All you ever need to know about the stock market is explained by Beanie Babies. And you already know it!
Beanie Babies. Is it possible that there is anyone on earth that has not heard about these small wads of cloth that rocketed to fame and desire? If you are among the multitudes that remember them, then you also remember the crazy prices that these pieces of cloth demanded as the public began to trade in Beanie Babies.
Demand outstripped supply at the stores. Individual Beanie Baby items were retired - they were no longer going to be manufactured; you need to buy now in order to ensure you weren't left out of this particular Beanie Baby!
All of these things created a pressure on the public to buy - buy now while they are available.
But what if you couldn't buy now? What if you wanted one of the favored Beanie Babies, coveted by multitudes? Why, you could buy from the public at large - no need for a store when you could find a source from the public.....and thus a market was born.
Demand for the product pushed prices up to very high levels; certainly levels high in comparison to the raw material and manufacturing costs of producing each Beanie Baby.
And with that high price, caused by high demand, people that owned Beanie Babies found a ready public willing to buy their discards - the public would pay high prices for something bought, used, and ready for the trash!
So a supply of used Beanie Babies started coming into the market. People with used Beanie Babies could make fantastic returns (the price they obtained from a sell of the Beanie Baby, less the price they originally paid) from Beanie Babies! If you had enough Beanie Babies, you could retire from the returns from Beanie Babies!
Everyday households, people that profess to not understand anything about the Stock Market, instantly grasped the concept of a market in Beanie Babies.....buy now while the demand is high, wait for it to be retired, then sell at a profit!
They could buy Beanie Babies, hold onto Beanie Babies while demand forced the price of Beanie Babies to new highs. Thus, a market was born, where buyers and sellers of Beanie Babies could come together. Buyers, outnumbering sellers, pushed the prices higher and higher. Sellers, once selling and realizing a profit, rejoined the buyers in looking for Beanie Babies to buy, hold, and sell.
The demand was huge! The more people realized they could buy cheap and sell high, reaping a high return or profit, the more people jumped into the market. The more people jumped in, the bigger the demand. And the bigger the demand, the harder it was to locate a Beanie Baby in a store! And the harder it was to locate one, the higher the fever was to find one, and the higher the demand! And the higher the demand, the higher the price you could charge for the ones you already owned! You, in owning the most sought after, the most expensive Beanie Baby, were to be envied - you had the coveted Beanie Baby. If you were rich enough, you could own the best.
All this fed off of itself. Huge numbers of people bought Beanie Babies with the intent to sell at a profit. A lot of people bought but didn't sell, preferring to hold, to wait until prices for their Beanie Baby rose. They bought and held.
Meanwhile, the manufacturer was increasing both production of the number of Beanie Babies being created, they were also creating new Beanie Babies, so more Beanie Babies were entering the market from an increased supply of Beanie Babies.
Then a funny thing began to happen. So many Beanie Babies were entering the market for sale - some new from the manufacturer, some resales from existing Beanie Babies being sold at a profit - that suddenly there was enough supply to meet demand.
As the supply began to meet the demand, the prices began to stabilize. People took notice, and decided now might be a good time to sell their Beanie Babies as the expected profit was eroding.
So many, many people that just a few days ago were counting their profits in the form of their hordes of Beanie Babies, began to sell their stocks to convert to cash while the selling was still good. They wanted to sell while there was still demand.
They may not have been able to explain supply and demand, but intuitively they understood supply and demand ... they were going to get out while the getting is good!
As more Beanie Babies were rushed to the market for sale, the price began to drop. With a drop in price, more fear of a price collapse brought more Beanie Babies to the market....and a new cycle was born....increasing supply beyond the demand, falling prices, panic selling.
Some people, seeing the falling prices, and remembering the high prices of just last week, decided that Beanie Babies were a buying opportunity, and bought more and more, knowing the price of Beanie Babies would rise again real soon now, and they would be the smart profit winners - they were able to buy at a big discount before the big onrush of demand!
Only the market of Beanie Babies didn't come back to the levels prior. Soon, they found themselves the owners of Beanie Baby stock, whose value was significantly below the market level of just a few weeks or months ago.
So....Beanie Babies explain the stock market.
