Government Bonds with Negative Yield?


I just read this

I quoted the whole news:

Britain sold a government bond that pays a negative yield for the first time on Wednesday – meaning that Britain’s government is effectively being paid to borrow as investors agreed to be paid back slightly less than they lent.

The bond, which matures in July 2023, sold at an average yield of -0.003%.

While investors will receive an annual interest payment of 0.75%, they paid above face value for the bond so the actual return in cash terms is less than they have lent.

Demand for the bond was low by recent standards, with investors bidding for just over twice the £ 3.75 billion (US$ 4.59 billion) on offer.

The last time a bid-to-cover ratio was below Wednesday’s 2.15 was on March 19, before the BoE announced it would buy an extra 200 billion pounds of assets, mostly government bonds, to support the economy through the coronavirus crisis.

This is interesting news, though it is not really coming as a big surprise.

What does it mean?

It means that UK government bonds carry coupon rate lower than the at-that-time-issued market interest rate, resulting to the market value of that bonds higher than its face value. Let’s say, the face value of that bonds is USD 100, then the investor is willing to buy that bonds at USD 103. In other words, the investor has purchased that bonds at premium.

Under normal condition, coupon rate of bonds will be set at the same rate of that market rate at the time of bonds issuance, giving rise to face value of bonds = market value of bonds.

The big fat question is why the investor is willing to pay the bonds higher than its face value?

Looking forward, the investor might predict that the UK demand in the future will be lower, putting the market interest rate declining in the long term. It might indicate that the demand will not that be strong in the economy, and the economy might be going to be weak. As the long-term interest rate is influenced by the demand vs supply, then from the investor’s perspective, he/she is willing to invest in government bonds with premium, expecting that the long-term interest market rate will be going down to that level lower than the bonds coupon rate.

How about Indonesia?

We need to look at the bonds market.

Source: (accessed on 21 May 2020)

Why we need to keep an eye on the bond market, regardless you invest in stock market or real estate.

As we learnt from macroeconomic class, interest rate is the mother of economy. In the bonds market we could find the bonds yield, and as you probably already knew, the interest rates and bonds yields are highly correlated  (though it doesn’t mean that it always move perfectly in step), and oftentimes, even both terms are used interchangebly.

This is why it is so important for the investor to always look to bonds market, as interest is one of the leading economic indicators and bonds market could be considered as a great “predictor” of future economic activity and expected future levels of inflation. Both interest and inflation, as we know, had, is and will always directly affect the price of everything in the economy, running from capital market, real estate market, and domestic household demand.

Back to the bonds yield pattern above, for Indonesia, it is still displaying normal curve, which have expected long-term rate higher than short-term rate. While short-term rate is more driven by the announcement by the Central Bank, yet the long-term rate reflects the market forces, supply vs demand and the underlying expectation. This “expectation” is one key element in the determination of the long-term interest rates that is largely a function of the effect the bond market players believes current short-term interest rates will have on future levels of inflation.

Guided by this bond yields with its a normal yield curve which starts with low yields for lower maturity bonds and then increases for bonds with higher maturity, then the market players foresee that Indonesia demand will still be strong, including its inflation being high in the long-term eyes. To me, this makes economic sense, in view of the large population that Indonesia have.

I’ll give you simple math to see this.

Currently, Indonesia has around 267 million population (with 133 mio of working people). Assuming we take a very floor assumption, which one people will spend around Rp 25,000 per day only for basic needs such as rice, sugar, salt, vegetables, cigarette, coffee, etc.

Then the “real” money flowing will be :

267 mio (I rounded it up to 270 mio for convenience) x Rp 25,000/ day x 365 days = Rp 2,500 Trillion.


This Rp 2,500 Trillion is only for the scenario for the basic needs consumption.

So readers, you could see the real domestic consumption strength in Indonesia, which in statistic, this massive and gigantic domestic demand have support Indonesia GDP growth more than 50% for years. I believe, this carries explicit confidence in the economy growth in Indonesia.

We need to be able to keep our eyes on the forest and not confused by the trees in between.

Though not really apple-to-apple comparison, yet I always remember that in early 2000s when the internet bubble burst out, what we saw it was the financial bubble that burst, but not the internet market. Internet market even continued to make its growth dramatically after that explosive bubbles. Which reminds me that it is always important to see what is going on in substance. With all this covid-19 pandemic outbreak and its short-term shock to Indonesia economy, Indonesia economy will still be there for 270 million people.

Jakarta, 21 May 2020

Reading: (accessed on 22 May 2020)

#StayAtHome Financial Modelling (2) Model


From getting a brief introduction to get a head-start on building a financial model, then you’re gonna said “What is NEXT”?

I will say, it depends…

Depends on What?

Depends on what models you are going to build, of course.

In practice, there are at least 6 (six) models that we could cover when we are talking about financial model:

  1. Corporate Model.
  2. Project Finance Model
  3. Acquisition or Leveraged Buyout Model
  4. Merger Model
  5. Financial Institution Model
  6. Real Estate Model

Here I would like to touch on Corporate Model vs Project Finance Model.

