Bitcoin Conundrum. Or Things I Do Not Understand

Out of three properties that were initially selected as an advantage of cryptocurrency (anonymity, speed and lower fees), Bitcoin has left with only one - anonymity.

The network fee for sending crypto amounts between wallets is above $40 dollars (Canadian). This is up from about a dollar in September 2017. The transactions are not that instant, since it depends on the network load.

Even though the decentralized nature of crypto currency assumes no intermediary between the buyer and seller, it happens that to support the operations one still has build the infrastructure. Users pay commissions to cryptocurrency exchanges, and other services like ATM fees. (ATMs transactions fees are at the level of about 10% for withdrawals).

Should I use bitcoin to sell my product?

Of course, if it helps to bring extra revenue. But how do you set the price? What if bitcoin will drop in price after you sell the product? Would you reset your price accordingly? One way to deal with the uncertainty, is to convert bitcoin back to cash immediately to avoid ‘currency risk’. For that you would pay the commission that exchange is charging (the buy/sell spread on the exchange I last used was about 1.5%) as well as the withdrawal fees for processing the wire transfer (2%). Of course you could include this extras in the price, but the customer has already paid similar fees to buy their bitcoin. Unless bitcoin price becomes more predictable, I don’t understand why businesses would use it.

Why bitcoin has a price?

It is often said that the main function of bitcoin is to facilitate the payments. This currency is not meant to be an asset. If that is the case, why does bitcoin has a price? And why people keep buying it? I can understand why people are buying a foreign currency. For example they intend to use it to buy foreign goods or to travel. They also buy foreign currency as the means of investment. The value of foreign currency is associated with the purchasing power of that currency within the country and with a relative stability of its economy compare to other countries. In case of bitcoin, there is no country. It is decentralized in nature. That means there is no one who can help stabilize the currency value. This function is performed by central bank in case of a national currency, but in a crypto world, this function is omitted by design.

How to value bitcoin?

Should I use similar techniques to evaluate bitcoin as to value a stock? On the surface, holding bitcoin is very similar to holding a sparse asset. The supply is limited and determined by an algorithm. There are still more people that don’t have bitcoin than those who already have it. The price is going up. However, bitcoin is nothing like a stock. There is no company, that generates a cash flow to promise the return on its capital. And thus, there is no target value that will determine whether bitcoin is currently over- or undervalued. As long as there is an interest in buying, the price will continue raising. But what if the interest dissipates. Especially if majority coin holders realize that they don’t use it. Especially with the current level of transaction cost and price volatility.

To summarise

My understanding is that, as long as there is a price tag attached to bitcoin it will behave like an asset. Since it is designed to be decentralized that price will always be volatile. As long as it is volatile, the producers or service providers will be hesitant to use it to price their products and as a result consumers won’t have the need to spend their coins. This will drive the interest in holding bitcoin down and thus the interest in buying it. After all, why would you buy bitcoin now, if you can always buy it later? Is it because there won’t be any bitcoin left? 

Work with Your Data

Many of us use google sheets on a daily basis. You can get by with a few functions and create a report that summarizes your data set in a nice and clear way. The two most popular functions that help with it are Sumif and Vlookup. In addition, you can create a Pivot table which is quite useful as well.

However, there is another powerful function to add in your arsenal – a Query function. It allows you to send requests to your data by utilizing an SQL-like syntax.

1. Type =Query () in your google spreadsheet.
2. In the brackets, first select a data set located on any of the tabs.
3. Then, within quotation marks, specify which columns to select by using an SQL-like query and a key word SELECT (just like in the example above).

Let’s say the data is stored in a range D2:F14 on a current tab. An example data set has Region, Country and Population. Then type the following to select all the countries located in Asia & Pacific region and their population.

=QUERY(D2:F14,"SELECT E, F WHERE D = 'Asia & Pacific'")

This will result in a list of countries as follows: 

To take it one step further and calculate the total population of all the countries that belong to an Asia & Pacific region, type the following:

=QUERY(D2:F14,"SELECT D, sum(F) WHERE D = 'Asia & Pacific' group by D")

The result will show:

To play with the data and create your own query, click here and make a copy of the sheet.

To learn more about Query function refer to this google doc. The source data for this example is taken from here: country by region, population by country.