Higher demand for the product can create a market. If demand is high enough, the value of the item will increase. As it increases, it generates excitement as people imagine they can buy now, wait for it to rise, and sell at a profit. Excitement lures more people in, and the demand increases. The demand increases until everybody that is interested is now in the market for that item. At some point, a tipping point, there is enough supply to meet demand. Prices begin to stabilize and then begin to fall. Some people see this as a buying opportunity, and buy, buy, buy. This pushes the market back up some, but now more supply enters the market to meet the demand, and the prices begin to fall again. Soon, everybody is in a panic to get out of the market so they can convert the product back to cash. Panic selling starts, and the price plummets. This continues until no more product enters the market, and supply and demand equalize.
You've just witnessed the classic 'bubble'.
At this point, if the product is something that will be needed or desired by people, then the price may begin to rise again.
If it was just a fad, like Beanie Babies, then the prices may never return to their historic highs, and just continue to muddle along where supply and demand meet.
Also, see Holland's Tulip Bulb Bubble market crash.
Showing posts with label Investing. Show all posts
Showing posts with label Investing. Show all posts
Saturday, August 20, 2011
Tuesday, June 14, 2011
Banjo's Insight - Bonds
Yesterday I posted an article about "Pocket Swapping", which had some information about bonds in it.
A lot of people are confused about bonds, so I thought I would put forth an example that I hope will explain it for people.
Most everyone has a general idea about how rental houses work. You know, for instance, that someone first buys the house, then rents it out and hopes to collect rent money. They hope to receive a yield on their investment.
So here's the example. I'm going to use simple numbers, which probably won't reflect the rental information in your area, but I want to keep it simple. We're going to really keep it simple - no taxes, no mortgage, no insurance, nothing except the bare necessities.
Notice as the investment cost goes up, the yield or rate of return goes down. It's costing me more, but I'm not getting any increase in the dollars I receive in return, so my yield or rate of return is going down.
A lot of people are confused about bonds, so I thought I would put forth an example that I hope will explain it for people.
Most everyone has a general idea about how rental houses work. You know, for instance, that someone first buys the house, then rents it out and hopes to collect rent money. They hope to receive a yield on their investment.
So here's the example. I'm going to use simple numbers, which probably won't reflect the rental information in your area, but I want to keep it simple. We're going to really keep it simple - no taxes, no mortgage, no insurance, nothing except the bare necessities.
- I buy a house for $100,000. I invest $100,000.
- I rent the house for $1,000 per month.
- In 12 months (1 year), I collect $12,000. I receive $12,000 from my investment.
- In 1 year, I made $12,000/$100,000 or 12.00% return on my investment.
Now let's look at a slightly different investment. My investment will cost me twice as much ($200,000 instead of $100,000), but I will still receive the same amount of $12,000 per year. I'm receiving less return on my investment.
- I have to invest $200,000 instead of $100,000. I invest $200,000.
- I rent the house for $1,000 per month.
- In 12 months (1 year), I collect $12,000. I receive $12,000 from my investment.
- In 1 year, I made $12,000/$200,000 or 6.00% return on my investment.
Now a final example. I only invest half as much, $50,000 instead of $100,000. I will still receive the same rent return of $12,000 in a year.
- I have to invest $50,000 instead of $100,000. I invest $50,000.
- I rent the house for $1,000 per month.
- In 12 months (1 year), I collect $12,000. I receive $12,000 from my investment.
- In 1 year, I made $12,000/$50,000 or 24.00% return on my investment.
Investment.....Received.....Yield or Rate of Return
$50,000 .........$12,000.......24.00%
$100,000........$12,000.......12.00%
$200,000........$12,000.........6.00%
Notice as the investment cost goes up, the yield or rate of return goes down. It's costing me more, but I'm not getting any increase in the dollars I receive in return, so my yield or rate of return is going down.
Bonds are auctioned with a yield, or Rate of Return. The yield is the same, but the price you pay for the bond can vary because of the auction. That means the Rate of Return will vary based on the amount you pay for the bond.
In the house rental example, you are buying a yield. The yield you are buying above is the rental income of $12,000 per year. However, you are paying different amounts for that yield ($100,000, or $200,000, or $50,000). The amount you are paying is different, but the payment to you remains the same, so your rate of return is different.
- If, as above, you pay more for the bond, your yield, or rate of return will go down. If you paid $200,000 for the house and it paid you $12,000 per year instead of paying $100,000 for the house, then your yield after receiving $12,000 on an investment of $200,000 is less than it would have been if you had only paid $100,000.