Cut to the chase, Corporate Model will involve the company that have a history and as like many corporation, they have longer life, and in many cases, the modeler, will build into the assumption, that that company (and business) could last indefinite (Note> INDEFINITE doesn’t have the same meaning as that INFINITE. Please use your online dictionary to find out the big difference of that two terms.)

Since we have assumed away that that company could last into indefinite years, then it will be much efficient, that we reflect that value of indefinite business into one figure, called or termed as Terminal Value. We could put whatever figures we want into this Terminal Value, as long as we can sell this idea to the investor or reader. For example, the question what does that Terminal Value mean?

We might assume:

The Company being sold (or purchased) = Terminal [Cash/Share Swap] Value

The Company being liquidated (or gone into bankruptcy) = Disposal/Scrap Value

The Company being merged with other company = Selling [Share Swap/Non-Cash] Value

The Company being there forever = Continuing Value

The Company being….. = Horizon Value (I put Horizon Value since I don’t know what term I need to put here…, can we put Probable  or even Future Value, since we have no idea what will happen in the future? Anything could happen.]

You could add your version yourself, but one thing to bear in mind, that you need to check the ROIC, ROE and ROA figures at that point of “Terminal” year as making economic sense. If they are too high…then it could indicate that that year should not be the “terminal” year. How long and how low can it go, then? Some finance scholars and practitioners might say that that ROIC might be not too far to cost of capital in the long-run. Is this correct? What do you think?

Check as well the working capital growth and the capital expenditures level at that point of “terminal value”. Again, remember the adage saying that it takes MONEY to make MONEY. So it will certainly take certain level for the working capital and capex level to sustain high valuation at Terminal Value.

If you believe in the Myron J. Gordon Growth formula for calculating Terminal Value = FCF_t (1+g)/(WACC-g), then be noted, that we could have a wide range of terminal value, just by changing the growth rate (g) and the WACC (cost of capital), two variables that are the most difficult to assess in many valuations, terminal growth rate and terminal cost of capital.

When setting the terminal growth rate, instead of focusing on how much we want to put the % for that rate, I guess, the more important to think is, what spurs that rate. High terminal growth rate will for sure require more capital expenditures to invest in that later years. How much is the growth rate for the capex? You should remember, that it takes Money (and some moderate grain of risk) to make Money. Without this engine, the “imaginary” high growth rate will come to a screetching halt.

Ok, we go back: it means we need a (detailed) forecast of EBITDA and then Cash Flows for the indefinite life of the company.

The key outputs of this Corporate Model is Earnings per Share (EPS), Return on Investments (ROI), and don’t forget your shareholders, which means we need as well ROE (Return on Equity). Making Shareholder’s happy should be your first and foremost goal! They love it when you put something about the measurement of the performance of the management of the company…..but they will be happier if you remember their money being invested into that company, and this will drag you to put ROE always in your model. The shareholders want to know whether their money invested will return return (2 Returns) that high enough to justify finance sense to put their money in that corporation business, compared to being put in the other investments, such as deposit, stock, bonds, etc. (equivalent investment with comparable risk and period.)

Corporate Model indicates explicitly that the search is for the Shareholder Value, which view is ubiquitous in many corporate finance textbook, and its term was first coming from Alfred Rappaport, a business school professor. However, as a side note, in 2019, 181 US Top CEOs signed a one-page declaration, which that ended as follows: “Each of our stakeholders is essential. We commit to deliver value to all of them, for the future success of our companies, our communities and our country.” ( The idea about 3Ps, Profit, People and Planet, or also know as “Triple Bottom Line” has increasingly been getting into the mainstream.

What do you think about Triple Bottom Line? Or is it Impossibility Trinity? Feel free to share your opinion.

However, for the time being, the Corporate Model will talk only the first P, that is Profit. And……it is a general’s command: return cash (dividends) to shareholders when there are no credible value-creating opportunities to invest in the business, earning return higher than its costs. This general’s command is something that we should put at the back of the mind even though the Corporate Model itself will drive the dividends modelling using sort of dividend payout ratio or policy (which again, this is a discretionary decision).

Another thing that I would like to mention is Return on Investment (ROI). Though this ROI sounds very familiar to many people, even from their university time, yet in practice, the way ROI is defined, might be quite different. I found there are so many abbreviations for such way to measure the productivity of capital, to relate profit to invested capital, or cash flow to spending, and to quantify the rate of return earned before or after getting the investors’ money back.

ROIC = Return on “all” Invested Capital,

ROCE = Return on Capital Employed vs Return on Common Shareholders’ Equity

RONIC = Return on New or Incremental Invested Capital

ROA = Return on Assets (and RONA = Return on “Net” Assets or ROC = Return on Capital)

Generally speaking, the rate of return on capital employed (interest-bearing debt + common shareholders’ equity  falls between ROA and ROE)

And the most confusing is the way that for what we put for the numerator and denominator to calculate all the above. For numerator, some put net income, net income before interest expense (net of tax savings) on long-debt, etc. etc.

