miniMBA: Basics of Investments – GMCA 2018

The Basics of Investments was a success! The event took place at Ryerson University on June 28, 2018, as part of the Graduate Management Consulting Association (GMCA)‘s miniMBA program. The event was exclusive to St. Michael’s research students. Thanks to the GMCA for letting me take part in this and thanks to the 55 students who took the time to come.

The miniMBA program is a lecture program provides graduate students and post-docs with:

  • A grounding in fundamental business concepts
  • The opportunity to learn from business experts
  • The chance to apply this new knowledge directly to business cases

If you are interested in this program, keep an eye out for registrations for 2019 later in December.

Cryptocurrency Craze

Cryptocurrencies have been making headlines frequently in recent times. This includes a whole series of digital currencies such as Bitcoin and Ethereum to name two of the most well-known out of a list of over 40 known cryptocurrencies.

Bitcoin was the first cryptocurrency to emerge on the market in 2009. It was created by Satoshi Nakamoto and was initially priced at nearly nothing. By March 2010, it was priced at only US$0.003/Bitcoin. At the end of 2017, it was priced at a whopping US$13,000/Bitcoin and subsequently fell to under US$10,000/Bitcoin a few days into January 2018.  The exponential growth is what made Bitcoin a staple name in the financial headlines in the last year. There have been reports of people selling all of their possessions to invest in Bitcoin. Many millennials are trying to buy in now to earn some quick cash and capitalize on the gains. The market frenzy is reaching levels of insanity, but what many don’t realize is that there is also the possibility of major losses.

The interesting thing is; most people don’t really know what a cryptocurrency is. There are a couple of key features that make cryptocurrencies unique.

  1. It is decentralized
  2. It is digital
  3. It is built using blockchain

Normally, in an economy, the amount and the regulation of currency is controlled by the central bank. This is known as centralized currency. The central bank is a government institution with the ability to print money and adjust interest rates. They control the total supply of money in that economy. The government monitors money fraud. Financial institutions such as retail banks and credit unions act as intermediaries to facilitate transactions to prevent fraud. When performing their role properly, they ensure that your money comes from a valid source that isn’t illegal or fraudulent. Cryptocurrencies are not regulated by a central bank and therefore making them decentralized which means they need another means of controlling supply and validity.

What makes cryptocurrencies even more challenging to monitor is that they only exist digitally and there is no central entity overseeing the supply. This exposes each unit of a cryptocurrency to the risk of being counterfeit. Why not copy one Bitcoin 100 times, 1000 times?

The measure used to control supply and prevent counterfeiting lies in blockchain.

At a very basic level, a blockchain is a sequence of data and each cryptocurrency’s blockchain is slightly different but the basic premise is the same. This blockchain is a record of where a particular cryptocurrency has been spent since its inception, also known as a “ledger” and it is universal.

For ease of discussion, let’s use Bitcoin as an example. The Bitcoins that appear to be in your account are really a set of queries from the universal ledger and the ledger has indicated your account as their current “address”. This is a major control that prevents counterfeiting. The universal ledger is publicly available and cannot be altered by an individual. Because the Bitcoins aren’t actually in your account per se, you can’t make a copy of it.

The blockchain is released in small “blocks” of data. For Bitcoin, each block is 1MB in size. To ensure the legitimacy of the new block, the block’s information is encrypted using cryptography with a hash ( or reference code) that links it to the last block. In order to read the information in these block, it needs to be decrypted.

This is where cryptocurrency miners come in. Miners could be anyone in that invested in the computer hardware and software equipped to break the code. Once a new block is released, miners from all over the globe race to decrypt the block of data. The first miner to decrypt the block is compensated with units of the cryptocurrency associated with the data that was just decrypted. So, these people are paid to maintain the universal ledger.

However, the amount of compensation released with each block may decrease as the supply of the cryptocurrency increases. Bitcoin will eventually cap at around 21 million units in circulation. This essentially controls the supply without a central bank.

Opinions over the viability of cryptocurrencies in the future as a staple and mainstream currency are highly debated. Supporters revere them and believe that they will eventually replace physical currencies. Skeptics have demonized them as the very thing that will corrupt economies. Both sides have valid arguments.

Blockchain technology is an interesting concept that many believe can be applied in the financial markets today; possibly integrated into the banking system. Some believe it will do away with or revolutionize the modern banking system entirely.

Conversely, some are concerned with the viability of the blockchain once the supply is capped. Once the supply of Bitcoin reaches 21 million units, miners will no longer be compensated for their efforts. The main incentive that drove them to mine and to maintain the universal ledger is gone, which could spell problems for the market as a whole.

The market will continue to watch cryptocurrencies; opinions will continue to clash. But like everything else that we have come across in history, we’ll figure it out eventually; whether it’s good or bad or neither. But to the everyday investor, it’s important to understand what you invest in before jumping on a bandwagon.