How affordable is it to live in warm and not-so-wet cities in Canada?

From left to right are top 10 Canadian cities that are rated to have good weather, then cities that are in the top 25 percentile of those to have good weather, and then all the other cities. From top to bottom: calculation of Average Value of Primary Real Estate divided by Median Household Income, then Total Annual Rainfall in mm, and then Days with Daily Min Temperature Greater than 0°C. 

It turns out that there are a number of cities that are affordable from home price to income ratio perspective. However, most of them fall under the category of medium and small. Cities that are rated to have a good weather and with home prices just above 3 times of median household income are mostly located in Ontario and Quebec. Unluckily, cities in British Columbia are either too wet, too cold or too expensive. Of course, there are plenty of other factors that make Vancouver, BC a great place to live.

Source of data: http://www.moneysense.ca/canadas-best-places-to-live-2016-full-ranking/

Canadian Jobs For International Students

Preface

The Thompson Rivers University’s independent student newspaper, The Omega, issued an article about barriers that international students are dealing with while looking for a job in Canada. Author of the article and a Roving Editor of The Omega, Karla Karcioglu, looked into the reasons of why international students struggle to find a job. Her interviewees gave possible explanation by analyzing their experience of working with international students for several years and researching the problem.

What it takes To Get The Job

The full article could be reached at http://truomega.ca/2013/11/12/university-portal-immigration/. Here are seven citations from the article to catch readers’ attention and maybe raise their interest to go through the whole work.

• Many international students who come to TRU already have some form of post-secondary education and many have degrees, but Bepple [Nancy Bepple, Kamloops city councillor and member of the career education department] said they discredit their previous education and value a Canadian education more. The same goes for prior work experience.
• Bepple said that people in Canada rely heavily on personal and professional networks to gain employment, but international students usually don’t have any networks when they arrive in Canada.
• Gibson [International student employment coordinator Sarah Gibson] said many employers are hiring by referral, causing a “hidden job market” that consists of jobs that aren’t even posted to job boards. If international students don’t have connections in their industry they will miss out on jobs that aren’t posted.
• Gibson said most international students are successful at entering the job market because they are invested in their education, not only financially, but by leaving behind their country, their home and their family. This drives them to succeed. She said they are also more willing to relocate than many domestic students who are usually tied to the region or the province.
• “There’s so many things I have learned from them,” Krauza said [Wendy Krauza is a senior lecturer in the English as-a-second language (ESL) department at TRU]. “We can never assume that because their first language isn’t English that they don’t have a world of experience under their belt already.”
• [Dmitry Sorokin graduated from TRU’s post-baccalaureate accounting program in the spring of 2013] He said it is important to socialize with people and let them get to know who you are. If they like you they will probably be willing to help you with your job search.
• Sorokin said another struggle international students may face is the demographics of the job market, with only three per cent of the labour market being immigrants who have lived in Canada for less than five years, according to the Government of Canada. He said he thinks employers are more likely to choose Canadian-born citizens or well-established immigrants than to take a risk on a new immigrant.

SWOT analysis of hiring an immigrant in Canada

Abstract and Disclaimer

This post highlights some strengths and weaknesses of hiring a person with a foreign experience. It represents my own opinion and does not try to cover all possible scenarios. It attempts to focus on advantages rather than disadvantages of having an employee with no Canadian experience.

Composition of the Canadian labour force, 2011

Preface

Canada has a straight forward policy on dealing with the aging population. It invites skilled immigrants to come and join the work force. The reason is clear – there is an increase in social spending after the retirement age, at the same time labor force that serves as a support for these social liabilities is decreasing. “In 2011 […] there were more people aged 55 to 64, typically the age group where people leave the labour force, than aged 15 to 24, typically the age group where people enter it.” (Statistics Canada)

At the same time, newcomers have a hard time with being actually hired (Policy on Removing the “Canadian experience” barrier). As a result, it creates additional uncertainty for those skilled immigrants who would like to come, but afraid they would not be able to find the job. It is bad for the country, for the current and future generation Canadians. “By 2051, about one in four Canadians is expected to be 65 or over.” (Human Resources and Skills Development Canada)

I believe that there is too much emphasis on the requirement to have Canadian experience when employers look for the “right” candidate for the job. It seems that only few employers aware of the benefits of having a team member with international experience. 