If you ask my suggestion, if you found such ROI, etc above, the very question you need to look at : ASKING and CHECKING how that ratio is calculated. Moreover, CONSISTENCY in calculation is crucial as well. For example, if we compare Net Income to total Debt and Equity, then I don’t think this is correct. Logically, net income is the residual income after the interest expense is deducted, and then this should only relate to Equity and not to the sum of total Debt and total Equity.

Another people,  instead of using end-of-month or end-of-year balance for Investment, Debt or Equity, will use the average of two period ends. I have no idea which one is correct.

I can’t say which one is correct from all above calculation for ROI. Each author have his/her own argument to defend : McKinsey, finance professor, finance practitioners.

Again, CHECK and always put your feet on the ground. If the number seems too good to be true, then it might be that so. Meaning it is not true.

If you feel the way is calculated, make you confused, probably that’s the intention. Albert Einstein once said:

If You Can’t Explain it to a Six Year OldYou Don’t Understand it Yourself”

My tip, if you see somebody gave you ROI, then back asking him/her, which one you are talking about, left-hand of the balance sheet or right-hand of the balance sheet, as depicted below:

Source: Corporate Finance : Theory and Practice by Pascal Quiry, Maurizio Dallocchio, Yann Le Fur and Antonio Salvi. Fifth Edition. 2018. Page 46.

If he/she can’t really tell you..then better to leave him/her.

Pls keep in mind that:

  • ROA measures the profitability of operations before considering the effects of financing. It will make sense to use ROA if what we are interested in, is the profitability and the efficiency of the firm’s core operations or its operating assets.
  • When somebody is talking about Returns (since Returns matters!) or cash flows, then you need to ask first, returns to whom? To the Firm or to the Capital providers? There is a big difference between this. For example, when we read the Statement of Cash Flows of the Company, then that’s the net cash flowing into or out of the Company.

How about ROE, which is one single ratio that represents the shareholder’s wallet. Well, as the manager of the company, then it is one of his/her job to maximize this ROE, in other words, to maximize the shareholder’s [market] value in the company.

My caveat to you, don’t be too impressed on ROE.

One of many issues with ROE, is in ROE, we can’t find risk element. Again, as you probably already new, RETURNS and RISKS is two sides of the SAME COIN. Under Modern Portfolio Theory, the shareholders do not only concern or care about the RETURNS but also, of course, the RISK.

Another shortcomings, in ROE, we don’t see the second crucial element to consider in all investment performance, that is the SIZE of the investments. In another color, how much money is invested by the shareholders to earn that ROE. Higher ROE, let’s say 50% of US$ 1 mio versus Lower ROE of 25% of US$ 10 mio: Which one you are going to pick up?

Shareholder’s [market] value will always involve the talk about the RETURN, the RISK and the SIZE of the “skin in the game” (read: money put on the table).

G. Bennett Stewart, III in his book “Best-Practice EVA: The Definitive Guide to Measuring and Maximizing Shareholder Value” (John Wiley & Sons, 2013), wrote (p. 86) about what’s wrong with RONA (= ROE)?

RONA and the other conventional return metrics are highly misleading and incomplete performance indicators, for reasons I will explain. And the deficiencies are far from academic. As you will see, companies that have aimed to increase RONA or maintain a high RONA have committed major blunders in strategy and resource allocation. And when RONA is judged
from the bird’s-eye view of how well it performs as an element in a firm’s. overall management system, it fails, or at least it is far inferior to EVA, as I have been saying and will continue to elaborate.

RONA fundamentally fails because it is inconsistent with what is—or should be—the main mission of every firm, which is to maximize the wealth of its owners. It is to maximize the difference between the capital that investors have put or left in the business and the present value of the cash flow that can be taken out of it. In short, the goal is to maximize MVA by maximizing the stream of EVA, as I have said.

Here’s the problem in a nutshell. RONA tells us about the ratio of market value to invested capital, but that is not the same thing as maximizing the spread between market value and invested capital, which is the true goal. A company that aims to maximize RONA will always tend to hold back and underinvest, underinnovate, underscale, and undergrow. It will leave value
and growth on the table, and become vulnerable to a hostile takeover or a toppling by upstart rivals.

I gather that now you are more skeptical about reading high or low ROE.

Always remember:

We can’t buy something using high or low ratio. Instead, it is the difference or the gap between the amount you invested and the amount you get back!

I gather, now we keep going.

Then, we move talking about Project Finance Model.

You said, the finance books that I had back in my finance class, all have title “Principles/Fundamentals/Essentials of Corporate Finance” or “Managerial Finance”, none of them have a title of Project Finance.

I hope you still remember that one of the chapters or sections in many Corporate Finance textbooks, they are talking about Capital Budgeting technique and how to apply that. Some techniques, such as IRR is useful when the model we build is about Project Finance Model.

