SHOULD NOT BE CONSTRUED BY THE READER AS BEING LEGAL, FINANCIAL, TAX, ACCOUNTING, ECONOMIC OR INVESTMENT ADVICE. NO OFFERING OF SECURITIES OR OTHER INVESTMENT INTERESTS OF ANY TYPE IN ANY ENTITY IS MADE HEREBY, NOR IS A SOLICITATION FOR THE PURCHASE OF SECURITIES OR OTHER INVESTMENT INTERESTS OF ANY TYPE IN ANY ENTITY MADE HEREBY. THIS DOCUMENT IS INTENDED FOR GENERAL INFORMATIONAL PURPOSES ONLY, AND IS NOT INTENDED FOR DISTRIBUTION OR TRANSMITTAL BY ANY MEANS. ANY REPRODUCTION OR TRANSMITTAL OF THIS DOCUMENT, EITHER IN WHOLE OR IN PART IS EXPRESSLY PROHIBITED, UNAUTHORIZED AND MAY CONSTITUTE A VIOLATION OF APPLICABLE LAWS. THIS DOCUMENT IS COPYRIGHT 2015 BY DOUGLAS CASTLE.

In many acquisition or investment transactions, the primary concern of the purchaser or investor is the preservation of invested principal. A zero coupon bond hedge functions as a form of principal protection insurance. Is is expensive, but it works very well, provided that the issuer of the zero coupon bond is creditworthy. Also, please note that this particular strategy does not guarantee the timely payment or liquidity of the principal. It merely means that over a designated time if you hold the the zero-coupon bond up to its maturity that upon that maturity date, you can collect the full amount of your principal.

The bonds are bought in the appropriate amount to facilitate the hedge [see the examples below] and are deeply discounted from their future value. These bonds are said to accrete value as interest payments accumulate toward the future value of the bond. And the annual accumulated interest (which is not paid to the holder, but which is instead allowed to accumulate) is taxable in many cases, even if you haven't received any amount of the accretion. For tax purposes, the accreted (but unpaid) interest on the bond may be taxable annually, despite the lack of cash flow to support and cover the amount of this payment. It is for this last reason, that an ideal pairing for a zero coupon bond is with a depreciable real estate or other depreciating asset investment; in these cases the accretion issue is often well offset by the amount of depreciation against it.

Without getting involved in a discussion of the tax ramifications associated with zero coupon bonds, let's examine how they may be used in some illustrative examples below:

In this particular example (and one which is demonstrative of the most extremely conservative case for purposes of illustration only), let us assume that we have $1,000,000.00 of principal to invest. If we invest approximately (all numbers are estimates) $500,000.00 in a potentially high-yielding investment opportunity, but we wish to guarantee the return of our full $1,000,000.00 principal regardless of the level of success or lack of success that we will experience in the investment activity, we may choose to simultaneously purchase a 10-year, 7.1% zero coupon bond for $500,000.00 which will accrete to the sum of $1,000,000.00 in 10 years, independent of all other variables. In essence, this means that we will receive our total principal of $1,000,000.00 back at the end of 10 years regardless of the performance of the investment opportunity in which we had invested the $500,000.00.

While the zero coupon bond as a form of “return of principal guarantee insurance” does reduce our yield somewhat on successful investments, it also provides us with the comforting assurance that invested principal (and in the above case, even our uninvested principal!) will be kept intact and returned to us if the zero coupon bond is simply held to maturity, regardless of the performance of the portion of funds invested in the riskier but more potentially high-yielding investment opportunity.

The true “cost” of this form of guarantee is actually 7.1% per year which we could have earned on the $500,000.00 if we'd had it to invest in alternative opportunities. But we must look at this cost in its appropriate perspective: If the investment opportunity in which we had placed the funds had generated a return of 30% per year, the cost of the protection afforded us by the zero coupon bond hedge would have been extremely worthwhile and actually quite minimal.

Variations on the above formula are available using smaller denominations of zero coupon bonds purchased for the protection of principal of lesser amounts or to a lesser extent. The above example in the first paragraph is the most extreme case. Had we wanted to merely purchase “return of principal guarantee insurance” for only the $500,000.00 invested amount, we could have purchased a 10-year, 7.1% zero coupon bond for $250,000.00, which would have accreted to the sum of $500,000.00 at the end of ten years. This approach, which is admittedly a bit more aggressive than the one set forth in the example in the first paragraph, would have left us an additional $250,000.00 of principal in our discretionary investment fund to do with as we chose.

