Finance and Investment Workshop Student actuaries at Michigan April 2018

Motivation Dutch East India Company – World’s First Stock Company

Motivation (cont.) How do we raise the funds needed to run our company? Ships and sailors are expensive We could just borrow all the money we need, but… How do we diversify the risk associated with this company? If a ship sinks, that could ruin a single investor/lender How should our company be governed? Since we will have many investors, who will be in charge? The solution? A new business model—joint stock companies

Starting our Public Company Let’s split our company up into small pieces that anybody can buy These are called “shares”, which are available for anybody to buy We are now a public company, not a private partnership We are now subject to additional government rules Stock certificate for Cape of Good Hope Diamond Company, 1881

Starting our Public Company Let’s split our company up into small pieces that anybody can buy These are called “shares”, which are available for anybody to buy We are now a public company, not a private partnership We are now subject to additional government rules Stock certificate for Cape of Good Hope Diamond Company, 1881

Starting our Public Company We need $10,000,000 to buy our first couple of ships The Bank of Natarajan will loan us $5mil, so let’s worry about getting the rest Debt Financing Let’s sell 5,000,000 shares at $1 apiece to the public IPO = Initial Public Offering Equity Financing Equity = the value of your ownership in something Ex: I own 5 shares, then I have $5 of equity

Diversifying Risk The shareholders are the owners of the company Ex: I own 1 million shares, I own 20% of the company Sink or swim all together What about the Bank of Natarajan? They gave our company a loan, they did not buy shares They are NOT owners in the company The company must pay back its debts as indicated in the loan agreement If we cannot, we will have to go bankrupt

Diversifying Risk 500,000−250,000−100,000−100,000=50,000 Let’s say we made $500,000 in our first six months 500,000−250,000−100,000−100,000=50,000 Earnings Labor 50,000 5,000,000 =$0.01 Interest to Natarajan Bank Dividend (per share) Taxes Number of shares Net Income Our shareholders will get $0.01 per share

Corporate Governance It’s a democracy! (Kinda) 1 Share = 1 Vote Board of Directors more directly oversee company They are influential shareholders The CEO answers directly to them

Advantages of Being Public “Easy” to raise capital by selling more shares Capital = money needed to run our business (buy ships) Risk is well-diversified among the shareholders “Easy” to transfer ownership by trading shares Disadvantages: what if shareholder interests and customer interests are not aligned? Is being for-profit necessarily good for society? Ex: Health insurance companies

Insurance Companies Public, For Profit Nonprofit

Other Types of Organization Mutual Company Customers/Policyholders are the owners of the company Dividends go to them (Nabil’s actuarial internship!) Private Partnership Experienced, senior workers in the firm are the owners Ex: Law firms, senior lawyers are partners Ex: Consulting, senior consultants are partners Type of business will affect what organization is appropriate

Stock Trading You can easily trade your shares on stock exchanges NASDAQ, NYSE Price of Stock Theoretical: PV of Expected Future Dividends Practical: Supply and Demand “Buy low, sell high” Investing vs. Gambling Looking for consistent returns, or to get rich quick?

Stock Trading Let’s look at a stock and some associated info Ticker = F Stock Exchange = NYSE Open = Price at start of day High = High price for the day Low = Low price for the day Mkt Cap = Value of all shares combined P/E Ratio = Price divided by Earnings Per Share Dividend Yield = Annual dividend as a percentage of stock price

Stock Picking—Junk Science? Cat vs. Professional Stock Pickers Well-respected fund managers Cat Illustrates the “random walk”—in the short term, individual stocks are volatile https://www.bloomberg.com/features/2015-stock-chart-trading-game/

Nabil’s 3 Rules of Investing Don’t put all your eggs in one basket Use index funds, ex: SPY Don’t try and get rich quick Don’t invest in what you don’t know, do your due diligence Do invest early and patiently It will pay off when you’re older

Index Funds Seek to match the returns of a stock index Index = summarizes the returns of some collection of stocks Individual stocks are volatile, but collections of stocks reduce variance of return Ticker: SPY Mirrors S&P 500 Index 80% return the last 5 years 14% over the last year

Getting Started w/ Investing Read the news, keep up with economic developments Wall Street Journal, New York Times, etc. Practice buying and selling stocks in simulations http://www.howthemarketworks.com/?gclid=EAIaIQobChMI87WWq6SJ2gIV17XACh3cGgiwEAAYAS AAEgLtdPD_BwE When you’re ready, open a brokerage account Robinhood—trading app, 0% commission per trade

Questions? Finance and Investment are the focuses of… MATH 423 FIN 302 Exam IFM Anything else? Cryptocurrency? Options Trading? nabilah@umich.edu