INVESTING TERMS
What are
SMALL
Treasury Inflation-Protected
Securities (TIPS) are
investments that are
indexed to protect against
inflation. These bonds are
backed by the U.S.
government and are considered extremely low-risk investments. Their par value, or face value, rises with inflation as measured by the consumer price index.
Deeper definition
At the most basic level, there are two kinds of stock: preferred and common. Preferred stock is rarer than common stock, generally comprising a small proportion of all shares. It’s often more expensive, and can come with a minimum purchase amount.
Treasury Inflation-Protected Securities (TIPS) example
This infographic was designed by Avalaunch Media
SMALL CAP?
Compared to other government and corporate securities, TIPS offer lower interest rates. While the bonds offer inflation protection, their usefulness decreases in periods
SHORT-TERM
CAPITAL GAINS
Profits made from selling assets owned for one year or less.
LONG-TERM
CAPITAL GAINS
Profits made from selling assets owned for more than one year.
Jeff bought a vacation home for $100,000 and used it as a rental property for five years before selling it for $150,000, giving him a capital gain of $50,000.
Since he owned the property for more than one year, he calculated his long-term capital gain based on his tax bracket.
Since his annual income placed him in the 15 percent tax bracket ($37,651 to $91,150 for a single person in 2016), he didn’t have to pay any taxes on the profit.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
EBITDA doesn’t need to be measured by the Securities and Exchange Commission’s accounting standards, the Generally Accepted Accounting Principles (GAAP), so it is not a required line item on a company’s financial statement. EBITDA has become much more common in recent years, although many firms list an adjusted EBITDA figure.
For example, if you buy a $10,000 bond with an interest rate of 2 percent but inflation equals 3 percent that year, the face value of the bond will be increased by $300 to $10,300 and the 2 percent interest rate will be applied to the new face value.
Before the proliferation of
inexpensive computer
technology, it had been very
difficult to create and price
complicated derivative contracts, but this problem was more or less solved by the 1990s, thanks also to the Black-Scholes equation. Mortgage-backed securities became very common investment products. Instead of using derivatives to effectively balance risk, institutional traders began buying them up as ways to create leverage and take on much more risk. When the U.S. housing market began to crumble in 2006 and 2007, MBS investments spread throughout the banking system began to rapidly lose value, precipitating the crisis.
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
When a company issues more shares, the price of an individual share falls. Anti-dilutive preferred stock allows investors to receive more shares of a stock than he original paid for in the event that his are worth less as a result of a dilution.
The measure can be calculated by taking a company’s net income and adding back interest expense, taxes, depreciation, and amortization. Alternatively, it can be calculated by taking a company’s operating profit — EBIT, or earnings before interest and taxes — and adding depreciation and amortization.
Susan opens a credit card with a $1,000 credit limit and an interest rate of 14.99.
She makes a purchase of $200.
Susan understands she will pay interest on the balance until she pays it off, but she decides to carry a revolving balance.
If Susan pays only the minimum payment of $20 per month, it will take her 11 months to pay off her balance.
If shares of Dynaco rise
above $150, the buyer of
the options wins and
Englebert is obligated to
sell 100 shares to the
holder for $150. But if they
never hit the strike price of $150, Englebert wins and gets to keep the $200 premium the buyer paid. If shares of Dynaco get closer to the strike price of $150, the buyer can resell the option and make a profit off his speculative bet, but if shares of Dynaco decline — widening the spread between the strike price and the underlying asset price — the price of the option falls.
$100 million
$2
$20 million
$10 million
– Minus
PRICE PER SHARE
EXPENSES
Equals =
$30 million
NET PROFIT
>$10B
Many fixed income investments come with inflation risk. As inflation increases, the value of the investment’s interest decreases. TIPS offer an effective way for income investors to eliminate inflation risk.
x
=
$10 Billion
PRICE/SHARE
MARKET CAP VALUE
NOT A LARGE CAP COMPANY
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A LARGE CAP COMPANY
=
63,000,000
$200
$12.6 Billion
Convertible preferred stock can be exchanged for common stock, but not vice versa.
Convertibility:
Anti-dilution:
when inflation is low or during periods of deflation. TIPS are issued with 5-, 10- and 30-year maturities. They can be purchased directly from the government via TreasuryDirect (part of the U.S. Department of Treasury), a bank or a broker.
The shareholder has the right to redeem her shares for a predetermined amount called a call price.
Callability:
TREASURY
INFLATION-PROTECTED
securities?
$300M–$2B
MARKET CAP
VALUE
OUTSTANDING SHARES
SHARE PRICE
OF THE STOCK
TIPS can be redeemed before or at their maturity date. TreasuryDirect requires a minimum 45-day period of ownership before redemption. While purchasing TIPS directly from TreasuryDirect is the least expensive, although the can be bought through mutual funds.
OUTSTANDING SHARES
PRICE/SHARE
MARKET CAP VALUE
A SMALL CAP COMPANY
=
30,000,000
$41
$1.23 Billion
The fixed interest rate on TIPS is paid every six months, and the inflation adjustment is made on a semiannual basis. The inflation adjustment is applied to the bond’s face value instead of the interest rate. This method protects the bond’s interest payment from inflation and also protects the bond’s face value.
The yearly profits from TIPS are considered taxable income by the IRS, even if the TIPS aren’t redeemed. Given the tax implications of TIPS investments, many investors purchase TIPS through mutual funds or deferred retirement accounts.
The S&P 500 index is part of the S&P Global 1200 family of indexes. Other members of the S&P Global 1200 family of indexes include the S&P MidCap 400, which measures the performance of stocks based on 400 midsize companies, and the S&P SmallCap 600, which measures stock performance based on 600 small companies.