The Project Finance model is being used to evaluate a project or investment that :

  • have no history of cash flows at all
  • the project have lifetime (like a human, there is a birth date and death date)

As a background for the popularity of Project Finance model, is, in many developing countries, government partners with private sectors to build infrastructures such as roads, hospitals, power plants, etc. Most of those projects are analyzed or financial-model built on project finance concepts.

We can’t bring corporate finance concept into project finance model, since the creditors cannot stand on assets-in-place (since there is no historical balance sheet at all to stand on) to seek remedy. And the risk is so big, considering no history of cash flows at all and no historical balance sheet to stand on in case the project fails),  then risk sharing is the key to this project success.

Accordingly, the project finance model should focus on two things:

(i) Cash flows flowing to lenders

(ii) Cash flows flowing to equity holders and/or sponsors

Those two cash flows are so important to model, as all cash flows generated by the project itself during the entire lifetime of the project will ALL distributed to lenders, equity holders, sponsors, and not be re-invested to the company (the latter is for Corporate Model). Accordingly, key outputs of Project Finance model will be the Project IRR (pre and post tax), and Equity IRR. Again, the latter is to let the shareholders know that you are thinking about their pocket ultimately.


a) If there is pre-tax IRR in the Project Finance model, how about in the Corporate Model? Do we have pre-tax ROI?

Answer: Pre-tax ROI? What I could say, the ratio of EBITDA to Investment (net working capital and net fixed assets) could represent pre-tax ROI. Though this might raise a bit question, since EBITDA is computed BEFORE DEPRECIATION, and when it comes to “Return”, it should be calculated AFTER DEPRECIATION. Nonetheless, EBITDA/Net Investment is commonly being used in the assessment of the Corporate Model.

b) Why do we need to come up with Pre-Tax IRR in the Project Finance model? How about if the resulting Pre-Tax IRR is lower than the market interest rate? How about if the resulting Pre-tax IRR looks higher than the cost of capital? What does it implicate something to you?

Prof. Peter DeMarzo’s comment:

Yes, the lack of collateral can diminish the opportunity for credit.  But indeed, this is not so different from many projects in the corporate sector, if the main assets are in the form of human capital. From the perspective of the cost of capital, again the main driver should be the beta of the project cash flows.   An additional risk may be that of expropriation, which is more likely in bad times.  This expropriation risk would raise the beta. What other factors do you see?

Karnen again:

I believe many project finance assets are not in the human capital. One of the common characterictic of many project finance, they are marked with low tech risks and mostly dealing with predictable market, so having heavy project physical assets still make reasonable finance sense.

About project risks..beta I don’ t think it could reflect all risks being involved in project finance. As I put before, project finance doesn’t depend on soundness and profitability of the company. Mostly will deal with totally new venture. So the soundness and profitability of the venture itself is the main critical factors.

Project finance in most cases will involve very large scale to the company’s current size, sheer higher risk compared to “average” risk that beta could capture, and have potential contamination risk. In view of these risks, project finance will carefully identify the risk during each phase of the project, such as during development phase, construction, completion, operations and maintenance, etc, then allocate that respective risk to the party that could handle that risk the most efficient and effective. This is why we see so many parties being parts to the Project Finance agreement.

This all brings to ascertain the project has low supply risk, low commercial risk as all output will be taken by a single offtaker or a few large buyer or products being consumed by general public, secured long-term concession (sometimes plus monopoly right being awarded), etc.

One classic paper to read is written by Brealey, Cooper and Habib “Using project finance to fund infrastructure investments” Journal of Applied Finance 9 (1996).

Project Finance in many fronts are quite different from Corporate Model, for example, there are different phases over the life of the a project (remember, a project have a date of birth and date of death), they are:

  • development phase
  • construction phase
  • operation phase
  • debt repayment phase
  • debt refinancing phase

The aforementioned different phases will involve different risks to handle, and WHEN THE RISKS CHANGES, THEN THE VALUE WILL CHANGE AS WELL.

From the eyes of the equity contributor, then he key output of Project Finance is Internal Rate of Returns to equity holders, which will mean that this IRR will be calculated from the project cash flows AFTER all debts and its interest have been serviced and paid to the debtholders. Which mean, at the end of the day, all cash flows generated by the project will flow to the last penny to all the contributors to the projects. Since IRR to equity holders are coming AFTER the debt servicing, then this resulting figure (good or bad, or as expected) will be flowing from the PROFIT AND LOSS PERFORMANCE (summarized in the Profit and Loss Statement), then CASH FLOW STATEMENT. Modelling through all these statements, the modeler could see that the following factors will play a role in determining the equity IRR for Project Finance model:

  • the financing size. This first factor is not quite surprising knowing that all project finance is all about funding big fat question, that is how to finance such sizeable project.
  • Once the financing size is answered, then it comes to ABC and the loan tenor. What is ABC? ABC is talking about the Debt repayment, how the project will pay back the loan : “A” Amortising Debt, “B” Bullet Repayment of Debt, and “C” Loan with Interest Capitalized. Here is about the TIMING of the repayment of the debt. Bullet Repayment as it puts there “Bullet”, it means the debt will be paid in one time at the end of the debt term or tenor (this is why possibly the term is called “Bullet” = Bullet to the Head if you don’t pay!), or the pattern of debt principal repayment is akin to the bullet form, so some portion of the debt amount is paid along the duration of the loan.