In utilizing the zero coupon bond hedge, the strategic objective is to pair a high risk-reward investment opportunity with the smallest comfortable level of zero coupon bond present value in order to maximize the spread between the investment upside potential and the cost of the “return of principal guarantee insurance”. The obsessive use of this hedging strategy can be too conservative and counterproductive; however the well-reasoned use of this strategy can provide a more conservative approach to investing in more aggressive investment opportunities with greater potential returns.

Tags, Labels, Keywords, Categories, And Search Terms For This Article:

principal, protection, investing, insurance, credit enhancements, zero coupon bonds, GEIconsulting, Douglas E. Castle, hedging, risk, protecting investments, bond computations, accretion

As always, thank you for reading me, and for visiting our website at http://globaledgeinternational.com

Douglas Castle for Global Edge International Consulting Associates, Inc. and The Global Edge International Blog

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Friday, August 14, 2015

Insiders Are Selling Their Shares? What Should I do?

Insiders Are Selling Their Shares!

What Does This Mean?

And What Should I Do Now?

By: Douglas Castle For Global Edge International And The Global Edge International Blog

When insiders, particularly officers, directors and owners of large blocks of stock (5% or more of the total shares issued and outstanding) are suddenly starting to sell off their shares of stock in a publicly-traded company, especially one in which you have an investment, before you take action, extend your very best efforts to try and determine what the underlying reason for the selloff is. Depending upon that reason (or reasons), you may wish to either: follow suit and liquidate some or all of your holdings; just sit tight and maintain your position; or actually purchase more shares. While this article does not provide financial, tax, investment or legal advice, it may help you in making a more-informed decision in terms of your own investment tactics or strategy with respect to your investment in that specific company. Since we at GEI Consulting are extremely imaginative, we'll refer to the subject company as “Company X”.

There are a host of reasons why significant shareholders may be selling off their shares in Company X, and an outline of some of the most prevalent possibilities are discussed below:

==+ They have come to the end of a statutory, regulatory or contractual stock holding period, and they are selling off some of their holdings to establish some liquidity – this is, of itself, harmless and is generally acceptable, especially in the second or third year following an IPO, or after a year or two of having commenced a C-Suite position in a more-established company.

==+ They are either retiring or contemplating retirement (they are at an advanced age) to pursue personal interests, and wish to 'cash out' to enjoy the benefits of a financially-substantial departure from a successful career.

==+ They are selling off shares and either reinvesting in Company X or lending the post-sale proceeds to Company X, presumably because Company X is illiquid or is accumulating losses. This type of activity can either be interpreted as admirable and positive heroics, or as a prelude to a death knell in the event that the tight cash situation is not just temporary or seasonal.

==+ If they are selling off shares (which they might have gotten very inexpensively early in Company X's evolution, or through the exercising of options or warrants) and using the proceeds to buy additional shares, it generally means that they believe that the stock is undervalued and is due for an increase through a market revaluation.

==+ If they are selling off substantial numbers of shares and not reinvesting proceeds in Company X, it generally means (barring an individual holder's personal financial hardship) that they believe that the stock is overpriced and is headed for a valuation adjustment in the downward direction.

Depending upon the circumstances (some of which are set forth above) and the underlying reasons, take action appropriately.

In order to get information on these substantial trades by influential shareholders, some good sources are these:

http://insidertrading.org/

http://www.insider-monitor.com/

http://insiders.morningstar.com/trading/insider-summary.action

http://insidertrades.org/

http://www.insider-monitor.com/insider_stock_trading_report.html

http://online.barrons.com/public/page/9_0210-instrans.html

http://www.secform4.com/

Generally speaking, the pundits (they generally like to call themselves that) tell us that when it comes to aggregate insider buying and selling, the following general rule applies [although in taking a close look at the individual circumstances involved as described above in this article, the general rules are possibly a gross oversimplification]:

When the buyers outweigh the sellers (in terms of number of parties and aggregate volumes), insiders are generally bullish (optimistic) about the short-term prospects of Company X;

When the sellers outweigh the buyers (in terms of number of parties and aggregate volumes), insiders are generally bearish (pessimistic) about the short term prospects of Company X.

Also, in the interest of keeping our nomenclature crystal clear:

"Insider trading" is a term that most investors have heard and usually associate with illegal conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC.

Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.

Thank you, as always, for reading me.