Your Song (Is For Sale)

Any stream of cash flows can potentially be sold for the present value of its cash flows. And one of the biggest cash flows being sold recently is an artist's song catalog. The owner of a song catalog receives the cash flows from the royalty paid whenever a song is played. It was announced yesterday that Justin Bieber's song catalog was sold for a reported $200 million. And although we agree that this is a tidy sum, it is still smaller than the $500 million that Bruce Springsteen or $300 million that Bob Dylan received last year for similar sales. The price isn't cheap as song catalogs are reportedly being sold for 30 times annual royalties.

It's Bobby Bonilla (Edwin Diaz) Day!

The New York Mets famously deferred $5.9 million in salary payable to Bobby Bonilla in 2000, instead paying the former $1.2 million per year from 2011 through 2035. Now, the Amazing Mets are at it again. The team just signed a deal with relief pitcher Edwin Diaz that was announced as a five-year, $102 million contract. Under the terms of the contract, the team will defer $5.5 million per year in 2023, 2024, and 2025, then $5 million per year in 2026 and 2027. In exchange, the team will make annual payments to Diaz through 2042. To complicate matters, there is an option year for 2028 and if the team picks up the option, none of the salary is deferred. It appears that the Mets like really long-term payments!

Buying An Annuity

While you now know that, in general, an annuity is an equal payment with a finite number of payments, how do annuities work in the "real world"? To give you an idea, check out Charles Schwab's annuity calculator. Notice, the website shows three different payment options. The first option, "For my lifetime (single life)", offers the highest payout per period. Using a mortality table for annuities, the insurance company estimates the number of payments on the expected life of the annuitant. If the annuitant outlives their expected life, payments are still made until their demise. However, if someone signs up for this type of annuity and dies immediately, no payments are made by the company. The second option, "For my lifetime and someone else's lifetime (joint life)", the number of payments are based on the expected number of payments based on the expected life of both individuals named in the contract. Again, if either party outlives their expected life, payments are still made until both parties pass away. Finally, "A set period of time (period certain)", the number of periods that payments will be made is fixed when the annuity is first issued. The interest rate used by annuity issuers in all cases is based of current market interest rates when the annuity is first issued.

Bobby Bonilla Day

Every July 1st is Bobby Bonilla Day! You may not be aware that the now retired slugger signed a contract with the New York Mets in 2000 that deferred his $5.9 million salary in exchange for about $1.2 million per year from 2011 through 2035 on July 1st. And while this is a great payday, Bobby Bo recently announced that he was auctioning off his copy of the famous contract. The package includes a baseball signed by Bonilla, a game-used bat, a Zoom call, breakfast and dinner with Bonilla, and attending a Mets game with the slugger. The starting bid is $10,000, so it looks like he will make even more money from the contract.

Negative Amortization

In the textbook, we discussed how a loan is normally amortized, with a portion of each payment going toward the interest accrued during the period and the remainder paying down principal. A recent article highlights the dangers of negative amortization, that is when the interest paid each period is less than the interest accrued during that period. One student graduated in 2010 with $50,000 in debt. Because his payments each month did not cover interest, his balance is now $110,000. One study cited in the article finds that 25 percent of student loans in 2009 had a higher balance in 2019 because of negative amortization. Although the article attributes part of the problem to high interest rates (relative to current interest rates), we should note that a fixed interest rate also guarantees that the interest rate won't rise. In other words, the optimum choice of fixed versus variable rate is generally only knowable in hindsight. The real issue is granting a negative amortization loan. Of course, the only negative amortization lender we know of is Uncle Sam.

Basketball TVM

Former NBA star Allen Iverson signed an endorsement contract with Reebok back in 2001. One of the terms of the contract was that Iverson would receive $800,000 per year for the rest of his life, plus a trust fund of $32 million on his 55th birthday on June 7, 2030. As an article about the agreement explains, Iverson may have received the worst of the deal, but we do have several problems with the analysis in the article. First, it is unlikely that Reebok would have offered Iverson $32 million in 2001 or $32 million on 2030. Reebok funded the trust with less than $32 million in 2001 with the intent that it would be worth $32 million in 2030. The second issue is a time value of money issue. The article notes that if Iverson had invested $32 million in 2001 at 5 percent, it would be worth $87 million in 2030. Check this for yourself and see if you don't agree that the future value of $32 million for 29 years at 5 percent is about $131.7 million

It's Bobby Bonilla Day!