SWOT analysis: Strengths – Weaknesses – Opportunities – Threats

Strengths

• Immigrants tend to work harder, due to the uncertainty they have in building a life in the new country
• They have strong self-motivation, and they are more optimistic when things go wrong (see the picture below). The desire to achieve higher goals – this is what brought them to Canada
• The international experience they gained in their home country. Knowledge of additional language
• Tolerance to other cultures, because of their experience of being in both roles – a citizen and an immigrant

Entrepreneurial Spirit Among Migrants vs. the Native-Born

Weaknesses

• Less understanding of business etiquette in Canada for the first 6 months at their first job
• Not always satisfactory knowledge of English language for the first 6 to 12 months
• Difficulties they encounter to build relations with some of colleagues due to differences in cultural background for the first 2 years
• In some industries there might be a concern regarding the relevance of the international experience¹.

¹However, this should not be a concern in Finance or IT because the education providers all over the world often use US books and statistical examples when teaching economics, corporate finance or software development.

Opportunities

• Diverse experience potentially helps to see the problem at different angles, which leads to better decisions
• Expand the business to emerging markets or strengthen the relations with international partners. It is easier to do with an employee, who know additional language and familiar with the work dynamic in their home country

• Savings on the salary:

v Fewer opportunities for immigrants on the job market results in less salary expectations. As opposite to native-born who feels more secure - they tend to require higher remuneration for the same job responsibilities

v  Immigrants seek for the balanced life. They do value other factors like stability or warm relations with colleagues, which in turn gives them a sense of being accepted by the society

• Smaller staff turnover ratio. Those with the work permit restricted to one employer – have less ability to switch employers. International students with the work permit more likely will stay with the same employer, because they need to satisfy work experience requirement in order to apply for the Permanent Residence status (this process may take up to 3-5 years) 

Threats

• Most people are afraid of something they are not familiar with. For this reason, some people are afraid of different cultures or could be less tolerant to the language barrier under time-deadline conditions. For example, this could turn down some new clients. Although, there is a potential to bring some new clients who also have an international background similar to those of employees. (Not only language barrier and familiarity with culture is a temporary problem, but this is simply solved by keeping the balance in the mix of Canadian and international employees)

What does it do to the society in general?

• More skilled work force would come and add development to the country
• Enormous savings on education. Immigrants have education in their home country and Canadian government does not need to pay for that: "Funding from governments covers most costs for a public elementary and secondary education [...]" (Education Indicators in Canada, page 3)
• It is better to have balanced society in terms of age. This leads to balanced consumption pattern and supports local businesses that were established earlier and now having problems selling the product to a certain age groups. These problems could be partially explained by the structural changes in the consumer age profile that are happening in Canada. “[…] the roots of slower growth lie in our changing demographics” (See The Destiny of Demographic Change by Rafael Gomez and David Foot)

Conclusion

Hiring manager might feel a higher level of responsibility by considering an immigrant in the team. However, the likelihood of the success seems to outweigh the risk. After some time, the “right” candidate will have both Canadian and international experience, which will benefit the employer over time. After all, it is not only the government’s responsibility to care about the future of Canadians.

Sources used:

1. Composition of the Canadian labour force, 2011 http://www.cic.gc.ca/english/resources/research/2012-migrant/sec02.asp 
2. Human Resources and Skills Development Canada http://www4.hrsdc.gc.ca/.3ndic.1t.4r@-eng.jsp?iid=33
3. Statistics Canada  http://www12.statcan.ca/census-recensement/2011/as-sa/98-311-x/98-311-x2011001-eng.cfm#a2
4. Policy on Removing the “Canadian experience” barrier http://www.ohrc.on.ca/en/policy-removing-%E2%80%9Ccanadian-experience%E2%80%9D-barrier
5. Picture. Entrepreneurial Spirit Among Migrants vs. the Native-Born http://www.travel-impact-newswire.com/2013/09/world-migration-report-immigrants-work-hard-create-new-businesses-remain-optimistic/#axzz2hlCSIcsO
6. Education Indicators in Canada http://www.statcan.gc.ca/pub/81-599-x/81-599-x2011007-eng.pdf
7. The Destiny of Demographic Change by Rafael Gomez and David Foot http://www.footwork.com/gomez_foot_policy_options.pdf

Why do YOU like ethical and professional standards?