As you probably know that IRR magnitude is very sensitive to (i) the pattern of the cash flows and (ii) the duration of the project cash flows. This is why IRR is called “INTERNAL”, the calculation of IRR doesn’t need external elements, all it needs is just the CASH FLOWS and the TERM of the Cash Flows. We don’t need even the Discount Rate or COST OF CAPITAL (from market).

You might say, oke, you’re covering the equity IRR. How about the debt contributor? They might take risk as well in the project.

From the perspective of the debt contributor, then the big fat question is always, whether:

  • Can I  get back my debt principal (Return OF debt)?
  • Can I get back my debt interest (Return ON debt)?

So the lender in this case will be quite prudent to see whether the project cash flow has sufficient BUFFER ABOVE the debt service obligations, and here, we are talking about DEBT SERVICE COVERAGE RATIO. You might call this “Margin of Safety”. The higher the DSCR, the more MOS that the lender have. DSCR = 1 will mean that all project cash flows are gone to service the debt and the interest. However, this is not prudent in case there is A SHOCK to the project cash flows, which means that the lender won’t get its repayment as scheduled.

The other factor that the lender would see is comparing the tenor of the debt vs the life of the project. If the project life is longer than debt tenor and could still generate cash flows, even after the forecasted debt repayment, then it means, the lender could have another MOS, in case the scheduled repayments do not happen as forecasted, and needs to come back to the project owner to negotiate for restructuring the loan. Here is called “Cash Flow Tail“. The longer the Cash Flow Tail period, then it is much better for the lender.

Some authors have outlined the difference between Corporate Financing and Project Financing as depicted below.

Source: (accessed on 31 May 2020)

Source: Project Finance in Theory and Practice : Designing, Structuring, and Financing Private and Public Projects (2nd edition) by Stefano Gatti. Page 4. 2013. Elsevier Inc.

However, I come to the point that Corporate Finance and Project Finance is an overlapped concept. Project Finance in its far end, like all those big infrastructure and energy projects, they are developing to different world on its own, so it is easy to forget that the concept is coming or shared the same way as that Corporate Finance in many aspects. Project Finance origin should be part of Corporate Finance, (as discussed originally in the capital budgeting sections of many books), but when that projects share no same characteristics as that the average projects that the company has run before, in terms of returns, risk, phase, etc…then this needs parties and partners to share the risk and return, I guess, this is where all the Project Finance books and training try to show us. Sharing risk and return is not something that we discuss at length under Corporate Finance, since the focus is on maximizing the shareholders’ value. Under Project Finance, we don’t always put too much emphasis on MAX shareholders’ value, though we use all the capital project evaluation concepts from CF, such as IRR, NPV, etc.

Respondent to Karnen (10 June 2020):

Corporations are portfolios of projects and the ultimate ROIC should be the aggregate of project IRR’s (with big problems of reinvestment etc.).  Similarly the ROE should correspond to equity IRR’s.


#StayAtHome Financial Modelling (3) William F. Sharpe : It’s Dangerous to Think of Risk as a Number


During this Covid-19 outbreak, what Bill Sharpe, the father of CAPM (pronounced: CAP-EM) and the receiver of the Nobel Prize in Economics in 1990, said in the title above, keeps ringing in my head.

I believe what he said is so true. Though mathematically, pretty much, we could model the risk, but the big fat question, does it work? This Covid-19 case is one of the good example.

When we build our financial modelling for the next 3-5 years (personally, I think even after 3 years, nobody could really have a good crystal clear idea about what will happen). Of course, human will still exist, but what happen to environment, economy, politics, etc…I guess, all we have just a good GUESS-ing. Even for some companies, near-term is the only agenda item they’re concerned about and the rest might be read as peering through the fog of uncertainty.

Normally, we have many cases or scenarios we put into our financial model, in general:

  • Corporate scenario or base scenario
  • Sunny or good scenario
  • Bad or worst scenario

Then where is the Covid-19 scenario?

I did remember one book written by Enrique R. Arzac with the title : Valuation : Mergers, Buyouts and Restructuring (2nd Edition) which he said that it is necessary that in the valuation, we need to do some stress test by assuming the revenue is BIG ZERO.

When I read that a couple of years ago, I didn’t really believe I would like to use that suggestion, and somehow I feel it was too extreme assumption to put into the financial model.

However, in one or two other books on financial modeling topics, the authors will suggest, that one of the testing of the integrity of the model is to assume away extreme figures, such as BIG ZERO REVENUES, and see whether there is something wrong in the model. I’ve never entertaining a thought when reading that such “model test” could actually be put as one of the scenarios to be built. But amidst this Covid-19 pandemic, all these suggestions are worthy noted and used somehow in the model. Good model should also take into factor extreme condition. How about if the company doesn’t have the revenue at all or revenue dropping off more than 50%. We could even say that Covid-19 is one of that “black swan” events. According to Nassim Nicholas Taleb in its beautifully-written book The Black Swan, The Impact of the Highly Improbable, a black swan is a highly improbable event with three principal characteristics: (i) It is unpredictable; (ii) it carries a massive impact; and, (iii) after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was. The question, can we put the impact of the highly improbable into the Model?

