One sealed document in the will, marked for Mike, was written in Braille. Mina's sons were furious. They questioned the lawyer, "Who is this Mike?"
The lawyer suggested. "Let's first see what message your mom has for the two of you. The first letter read, "To my older son, be a patient investor."
Everyone looked puzzled.
The second letter read: "To my younger son, be a smart investor. Also, there are three ways to protect your investments. One is convertible bonds, second is to sell call options and the third is to buy put options."
The second son remarked, "I don't understand any of this. I would say putting the money under the pillow is the safest."
The lawyer said, "Many countries have now experienced major corrections. They include India, US, Japan and Mexico. However patient or smart we are, we sometimes need to know how to protect our investments." The second son said. "Okay. Call Mike. The third letter is for him. We should know what is written in it. We still don't know to whom Mom left all her money."
The lawyer volunteered. "Mike was your paralysed mother's sole companion in the shelter home for the last five years. I will arrange to bring him over." Before Mike could open his document, the second son asked, "You spent a lot of time with my mother. You wouldn't know what a convertible bond is, would you?"
Mike, falling into the trap, said, "Yes. A company that needs to raise capital can either issue stocks or bonds to the public. Issuing stocks might bring in more cash to the company, but the stock price might get crushed. When the total number of shares outstanding is more, earnings per share may get lowered. Issuing bonds doesn't affect the total shares outstanding but the company is committed to paying higher interest every six months to attract investors, especially when the interest rates are rising throughout the world.
"To balance the stocks and bonds, when a company needs more cash for its business, it might issue convertible bonds. A convertible bond has all the protections that a regular bond offers, like security and guaranteed interest payments at the end of every six months. However, unlike regular bonds, its interest payment would not be much higher. Instead, it offers lower interest rate for the investment."
The first son, wanting to understand better, in case he did inherit Mina's fortune, verified, "So the big advantage of investing in a convertible bond is investors can opt for stocks any time in the future."
"Yes," said Mike. "A convertible bond, when issued, comes with a ratio for issuing stocks, called conversion ratio. For example, Archer-Daniels-Midland Co. (ADM) might want to raise more money by issuing convertible bonds in the ratio of 25:1. Thus, an investor buying bonds worth $1,000 would be issued 25 shares of ADM anytime the investor wants. So let us assume ADM is currently trading at $40 and in the next couple of months, it rises to $60. Now, the convertible bond owner can convert his bonds at this higher price, thus yielding an excellent return.
"Should the share price fall, the bond holder would still be receiving the interest payments and the principal amount at the end of maturity.
"One way of profiting from the surge in the stock market and lowering the risk is by buying convertible bonds instead of shares directly. But not all companies issue convertible bonds in the open market. Okay, can I leave now?"
The second son thought an opportunity to get free financial advice might be slipping away. "Mike," he said, "Let me buy you lunch... My mom mentioned to us that she loved talking finance with you , especially discussing call and put options. Is that right?"
"Yes sir," said Mike. "If you want to buy shares but still want to protect your investments in case of a major correction, then you can sell call options and buy put options. For example, Harley Davidson (HDI) is one of the undervalued companies in spite of reporting healthy returns recently. Naturally, the investors are going to like the company in the future. So, you want to buy 10,000 shares of Harley Davidson. At the same time you want to protect your investments in case of correction in the stock price. Thus, currently the stock is trading around $53. You can sell a call against the shares that you are holding. The $60 call for November 2006 is being sold at $1 right now. By selling the calls against the shares that you own, you make an instant profit of $10,000.
"By selling calls, you lose nothing. You make instant profits instantly without waiting for the share price to appreciate. But, if the share price goes above $60, then you are obliged to sell all the shares at $60. If you are content with decent profits and also want to protect your investments then the wise choice would be to sell calls that are due to expire in the next three to four months.
"If the share price doesn't go higher than $60 by November, then you can sell calls once again after the option expires by November third week. You can keep selling calls and make instant profits as long as you continue to hold the shares." Mike devoured his lunch and was in no hurry to open his share of whatever Mina left in her will. Mina's sons' wanted to know more about `put options.' Without beating around the bush they asked him.
Mike obliged, "As an investor, if you are neither interested in buying convertible bonds nor short profits, then the third alternate to protect your investments is to buy puts. Let us assume you got 10,000 shares of Bed Bath and Beyond (BBBY) at $35 and you are confident that the stock would never go below $35 as the stock's lowest price in the last two years was just $34.
"However, you still want to protect your investments in case the stock price goes below $35. Thus, the $35.50 puts for November 2006 is being sold for just $1. You can pay an extra $10,000 to buy 100 contracts for Bed Bath and Beyond puts for November at $32.50. In case the stock price appreciates, the value of puts that you bought would expire worthless. If it crashes, the value of puts would rise accordingly.
"Let us assume that the stock price got hammered to $20 by November. As a put holder, you would still make $12.50 for every share and that is equivalent to $125,000 and you would be still holding your shares. An equity investor has got plenty of options to protect his investments and still enjoy the profits." Finally, Mike opened the third letter. He read it through tears, "Mike. You and I have been through a lot at the shelter home. I am leaving my entire wealth to them. As for you, you were like my eyes to the world, for the last five years, keeping company when all I could do was just breathe. As my parting gift, I have donated my healthy eyes to you. With your newfound vision, I am sure you can conquer the world."