It is a New York holiday (at least until 2035) that you may not be aware of, Bobby Bonilla Day. What is Bobby Bonilla Day? In 2000, the New York Mets owed Bonilla $5.9 million to buy out his contract. Rather than pay the lump sum, Bonilla and the Mets agreed to a payment of about $1,193,248.20 every July 1st for 25 years, starting on July 1, 2011. The agreed upon interest rate was 8 percent. So, the former Mets slugger will be receiving payments until 2035, when he turns 72, 36 years after he last played for the team.

Good News For Student Borrowers

If you have a student loan, there is good news. The interest rate on new undergraduate student loans has fallen from 4.53 percent to a record low of 2.75 percent. This means that the monthly payment on a $10,000 loan repaid over 10 years will fall from $103.78 per month to $95.41 per month. For graduate students, the interest rate has fallen from 6.08 percent to 4.3 percent, which will drop the monthly payments on the same $10,000 loan from $111.42 to $102.68.

TIme Value Of Money And Baseball

In case you missed it, two days ago, Steven Strasburg signed a record 7-year, $245 million contract to pitch for the Washington Nationals. One day later, Gerrit Cole signed a 9-year, $324 million contract to pitch for the New York Yankees. As we discuss in the textbook, many sports contracts are actually paid out longer than is stated. You need the time value of money to properly evaluate such contracts. For example, Bruce Sutter signed a then record 6-year, $9.1 million contract with the Atlanta Braves in 1984. While this works out to a little over $1.5 million per year, Sutter was actually paid only $750,000 per year in interest for the six years of the contract. The rest of the money was paid as a deferred annuity. Sutter last pitched in 1988, but, in 2022, he will receive his last annuity payment. Importantly, note that it was believed at the time that a one-time payment of $1.7 million would have funded the annuity.

TVM And Max Scherzer

The time value of money is everywhere and when you see large cash flows over many years, you need to be careful about the reported values. Consider the analysis of Max Scherzer’s contract, which was stated as having a $210 million value. Even though Scherzer would pitch for only seven years under the contract, he would receive $15 million per year for 14 years. At a 7 percent discount rate, the present value of the contract is only $131 million. A more typical contract, with the salary increasing over seven years, would result in a present value of $158 million, and an equal annual salary of $30 million would result in a present value of $162 million. That’s quite a disparity in values. And, while we agree with the calculations, we aren’t convinced that the seven percent rate being used as a proxy for the long-term return on the stock market isn’t a bit low.

The Power Of Compounding

We hope you have learned about the power of compounding by now. If not, consider your future retirement. How much of your salary do you need to save in order to replace your pre-retirement income? Somewhere between 4 and 44 percent of your salary! If you start saving at 25 and retire at 70, you only need to save 4 percent of your salary, but if you wait to start saving until you are 45 and want to retire at 62, you will have to save 44 percent of your salary. That is quit a big difference and shows the power of compounding.

A Great Risk-Free Rate?

Generally, savings accounts are considered to be close to a risk-free investment. Given what you have learned about risk and return, you would expect a low return, and you would be right. Bankrate.com states that the current average savings account interest rate is .10 percent, although the highest rate offered is 2.35 percent. But what if you could get a 6.2 percent return on your savings account? You can with a BlockFi Interest Account. BlockFi allows you to deposit bitcoin or ether and will pay you a 6.2 percent APY (or EAR). BlockFi is regulated by the New York Department of Financial Services, but does not have the FDIC protection carried by most banks. As with banks, BlockFi depends on charging borrowers a higher rate than it pays to savers. Now the question remains: Is a savings account with BlockFi truly risk-free?

Time Value Of Money And The Real World

If you win the lottery, would you take the annuity payments or a lump sum? The South Carolina winner of the $1.537 billion Powerball jackpot chose the lump sum distribution of $878 million. The annuity option would have been an immediate payment, with 29 more annual payments increasing at 5 percent per year. The first analysis is typically to calculate what rate is being offered, but we need to know the first payment amount to calculate the rate. However, real world factors, like income taxes and estate taxes, complicate the decision. The current income tops out at 37 percent, but some in Congress have argued that the top tax rate should be 90 percent, so the future income tax rate could be much higher, making the lump sum distribution even more valuable. Additionally, if the winner dies before all the annuity payments are made, whoever inherits the remaining payments would be responsible for estate taxes on these future payments immediately, not when the payments were made. In short, if you win a big lottery jackpot, we recommend you contact a lawyer and/or tax advisor because the decision is not as simple as a time value of money decision.

Trading Royalties

If you are interested in an entertaining evening with Finance, we would recommend you curl up on the couch with popcorn and watch the classic movie Trading Places. And now you can own a piece of this movie as the royalties from the movie are up for sale. The producer died in 2007 and the current owner of the royalties is selling the future royalty stream. Last year, royalties from the movie generated $7,988. The current bid is $74,700. Royalties generally extend 70 years past death, so there are 58 years left. Assuming the royalty payments stay constant, see if you don't agree that the buyer will earn a 10.66 percent rate of return.