By the way, talking about risk and CAPM, the insight I got is not all risks that other people is willing to pay. For example, if you are crossing the busy street recklessly, then I don’t think there is somebody that wants to pay you for taking that risk. In CAPM world, only systematic risks that deserve a (expected) return to ask. Can we call this systematic risk a real risk that an investor is willing to pay?

Another thing to look at investment that give us a payoffs in bad times (for example, during this Covid-19 pandemic) then, logically , it should be valued more higher or more expensive. Since we need to pay more expensive, then it means we are willing to accept the lower expected return compared to investment that will give us payoffs in good times.

My simple question to you:

Loosing US$1,000 when you are in bad financial condition vs Gaining US$1,000 when you are in good financial condition, IS NOT THE SAME, though the money is the same, that is US$1,000.

Loosing US$1,000 when the money is scarce, is a lot painful, and we might call this ‘REAL RISK’.

CAPM is built under Markowitz Modern Portfolio Theory and its main engine is diversification, which will wash away all firm-specific risks, and such risk will not be priced into the expected returns for common equity. Only the risk that can’t be diversified then that investor or shareholders are willing to pay. However, this same rationale could not be brought into the case where the securities have limited upside potential and greater downside potential arising from firm-specific risks. For example, securities such as bonds issued by the company. If the bond issuer is doing well, then the bondholders will only be limited to receive the promised principal and interest coupons. However, if the company is doing bad, then the bondholders might not receive the payments of principal and/or interest coupon as promised. It might be in lesser amount or even part of all principals are never recovered. So for such investment, mean-variance framework will not work.


#StayatHOme #SavetheWorld

I guess, this is new reality

in the future, contact-free economy will be more preferred

as Covid-19 probably might come again in different form

meaning that face-to-face meeting will be reduced

yes, life will change to new reality

people now comes to higher awareness that interfacing with other humans exposed him/herself to undetected risk

I am glad to be honest

Covid-19 happens after we are in the internet world

can’t imagine if this came prior to 1990s

life will be much difficult

so we don’t have total shutdown, but we are able to flatten out the curve

to buy time

to get the vaccine coming

I hope all people have that patience (lots of that)

in the future, which is not too distant

sure…human is the most complex organism…

that has been survived for thousands of years…

yeah…i hope human learnt something of value from this Covid outbreak

we can’t exploit nature too much..

balance is the key

somehow I feel, this is God’s way to bring us back to basic stuffs


give break to nature

and room to breathe again

I watched one video, dolphin back to one of Turkey river

usually it is a crowded river with many ships back and forth

but since the lockdown

dolphine back again swimming


I believe we don’t need so much to take from nature

all this consumerism world is crazy

how many dresses we need

how much food we need to eat

how much oil we need

how much..

how much..

never enough

we burn everything off

we need to give room to the nature
we can’t occupy every inch of this earth

we don’t need that

we need to define the new “enough” to this new generation

we need to define new stuff for whatever it is meant to be rich

to be successful

do we need to beat up earnings forecast every quarter?

do we need to kill so many animals to satisfy our hungry to being a man

at the end, we don’t even bring anything out from this earth

just a gravestone and a memory 

at the end

#StayAtHome Financial Modelling in the Mind

Tanous: I was an economics major at Georgetown. In my first economics class as a freshman, our professor, Dr. Gunther Ruff, asked the students why they were taking the course. I said, because I thought I might learn how to make money.

He said, “My dear fellow, I have a Ph.D. in economics, and if I knew how to make money, I wouldn’t be here.”

(quoted from an interview with Merton Miller — this is the second M in the MM Nobel Laureate — Peter J. Tanous, Investment Gurus, 1997, page 191)


Sometimes I got questions asking about when we are going to build a financial model, then what we need to do first.

You are given a blank spreadsheet (sounds familiar, right?) and then what is NEXT?

On your desk, you got heaps of the company’s financial statements, let’s say for the past 5 years.

The assignment from your boss is build the financial model to see how much is the estimated value of the Company.

You’re scratching your head and thinking hard and fast what is the first line to build and need to get prepared with sound answer in the case your boss is asking you WHY.

Ok, time is ticking away.

You are surfing the internet and find the website : with many articles inside that website but still you feel a bit anxious about what TO GET STARTED on your blank spreadsheet.

You sent email to Karnen, and he replied:

Please refer to the paper of 1958 and EBITDA (Earnings Before Interest Tax Depreciation and Amortization (or EBDAIT if we follow the sequence of those items shown in the Statement of Profit and Loss).

You stopped and can’t believe what you’re reading: what the h**ck the paper of 1958 is to do with the Financial Modelling? EBITDA, yeah,,, I heard that before and I know what’s is that…the earnings power of the company, taking out the financial structure of the company (you feel a bit puffed up).