The are two reasons why I like ethical and professional standards in the investment industry:

• It is one of the most understandable section in the CFA curriculum
• There is so much room for improvement 

According to Edelman TrustBarometer, financial service industry was ranked as the least trusted industry globally in the 2013. Here is a picture from the presentation found on Edelman web site. http://www.edelman.com/insights/intellectual-property/trust-2013/trust-across-sectors/trust-in-financial-services/ (slide 13th out of 31).

Looks like people trust Media more than their financial advisors.

Computing FCFF from EBIT. Tax shield issue

Calculation of FCFF from EBIT. Tax shield issue

Introduction

Free Cash Flow to the Firm (FCFF) from earnings before interests and taxes (EBIT) defined in CFA Curriculum[1] as:

FCFF_a = EBIT * (1-tax rate) + Non-Cash Charges (Depreciation) - Working Capital investments - Fixed capital investments,

Or rewriting in a short way using abbreviations:

                                       FCFF_­a = EBIT * (1-tax rate) + NCC – WCI – FCI                        [1]

This formula is quite popular in practise. However, students usually get confused by the absence of the ctax shield. They think tax shield, which is [interest expenses * tax rate], should be added back to calculate FCFF because most companies deduct interest expenses in calculating taxes.  However, computing FCFF by using the formula [1] is quite logical for the calculation of company’s value using after-tax weighted average cost of capital (WACC_a) as a discount rate.

Let’s take a closer look at the formula and FCFF concept.

Explanation

Theoretically speaking, FCFF could be defined as the firm cash flow after subtracting operating expenses, working capital investments and fixed capital investments. The exact reading of this definition gives us the following formula for FCFF:

                                        FCFF_b = EBIT – Taxes + NCC – WCI - FCI                              [2]

By having Taxes = EBT * tax rate, which is = (EBIT – Interest expenses) * tax rate, the formula [2] could be further developed as:

FCFF_b = EBIT – (EBIT – Interest expenses) * tax rate + NCC – WCI – FC  
= EBIT – EBIT * tax rate + Interest expenses * tax rate + NCC –WCI - FCI
                = EBIT * (1 – tax rate) + NCC – WCI – FCI + Interest expenses * tax rate    [3]

Thus, by following the definition for FCFFb we have the tax shield term in the equation. This is exactly what students would want to see based on the intuitive feeling on tax shield idea. Although, in practise it is more common to see FCFF_a rather than FCFF_b, my opinion is that both ways are appropriate from the calculation of company value standpoint.

Next table summarizes that formula [1] differs from [3] by the amount of Interest expenses * tax rate.

Column A (practical alternative)[2]	Column B (theoretical alternative)
FCFFa	FCFFb
EBIT – EBIT * tax rate + NCC – WCI – FCI    = FCFFa	EBIT – EBIT * tax rate + NCC – WCI – FCI + Interest expenses * tax rate    = FCFFb
Thus, FCFFa less than FCFFb by Interest expenses * tax rate

Company value estimation by discounted cash flow method

The purpose of calculating FCFF is to estimate the value of the company, by discounting forecasted FCFF by the average cost of capital (debt and equity). Taking into consideration FCFF calculated in the column B (theoretical one), we would discount FCFF_b by the average cost of capital calculated as:

WACC_b = Cost of debt * Debt/Assets + cost of equity * Equity/Assets

Here, we are not using after tax cost of debt because the adjustment for the tax amount has been done on the stage of calculating FCFF_b. 

However, it is common to calculate the average cost of capital on the after tax basis:

WACC_a = Cost of debt * (1 – tax rate) * Debt/Assets + cost of equity * Equity/Assets

Which is less than WACC_b by the amount of Cost of debt * tax rate * Debt/Assets, which is an interest rate * tax rate *Debt/Assets.  Where interest rate * Debt/Assets is the Interest expenses expressed in terms of percentage from Assets (Interest rate * Debt/Assets = Interest expenses / Assets). These are the same Interest expenses we used in calculating of FCFF and the tax shield term.