Mortgage Mayhem

Millennials are frequently blamed for the downfall of businesses and even entire industries. These include department stores, cereal, and diamonds just to name a few. Heck, some believe we will be the downfall of society as a whole. The accusations sound exaggerated and even humorous but the reality is; we’re not spending money on a lot of the things that our parents spent money on.

I’d like to think the reason is that the world is a lot more financially hostile than it was 30 years ago. Think of it this way; back then, someone working a blue collar job in a factory could earn enough to support a family and buy a home. There’s no way that’s happening now.

And recent developments aren’t helping. The Office of the Superintendent of Financial Institutions (OSFI) is the Canadian regulator for banks, and on October 17, 2017, they updated one of their guidelines. Guideline B-20 − Residential Mortgage Underwriting Practices and Procedures outlines the procedures and practices each bank should follow in order to approve and extend residential mortgages to the general public – people like you and me.

The major change involves increased stringency in stress testing. For each mortgage application, as part of their risk approval process must run a stress test involving different scenarios to assess whether the borrower can repay their mortgage under various circumstances. One of these is the increase in interest rate. Interest is a percentage of the total value of your mortgage and is repaid along with the principal borrowed amount. As interest rates rise, the value of each payment made at every interval increases.

The change in the guideline requires uninsured mortgage borrowers to show that they can afford to pay for a mortgage at a rate that is 2% higher than the rate that they are applying for in order to get approval. These borrowers are those that have made a 20% downpayment and are not required to get mortgage insurance with the Canadian Mortgage and Housing Corporation (CMHC).  This translates to a substantial decrease in borrowing power.

To illustrate, let’s assume that you have enough income to spend $2,000 of your monthly income on mortgage payments. The rate that you are applying for is a 25-year term with a 2.45% fixed interest rate. Based on these numbers, theoretically the maximum mortgage you could obtain is around $440,000. With the new rules, you have to add a stress test of 2% to the 2.45% that you are applying for. If you apply the same formula at 4.45%, the maximum mortgage you could obtain drops to around $350,000. This gap widens as the value of your loan increases. If you could originally afford a $1,100,000 mortgage, you would only get a $900,000 mortgage.

The reason for this change was mainly to protect the housing market from shock in case of additional interest rate hikes. Nevertheless, the change adds further financial pressures on millennials and any new families looking to buy a home. With finances tight and the future uncertain, it’s even more important to know what financial resources you have and how to use them.

Millennial Relevancy

Financial literacy was only recognized as an issue recently; for most, it didn’t feel relevant nor did they have any interest. Most articles calling for more financial education only surfaced around 2013-2014. The rising need for financial literacy in the general public, in my view, is due to two main factors.

The cost of living is increasing, and wages are not keeping up. Statistics Canada tracks the Consumer Price Index of Canada on a monthly basis. The purpose of this index is to indicate how much the cost of living has increased from a reference year to the current point in time. According to their data, the CPI has increased to 130.4 in July 2017 from the 100 reference point in 2002. It has increased by over 30% in 15 years! In another study, Statistics Canada has indicated that between the years 2000 and 2013, the average increase in income was 1.2% annually. When calculated, that’s an average income increase of only 19.6% in 15 years! I understand that the statistics may not be perfectly comparable. However, the bottom line is, we are spending more but earning less as time progresses.

The other reason for the urgency to be more financially literate is the increase in Financial Technologies (FinTech). There are more ways than ever to connect to your finances. This includes phone apps for banking, online self-directed stock brokerage (Questrade), robo-investor (Wealthsimple), primary bond issuance platform (Overbond), pay-per-mile car insurance (Metromile), real estate investment platform (Cadre) just to name a few. These services are delivered to your fingertips at the touch of a button (or screen). Companies are spending millions if not billions of dollars on new technologies to better their financial services, and to market their services. These technologies are rapidly integrating what was once the exclusive territory of “business people” into the lives of every person on the street.

Suddenly, in a world where budgets, money, banking, investing are discussed everywhere, governments realize that most of their population have no idea what is going on. If you search “Financial Literacy” on any search engine, you will see articles of panicked governments frantically trying to address the problem. They are going to great lengths to ensure the future of their population is financially literate. In fact, the Ontario government is now piloting the integration of financial literacy into their school curriculum.

The unfortunate part of this story is, there is an entire generation who did not benefit from government or school board training who are just beginning to enter the workforce. That is us; Millennials. While, for previous generations, this is also an important issue, the greatest impact is on Millennials. We have our entire professional lives and careers ahead of us and in about 10 years, we will have to compete with our younger counterparts who will have Financial Literacy training.

Becoming financially literate is no longer a matter of interest, but a matter of relevancy and to some degree, survival.