Ok, then I am asking you, are you coming from Finance class?

and you answered, yes, I was coming from Finance class, but that’s probably 10-15 years ago. If I can’t remember the title of the finance book, then how come you expect me to remember the 1958 paper. You might be pulling my feet away!

Oke..oke…let’s me clarify that.

1958 is the year, when the two economists on Carnegie Tech’s Business School faculty, published their seminal and momentous paper: The Cost of Capital, Corporate Finance and the Theory of Investments (American Economic Review, June 1958, page 261-297). They are (i) Franco Modigliani, an Italia who after emigrating to the United States in 1939 studied with another giant economist, Jacob Marschak; and (ii) Merton Miller, a Ph.D from Johns Hopskins.

You should read this paper, I said, especially the title has mentioned “…theory…” word. I like it when the paper puts this “theory” word, which means, there is something beyond a mix of common sense, judgment, and tradition in finance world.

What comes up from that 1958 paper is the idea that it is super essential in any financial model that we should begin with EBITDA then evaluate what is needed to generate EBITDA before paying money to investors.

Two Giant Nobel Laureate, MM, with its 1958 paper is one of the most well-known paper in the world of Corporate Finance. They both could prove, that under given assumptions that are *):

  1. Securities issued by companies are traded in a perfect capital market, in which this is a frictionless market with no transaction costs and no barriers to the free flow of information.
  2. There are no taxes.
  3. Companies and individuals can borrow at the same rate of interest.
  4. There are no costs associated with the liquidation of a company,


This will in effect implicate that changing a company’s debt-equity ratio will change the way in which its NET OPERATING CASH FLOWS are divided between debtholders and shareholders, but it WILL NOT change the value of the Cash Flows.

That’s MM First Proposition or theorem, which is a law of CONSERVATION OF VALUE.  This law states that the value of an asset remains the same, regardless of how the net operating cash flows generated by the asset are divided between different classes of investors. The second MM proposition will talk about the NATURAL CONSERVATION OF RISK. So Value and Risk is like two sides of the same coin.

In another color to say, it is V_unlevered  = V_levered

Got it?

To give you a brief sense of HISTORY, the idea about the conservation of value could be traced back to 1938 book by another GREAT MINDs, John Burr Williams, in his pathbreaking book, The Theory of Investment Value. Another book with “Theory” word….

He said

If the investment value of an enterprise as a whole is by definition the present worth of all its future distributions to security holders, whether on interest or dividend account, then this value in no wise depends on what the company’s capitalization is. Clearly if a single individual or a single institutional investor owned all the bonds, stocks, and warrants issued by a corporation, it would not matter to this investor what the company’s capitalization was. Any earnings collected as interest could not be collected as dividends. To such an individual it would be perfectly obvious that total interest- and dividend-paying power was in now wise dependent on the kind of
securities issued to the company’s owner. Furthermore, no change in the investment value of the enterprise as a whole would result from a change in its capitalization. Bonds could be retired with stock issues, or two classes of junior securities (i.e., common stock and warrants) could be combined into one, without changing the investment value of the company as a whole. Such constancy of investment value is analogous to the indestructibility of matter or energy; it leads us to
speak of the Law of Conservation of Investment Value, just as physicists speak of the Law of the Conservation of Matter, or the Law of Conservation of Energy.

It is wonderful, isn’t it? 1938 paper and 1958 paper.


If you are accountant, then let me wear first my accountant’s head to brief this:

Thus proposition 1 of MM Theorem tells us that  Firm value is determined on the left-hand side of the balance sheet by real assets—not by the proportions of debt and equity
securities issued to buy the assets.

Ok, Ok, I got it, why we need to start with the EBITDA. But you said and kept saying about Cash Flows…. So how to get there?

Before, I am jumping to that, I need to make sure I could nail this EBITDA down to you.

It is super essential that you look into what components behind generating EBITDA. In other words, the KEY MAIN DRIVERS. EBITDA is something that you could see and even distribute it. You need to put your feet on the ground, and in the real world of corporate life, it is PRICES, DEMAND, CAPACITY and UTILIZATION (in the company and within the industry), OPERATING COST STRUCTURE (fixed cost and variable costs), etc. etc. Get your late-night homework done on analysing all of these. The whole purpose of breaking EBITDA to its main key drivers is to ensure that the project being analyzed is not just a black box, which what we are doing is just pickup whatever assumptions make sense, then build cash-flow forecasts, assess the risk, choose the discount rate and come up with the result (value, NPV, whatever it is). What could go wrong (it will be in reality) should be part of all this exercise!

I gather you are ready to move to the second stair, once you have a good grip on EBITDA, (while you pray) move your feet to CAPITAL EXPENDITURE. EBITDA will not be there unless you burn something. IT TAKES MONEY TO MAKE MONEY, another 2 MMs here. Hope you’ve never forgotten this. Capital expenditure, both new and maintenance, will be essential to keep the EBITDA churning as expected and forecasted.