Column A (practical alternative)	Column B (theoretical alternative)
WACCa	WACCb
WACCa =    cost of debt * Debt/Assets + cost of equity * Equity/Assets - cost of debt * tax rate * Debt/Assets	WACCb =    cost of debt * Debt/Assets + cost of equity * Equity/Assets
Thus, WACCa less than WACCb by Interest rate * Debt/Assets * tax rate

Now we have the tax shield term shown up in the calculation of both FCFF and WACC. This helps us to understand the difference between A and B ways to calculate firm's value. Next table summarizes the result. 

Column A (practical alternative)	Column B (theoretical alternative)
Firm Valuea	Firm Valueb
∑ FCFFa / WACCa	∑ FCFFb / WACCb
Here, by calculating Firm Valuea we subtract Interest expenses * tax rate in the numerator, and interest rate * Debt/Assets * tax rate in the denominator, which conceptually gives the same result as the Firm Valueb  [3]

Calculation of Free Cash Flow to the Equity holders (FCFE)

Further, if we want to calculate Free Cash Flow to the Equity holders (FCFE) starting from the Free Cash Flow to the Firm (FCFF) step from the practical point of view, it would be suggested subtracting after-tax interest expenses and adding Net borrowing component:

FCFE_a =  FCFF_a – Interest expenses * (1 – tax rate) + Net borrowing

However, from a itheoretical point of view (column B), we would adjust our FCFF_b by subtracting whole interest expenses and add Net borrowing component to reflect the amount of cash left to the providers of equity capital, which gives us FCFE_b.

Column A (practical alternative)	Column B (theoretical alternative)
FCFEa	FCFEb
FCFFa - Interest Expenses * (1- tax rate) + Net borrowing = FCFEa	FCFFb - Interest Expenses + Net borrowing = FCFEb

By making some rearrangement in the formulas [1] and [3] will show us that FCFE_a and FCFE_b are equal.

Indeed, let's take a look at FCFE_a:

FCFE_a = FCFF_a - Interest Expenses * (1- tax rate) + Net borrowing

Substitute FCFF_a from the formula [1]:

FCFE_a = EBIT * (1-tax rate) + NCC – WCI – FCI - Interest Expenses * (1- tax rate) + Net borrowing =

= (EBIT – Interest expenses) * (1 – tax rate) + NCC – WCI – FCI + Net borrowing   [4]

Now let's take a look at FCFE_b:

FCFE_b = FCFF_b  - Interest Expenses + Net borrowing

Substitute FCFF_b from the formula [3]:

FCFE_b =  EBIT * (1 – tax rate) + NCC – WCI – FCI + Interest expenses * tax rate - Interest Expenses + Net borrowing =

= EBIT * (1 – tax rate) + NCC – WCI – FCI - Interest expenses * (1 - tax rate) + Net borrowing =

= (EBIT – Interest expenses) * (1 – tax rate) + NCC – WCI – FCI + Net borrowing     [5]

Thus, we have right sides of [4] and [5] are equal which means left sides are equal as well: 

FCFE_a = FCFE_b

This gives us no difference in calculating Equity Value of the company either by practical or theoretical alternative. We just need to use the cost of equity as the discount rate.  

Which one to use - FCFF_a or FCFF_b? 
When we think about the value of the company as of the price one party actually pays after all negotiations have been completed, the method to estimate the value of the company should be chosen in favour of the party. The selling party probably would try to use a method that gives higher estimation. The buying party - could choose smaller estimation. Eventually, analyst would use a number of methods to come up with a reasonable estimation, such as finding similar publicly-traded companies and using multiples to compare; or finding information on recent transactions for similar companies. 

Conclusion

Calculation of FCFF should be consistent with further calculation of WACC in order to estimate proper company’s value. If we use after-tax cost of debt in the WACC rate, then we should use after-tax interest expenses in the calculation of FCFF (variant A). Or, if we use WACC without adjusting cost of debt, then FCFF with adding tax shield term would be appropriate (variant B).

As to the calculation of FCFE starting from FCFF, both ways of calculation FCFF give exactly the same result for value of FCFE.

---

[1] Institute, CFA. Level II 2012 Volume 4 Equity, 6th Edition. Pearson Learning Solutions, p. 298

[2] The reference on "practical" and "theoretical" alternatives is done to simplify the discussion so it will be easier to distinguish between A and B way of calculation in the text

[3] Both values are not mathematically equal, and they should not be, because these are two different ways to estimate the value