12:00am, Astera, 3-Star Restaurant
"It's a pleasure to meet you" Jeremy said, the man across from the table.
I got up from my seat, I shook his hand, and covered it with my left hand while I gave him a warm smile.
"Ahhh the pleasure is all mine" I responded with a thick Nigerian accent, "I am eager to learn how the greatest financial capital of the world operates. Please, take a seat"
"Yes of course"
"What shall we order…." I stared at the menu. I genuinely didn't know what this meant. This was made from his memories not mine. "You are the native here, not me. What do you recommend my friend?"
"We can start with the chef's meal."
"That sounds splendid. Let's skip the chit-chat, tell me about finance"
Jeremy looked shocked, but he was prepared.
His eyes looked focused and I let out a slight smile.
Look I'm not going to bore you, he talked about options and stocks.
Actually, this is my journal. I can do whatever I want.
I am going to bore you!
I'm not going to recite word for word though. This isn't a textbook, where I recite all that financial knowledge for three hours. I can though!
Ohh!! I really want to!
I really really want to!
I really really really want to!
Mammon is usually the unfortunate recipient of all this knowledge whenever I'm mega drunk.
He's actually my best friend because he finds it interesting, even if he's drunk.
I'm lucky to have a friend like him.
That aside!
Let's do the summary of what he talked to me about.
Finance is the industry of efficient resource allocation through the use of promises.
Sounds difficult?
Don't worry, everyone sees it that way in the beginning.
He began with fixed income securities.
Let's say a company needs $100M to build a factory. The factory will generate $300M over the next thirty years. How does a company get $100M to build this factory?
That's the resource allocation problem. We solve it by selling promises.
Promises for $100M today, for a return of 2% per year for the next 10 years.
The promise is to pay $2M every year for 10 years, and in year 10 they'll be repaid $100M.
If we add it all up we can value the promise of $100M today for $120M in the future. The $20M is the compensation the banks require for taking that risk on you.
Let's assume that banks want to give you the lowest price possible. $120M in the future compensates in exchange for $100M today assumes that there is a 84% chance of you paying back your loans..
$120 * (84%) = $100.4
If the Banks gave out the same exact loans to a large number of people with the same risk level, then they'll be making the same exact amount of money if we calculate the possibility that a minority of them default and a majority of them pay the loans back!
We're finished with fixed-income securities!
Of course if you're familiar with the financial field you'll also know about the discount rate.
When the Banks give you $100M to build a factory, they're at the same time denying themselves from taking other investments at the same risk level. (84% chance of you paying it back)
Let's say that these banks are able to gain a 1.5% yield on a similar investment with the same risk level.
I don't know, they loan money out to farmers who'll use the money to grow crops and return to them a 1.5% yield.
Then each year, they're not actually gaining 2%, they're gaining the difference between your 2% return and the 1.5% return.
That's the real value added by choosing the factory option over the farmer option.
Isn't this cool!
I think it's pretty cool!
So if we discount the future cash flow with the discount rate we can summarize this value by,
Present Value(Today Dollars) * (1 + Rate of Growth)^Time = Future Value(Tomorrow's Dollars)
We assume that the money we give back to the bank will be used for other investments thus the compounding of time.
Flip that around!
Future Value(Tomorrow's Dollar) / (1+Rate of Growth)^Time = Present Value.(Today's Dollars)
Then it's $2/$1.5 = $1.33
So they're not gaining $2M every year but $1.33M instead!
I told you it would be the basics!
We're getting into the nitty gritty, I didn't build Inkosyth's best financial system because I missed the details!
The way this world trades fixed income bonds though is pretty interesting.
They have machines that calculate the value of bonds and trade them without the use of humans. That's fascinating!
Continuing from that, he began talking about derivatives, which is what really surprised me.
We don't have highly intelligent slaves like the machines they talk about.
Derivatives are promises built off other promises.
I'm getting into the thick of it~
Ahhh!!
Screw it! I am going to talk about it!
I told you I was going to talk about the basics and I lied!
That's right I lied!!
I want to discuss derivatives!
I already understood the main essentials of finance from our world, but the advanced ways that they use derivatives still have me wondering how Mamon got this guy here.
It's like the best present ever, it's like a treasure trove of knowledge.
I'm bringing all of this back to Inkosyth and more.
Derivatives are promises built of promises, I already told you that.
Let's talk about a simple promise.
It's an IOU(I owe you) from your friend. He owes you a favor, he'll do anything you ask of him.
Now let's make a derivative from this IOU, the derivative is that I promise to buy the IOU in 5 years from now.
Seems reasonable, but that IOU's value will change over time depending on how powerful or powerless your friend becomes in the next 5 years.
This is where it becomes complicated. To gain the right to purchase the IOU at a specified price, you need to value all the possibilities that your friend becomes either rich or famous or homeless and poor. We can use past examples of people like him to project our most likely spread of possibilities in his future.
If he's extremely connected, and he's rich then he has a high likelihood of owing you a powerful favor. The value of that derivative goes up.
If he's poor, has debt, and has a drinking problem then there is a high likelihood of him owing you a useless favor. The value of the derivative goes down.
I'm not going into the math, that's for another day. When I get drunk enough.
Furthermore their companies are listed on the public stock exchange.
A stock in simple terms is the promised payments of a company's earnings.
It's the cumulative sum of expected company earnings. Each year a company pays out a dividend (A Share of its Earnings), if holding this stock gives you a dividend every year then all you need to do is to add up the expected amount of money you'll get from the dividends to get the stock price!
That's about it, news about if the company can payout at their expected level of dividends or not will determine shifts in the stock price.
Company executives are by law forced to act in the best interest of the shareholders. If they don't then the shareholders can sue them.
If the company executives believe that the shareholders can gain more by reinvesting it back into the company then we won't see any dividends from holding onto the stock for that year..
If the executives believe that there aren't any more investing opportunities then it'll begin to give out the earnings to the shareholders.
I can't talk about financial instruments all day though. I need to focus!
Focus!!!!
We began to talk about the ways developing nations have a place for financial institutions. The opportunities and growth that's possible in these less-developed parts of the globe.
I began to talk about space and the possibility of us going to space.
He was confused.
It's a shame he was confused. On the bright side, the food is delicious.
We continued to talk until I said goodbye and once he left the restaurant, I closed my eyes and left the dream.