Math Archives – Page 2 of 5

April 21, 2021April 22, 2021

R is for ROI (Return on Investment)

ROI is overrated.

Return on Investment (ROI) is one of the most widely used financial ratios, like Earnings Per Share (EPS), Current Ratio (CR), or Debt to Equity (DE). These things grow like weeds, once fledgling MBAs get hold of an HP 12-C calculator. Soon every conversation gets sprinkled with acronyms. Then, executives try to apply financial ratios to everything, and anyone who objects that you can’t put a value on everything is told to take a hike.

Net Profit means after subtracting the Cost of the Investment. Graphic from investinganswers.com.

Not Entirely Useless

ROI can be a useful measure, especially in making choices. Suppose you have a portfolio–that’s investor slang for “bunch of different”–investments that you made of differing amounts. You want to know which one has grown the most consistently over the last five years. An ROI comparison makes the numbers comparable.

April 14, 2021April 15, 2021

L is for Liabilities

Why do people always make liabilities sound so complicated?

An online lesson making liabilities simpler. Photo from Youtube.

For example, *ahem* the semiannual interest payment for a five-year, $1,000 par-value bond with an annual 8% coupon is $40: ($1,000 x 0.08) / 2 = $80 / 2 = $40… or… if the bond was issued at a premium of $200, the semiannual amortization using the straight-line method is simply $20: ($200 / 5) / 2 = $40 / 2 = $20. Therefore, debit interest expense by $20 ($40 – $20), credit cash by $40 and debit premium on bonds payable by $20.

See? Nothin’ to it.

Easy for you to say.

Liabilities are complicated because people are forward-thinking. Humans do not live on cash flow alone. There must be accrual. And accruals are the stuff of science fiction because they suggest the future.

April 9, 2021April 10, 2021

H is for Hedge

“Greed is good,” trader and arbitrageur Ivan Boesky told our MBA class of 1984. He arrived with a stretch limo and an entourage, wearing a fur coat and an expensive Italian suit. He explained that his job was to find opportunities that others missed and that the trade-off in risk and reward was real. Those willing to accept more risk–the risk of losing money because a ship sinks or a drug fails–should get the bigger payout when the exotic cargo comes into port or the cure for disease proves successful.

The risk part is the problem. How can you minimize the risk and still receive high enough payouts to cover costs? Entourages aren’t cheap. One answer is a hedge fund.