The lawyer looked at the gaping sons and said, "Your mother sure did put a positive spin on `eye for an eye'"
The lawyer suggested. "Let's first see what message your mom has for the two of you. The first letter read, "To my older son, be a patient investor."
Everyone looked puzzled.
The second letter read: "To my younger son, be a smart investor. Also, there are three ways to protect your investments. One is convertible bonds, second is to sell call options and the third is to buy put options."
The second son remarked, "I don't understand any of this. I would say putting the money under the pillow is the safest."
The lawyer said, "Many countries have now experienced major corrections. They include India, US, Japan and Mexico. However patient or smart we are, we sometimes need to know how to protect our investments." The second son said. "Okay. Call Mike. The third letter is for him. We should know what is written in it. We still don't know to whom Mom left all her money."
The lawyer volunteered. "Mike was your paralysed mother's sole companion in the shelter home for the last five years. I will arrange to bring him over." Before Mike could open his document, the second son asked, "You spent a lot of time with my mother. You wouldn't know what a convertible bond is, would you?"
Mike, falling into the trap, said, "Yes. A company that needs to raise capital can either issue stocks or bonds to the public. Issuing stocks might bring in more cash to the company, but the stock price might get crushed. When the total number of shares outstanding is more, earnings per share may get lowered. Issuing bonds doesn't affect the total shares outstanding but the company is committed to paying higher interest every six months to attract investors, especially when the interest rates are rising throughout the world.
"To balance the stocks and bonds, when a company needs more cash for its business, it might issue convertible bonds. A convertible bond has all the protections that a regular bond offers, like security and guaranteed interest payments at the end of every six months. However, unlike regular bonds, its interest payment would not be much higher. Instead, it offers lower interest rate for the investment."
The first son, wanting to understand better, in case he did inherit Mina's fortune, verified, "So the big advantage of investing in a convertible bond is investors can opt for stocks any time in the future."
"Yes," said Mike. "A convertible bond, when issued, comes with a ratio for issuing stocks, called conversion ratio. For example, Archer-Daniels-Midland Co. (ADM) might want to raise more money by issuing convertible bonds in the ratio of 25:1. Thus, an investor buying bonds worth $1,000 would be issued 25 shares of ADM anytime the investor wants. So let us assume ADM is currently trading at $40 and in the next couple of months, it rises to $60. Now, the convertible bond owner can convert his bonds at this higher price, thus yielding an excellent return.
"Should the share price fall, the bond holder would still be receiving the interest payments and the principal amount at the end of maturity.
"One way of profiting from the surge in the stock market and lowering the risk is by buying convertible bonds instead of shares directly. But not all companies issue convertible bonds in the open market. Okay, can I leave now?"
The second son thought an opportunity to get free financial advice might be slipping away. "Mike," he said, "Let me buy you lunch... My mom mentioned to us that she loved talking finance with you , especially discussing call and put options. Is that right?"
"Yes sir," said Mike. "If you want to buy shares but still want to protect your investments in case of a major correction, then you can sell call options and buy put options. For example, Harley Davidson (HDI) is one of the undervalued companies in spite of reporting healthy returns recently. Naturally, the investors are going to like the company in the future. So, you want to buy 10,000 shares of Harley Davidson. At the same time you want to protect your investments in case of correction in the stock price. Thus, currently the stock is trading around $53. You can sell a call against the shares that you are holding. The $60 call for November 2006 is being sold at $1 right now. By selling the calls against the shares that you own, you make an instant profit of $10,000.
"By selling calls, you lose nothing. You make instant profits instantly without waiting for the share price to appreciate. But, if the share price goes above $60, then you are obliged to sell all the shares at $60. If you are content with decent profits and also want to protect your investments then the wise choice would be to sell calls that are due to expire in the next three to four months.
"If the share price doesn't go higher than $60 by November, then you can sell calls once again after the option expires by November third week. You can keep selling calls and make instant profits as long as you continue to hold the shares." Mike devoured his lunch and was in no hurry to open his share of whatever Mina left in her will. Mina's sons' wanted to know more about `put options.' Without beating around the bush they asked him.
Mike obliged, "As an investor, if you are neither interested in buying convertible bonds nor short profits, then the third alternate to protect your investments is to buy puts. Let us assume you got 10,000 shares of Bed Bath and Beyond (BBBY) at $35 and you are confident that the stock would never go below $35 as the stock's lowest price in the last two years was just $34.
"However, you still want to protect your investments in case the stock price goes below $35. Thus, the $35.50 puts for November 2006 is being sold for just $1. You can pay an extra $10,000 to buy 100 contracts for Bed Bath and Beyond puts for November at $32.50. In case the stock price appreciates, the value of puts that you bought would expire worthless. If it crashes, the value of puts would rise accordingly.
"Let us assume that the stock price got hammered to $20 by November. As a put holder, you would still make $12.50 for every share and that is equivalent to $125,000 and you would be still holding your shares. An equity investor has got plenty of options to protect his investments and still enjoy the profits." Finally, Mike opened the third letter. He read it through tears, "Mike. You and I have been through a lot at the shelter home. I am leaving my entire wealth to them. As for you, you were like my eyes to the world, for the last five years, keeping company when all I could do was just breathe. As my parting gift, I have donated my healthy eyes to you. With your newfound vision, I am sure you can conquer the world."
The lawyer looked at the gaping sons and said, "Your mother sure did put a positive spin on `eye for an eye'"
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