- If you pay less for the bond, your yield or rate of return will go up. If you paid $50,000 for the house and it paid you $12,000 per year instead of paying $100,000 for the house, then your yield after receiving $12,000 on an investment of $200,000 is more than it would have been if you had to have paid $100,000.
You can buy bonds in different ways. You can buy them from a bank, or you can buy into a Bond Fund, such as an ETF. Since you can buy them, then you can also sell them.
The price of bonds fluctuates day-to-day with the auction process. That means the value of your bond changes. The payment you receive will stay the same, but if you have a bond and decide you need to sell it, and you paid $100,000 for it, but now the market says it is only worth $90,000, then you will lose money on it if you do in fact sell it - you will lose $10,000. $100,000 (purchased) minus $90,000 (received from the sell): $100,000 - $90,000 = $10,000 loss.
When someone creates a bond, they are creating an IOU. They are exchanging the IOU for dollars. They have to pay interest on the IOU in exchange for the use of your dollars.
The US Government's Department of the Treasury creates bonds known as Treasury bonds (or Treasuries).
At the time I write this, the Federal Reserve of the US Government's program known as Quantitative Easing II (QE2) will end on June 30, 2011. Under QE2, the major buyer of Treasuries has been the Federal Reserve. When QE2 ends, the Federal Reserve will no longer be buying Treasuries. Instead, the open market (other nations, big banks, you, me...) will be the buyers.
Since the major buyer is leaving the market for Treasuries, there will be a reduction in the demand for Treasuries. We all know from Economics 101 that reduced demand means lower prices.
As we say from the rental house example above, lower prices means higher yields. So the Dept of the Treasury will be receiving less money in return for the bonds it is selling. This is the same as paying a higher yield, or higher expenses. So the cost of borrowing money via selling bonds is going to go up for the US Government.
If it's going to cost the US Government more, then that means it's going to cost you - the taxpayer - more.
If you already own bonds, and you need or want to sell them after QE2, then you are going to have to match the current going yield investors expect to receive. That means you are going to have to lower the price you are willing to receive in exchange for your bond. The value of your bond is going to go down, as it has to be since the yield is going up on the bonds the Treasury is creating.
Since the US Treasury bonds are considered the most safe investment available (well...we haven't defaulted on any yet), other things are going to start going up. A simple example - Certificate of Deposits (CDs), issued by banks, will have to increase in yield in order be attractive against the Treasury's bonds.
The price of bonds fluctuates day-to-day with the auction process. That means the value of your bond changes. The payment you receive will stay the same, but if you have a bond and decide you need to sell it, and you paid $100,000 for it, but now the market says it is only worth $90,000, then you will lose money on it if you do in fact sell it - you will lose $10,000. $100,000 (purchased) minus $90,000 (received from the sell): $100,000 - $90,000 = $10,000 loss.
When someone creates a bond, they are creating an IOU. They are exchanging the IOU for dollars. They have to pay interest on the IOU in exchange for the use of your dollars.
The US Government's Department of the Treasury creates bonds known as Treasury bonds (or Treasuries).
At the time I write this, the Federal Reserve of the US Government's program known as Quantitative Easing II (QE2) will end on June 30, 2011. Under QE2, the major buyer of Treasuries has been the Federal Reserve. When QE2 ends, the Federal Reserve will no longer be buying Treasuries. Instead, the open market (other nations, big banks, you, me...) will be the buyers.
Since the major buyer is leaving the market for Treasuries, there will be a reduction in the demand for Treasuries. We all know from Economics 101 that reduced demand means lower prices.
As we say from the rental house example above, lower prices means higher yields. So the Dept of the Treasury will be receiving less money in return for the bonds it is selling. This is the same as paying a higher yield, or higher expenses. So the cost of borrowing money via selling bonds is going to go up for the US Government.
If it's going to cost the US Government more, then that means it's going to cost you - the taxpayer - more.
If you already own bonds, and you need or want to sell them after QE2, then you are going to have to match the current going yield investors expect to receive. That means you are going to have to lower the price you are willing to receive in exchange for your bond. The value of your bond is going to go down, as it has to be since the yield is going up on the bonds the Treasury is creating.
Since the US Treasury bonds are considered the most safe investment available (well...we haven't defaulted on any yet), other things are going to start going up. A simple example - Certificate of Deposits (CDs), issued by banks, will have to increase in yield in order be attractive against the Treasury's bonds.
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