Two last but certainly not least, is the (i) TAX…Taxes should be paid before any money is paid to investors. Don’t ever forget it. Benjamin Franklin said only certain in life: death and TAXES (Note: Did he ask the company to pay tax?), and .(ii) WORKING CAPITAL change to adjust the EBITDA to CASH FLOW level. The end is what financial gurus coined it “Free Cash Flow”. If you are not happy with the word “Free” seems you know in life, there is no such called “free” then, you might just put “FCF” and you could interpret the first “F” with whatever you want it. Funny Cash Flow, Flowing Cash Flow, Forecast Cash Flow…

I don’t care about what is your interpretation of the FCF, but in essence, it is UNLEVERED CASH FLOW which will determine under a rational and perfect economic environment, the stock prices will be ultimately determined solely by REAL stuffs, in this case, in the MM world, the EARNINGS POWER OF the company’s assets and its investment policy. and NOT by how the the Company got its money to finance it (either by issuing bonds, selling shares, or reinvesting earnings), or even how the fruits of those earnings power are packaged for distributions.

The great thing about MM Theorem, which Professor James Lorie from University of Chicago said jokingly to his students in the 1970s, “is that NOTHING REALLY MATTERS” (quoted from page 82 of the Myth of the Rational Market, by Justin Fox).

This stuck up to my head…nothing really matters.

I tried so hard
And got so far
But in the end
It doesn’t even matter
I had to fall
To lose it all
But in the end
It doesn’t even matter

(Linkin Park)

Super-separating Investment and Financing or Funding is important in building up your Financial Modelling to be more transparent and traceable..and easier to build. The key word : Divide and Conquer! From the Financial Model, the viewer could see clearly which assumptions and key drivers for Investment and which ones for Financing. Financing will only come later after you build the Investment section first. Again, the flow should follow the Waterfall concept. We trace first from where the magic revenue and money will be generated.

So you said, but having unpaid debt is what makes my night restless…..

For that, I don’t have the solution for you.

Though your banker said that debt analysis is very important to factor into the Financial Model or to many valuation modelling, yet the structure of virtually any financial model should follow the ideas of MM in that building a financial model should all start with WHAT THE COMPANY REALLY DOES AND THE FCF AVAILABLE TO THE INVESTORS.

I do hope you got my point. If not, then again, I can’t help you.

#WFH…Work From Home and From Heart!


1 May 2020

*) Note: you might say, geez……..these underlying assumptions are super restrictive and it is not even existent at all in the real world. Yet….I have something to argue back. It is the IMPLICATIONS of the theory that mattered, not the assumptions.

You might think what the implication it was that is so important to make MM awarded with prestigious Nobel.

I tell you what, you might heard this term before, it is called “arbitrage”.

As Marco Pagano put in his Working Paper No. 139 (2005), under the title “The Modigliani-Miller Theorems: A Cornerstone of Finance”:

The second reason for the seminal importance of MM is methodological: by relying on an arbitrage argument, they set a precedent not only within the realm of corporate finance but also (and even more importantly) within that of asset pricing.

In a footnote to its 1958 paper, Modigliani and Miller made references to J.B. Williams (1938), David Durand (1952), and W.A. Morton (1954) as precursors to the first of the M&M propositions. Modigliani distanced his theory from those of the above-mentioned forerunners. He wrote, “None of these writers describe in any detail the mechanism which is supposed to keep the average cost of capital Modigliani and Miller’s (M&M) Hypothesis  constant under changes in capital structure. They seem, however, to be valuing the equilibrating mechanism in terms of switches by investors between stocks and bonds as the yields get out of line with their ‘riskiness.’ This is an argument quite different from the pure arbitrage mechanism underlying our proof, and the difference is crucial.” (quoted from page 110 of the book “Franco Modigliani, A Mind that Never Rests, by Michael Szenberg and Lall Ramrattan. Palgrave MacMillan. 2008)

In the Corporate Finance textbook by Jonathan Berk and Peter DeMarzo from Stanford University (Fourth edition, Pearson, 2017, page 526), the author said MM and the Real World, quoted as follows:

Students often question why Modigliani and Miller’s results are important if, after all, capital markets are not perfect in the real world. While it is true that capital markets are not perfect, all scientific theories begin with a set of idealized assumptions from which conclusions can be drawn. When we apply the theory, we must then evaluate how closely the assumptions hold, and consider the consequences of any important deviations.

As a useful analogy, consider Galileo’s law of falling bodies. Galileo overturned the conventional wisdom by showing that, without friction, free-falling bodies will fall at the same rate independent of their mass. If you test this law, you will likely find it does not hold exactly. The reason, of course, is that unless we are in a vacuum, air friction tends to slow some objects more than others. MM’s results are similar. In practice, we will find that capital structure can have an effect on firm value. But just as Galileo’s law of falling bodies reveals that we must look to air friction, rather than any underlying property of gravity, to explain differences in the speeds of falling objects, MM’s proposition reveals that any effects of capital structure must similarly be due to frictions that exist in capital markets.