Inflation Expectations

One thing to keep in mind with present value calculations, if you calculate the present value using real cash flows and the real interest rate or nominal cash flows and the nominal interest rate, the present value will be unaffected. This is true for capital budgeting as well So where can you get expectations of future inflation? One place is the New York Federal Reserve, which publishes microeconomic data, including expectations of consumer inflation. We should warn you, these are expectations, and like any expectations, are not exact.

Retirement Planning

We know that most students are interested in personal finance topics, so we like to post on personal topics occasionally. Consider your retirement. How much should you have saved for a comfortable retirement? A recent article discusses this topic and reports some conflicting conclusions. If you notice, Fidelity suggests that you have 10 times your pre-retirement salary saved at age 67, while the next paragraph notes that, according to Tony Robbins, you need 20 times the annual amount you want to spend in retirement. These two rules of thumb are consistent only if you withdraw half of your current pretax salary in retirement. Of course, these are only rules of thumb. Life expectancy is an important consideration. For example, on average, women live longer than men, which suggests women need more money for retirement for the same withdrawal amount. Another consideration is whether you are willing to dip into principal, which means you would need less than if you do not wish to dip into principal. You also need to consider the amount of risk you are willing to take with your investments. If you are only willing to invest in a savings account, you will need to have more saved, on average, than if you are willing to take more risk and invest in stocks.

We would like to close with a rule of thumb calculation for you. Research into retirement withdrawals using historical market returns suggests that withdrawing 4 percent of your retirement portfolio value per year has generally supported at least 30 years of withdrawals, assuming the portfolio is 60 percent or more common stocks. We should state that many retirement planners would consider this a relatively risky portfolio in retirement. If you are willing to accept this risk, what multiple of annual retirement spending does this suggest you need for your retirement portfolio? What happens to this multiple if you are more risk averse?

Dow 150,000!

With the DJIA at about 18,500, it may be hard to imagine the DJIA hitting 150,000, yet there is a good chance the Dow hitting or exceeding that mark in your lifetime. Even though the number may seem impossible, such is the power of compounding. As this article points out, for the Dow to hit 150,000 by 2046, the annualized return only needs to be about 7.25 percent. One important note on the Dow is that it is a price index, not a total return index, so it excludes dividends. Unfortunately, many people, including business writers, have little idea of the effect of compounding. In 1995, when mutual fund pioneer Bill Berger predicted that the Dow would hit 116,200 by 2040, the business writer audience laughed. However, based on the level of the Dow when he made the prediction, such a move only required an annual return of about 7.5 percent. While we hope you take many things from this textbook, time value of money and compounding is perhaps the most important. 

Activist Investing Increases

Activist investing has been on the rise in recent years. According to CFO, FactSet reported 355 activist campaigns in 2015, with 127 resulting in at least one board seat, while Ernst & Young reported 516 activist encounters. However, today's activist investors seem to be more collaborative than corporate raiders of the past. Importantly, the rise in activist investors appears to have lead to increased conversations between management and investors, which is a positive result. In fact, clear conversations between management and investors can head off confrontations as management may have information that shows an action desired by investors is a bad idea. While activist investing does not seem to be slowing any time soon, it does appear that in many cases, it has resulted in management becoming more focused on company performance and becoming more transparent.

The Return On Powerball

At the current projected value of $450 million, tonight's Powerball jackpot will be the sixth largest lottery payout in history. The winner has a choice of $275.4 million today today, or 30 payments of $15 million with the first payment today. So, what is the break-even interest rate on this choice? Verify for yourself that it is about 3.8 percent. Good luck and we hope you are "stuck" with this choice.

Retirement And Time Value Of Money

A recent article at Bankrate.com discusses how saving earlier in your IRA can mean big money at retirement, which we hope you already know this. As the article discusses, many people make their IRA deposit right before April 15th each year when taxes are due. However, if the deposit were made a year earlier, the difference under Bankrate's assumptions would be $113,985 at retirement. The assumptions used in the article are a $5,500 annual deposit at 8 percent for 40 years. Check for yourself that if the deposits are at the end of the period, the future value is $1,242,810.85 and if the deposits are an annuity due, the future value is $1,538,795.72. So, Bankrate's article presents a set of calculations that we hope you are already familiar with. Of course, the future value will increase another $30,000 or so if you make your deposits on January 1st of each year, 15 months before the last date April 15th of the following year.