Investment Analysis FINA3324
Tutorial Questions for Week Beginning Monday 1 March 2021
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Preliminary Comments
It is not expected that tutors will cover all questions during the tutorial. They will spend about
10 to 15 minutes addressing the more challenging quantitative questions. The rest of the time
will be devoted to discussion of the qualitative questions. Solutions to the quantitative
questions will be made available on LMS at the end of each tutorial week.
To encourage in-class discussion, solutions to qualitative questions will not be posted. Tutors
have been expressly instructed not to make available answers to qualitative questions.
Investment Analysis requires significant investment of your time. You may work in groups to
answer the qualitative questions. It is the quality of your contributions to the class discussions
that will impress the tutors.
The final exam will include questions similar to the tutorial questions. The exam will also
feature questions based on the lectures (i.e., you cannot address just the tutorial questions and
expect to perform well in the final).
Background to this week’s lecture and questions
One definition of Investment Analysis is the work required to evaluate whether a project or asset
offers an attractive return for the risk involved. This definition presumes investment opportunities
are neatly packaged and essentially independent of other parties. This is a reasonable
approximation of what Investment Analysis means for ordinary investors considering whether to
invest in, say, shares, bonds or housing. However, the definition doesn’t describe the work
involved in developing the investment product available to investors. More specifically, the
definition isn’t helpful in identifying the services provided and value added by the financial
industry, that is, it doesn't describe what is known as “financial intermediation”. If you work in
finance then it is most likely you will be engaged in an aspect of financial intermediation rather
than spending your time evaluating a series of different investments. Obviously, fund managers
do this but they are a small fraction the total population of finance sector workers and even then
they are engaged in financial intermediation, unless they trade entirely their own money.
Two aims of week one’s lecture were to (a) illustrate the social value of finance and (b) identify
different aspects of financial intermediation. It is useful to know the function performed by each
entity in finance. One finance graduate told me she was thrilled to find she had been offered a
position by a large bank in its “Private Markets Investment Management: Treasury and Trade
Execution”. A few days into her work she realized the section she was in was responsibly primarily
for doing the paper work required to complete transactions initiated elsewhere in the bank. She
later moved into the “Global Corporate Bank: Commercial Banking Cash” section, which perhaps
sounds less glamorous but her work now involves selling the banks cash management services to
companies and it suits her perfectly.
The work of financial intermediation is often under-appreciated because the full costs of obtaining
information, enforcing contracts and taking on risk are not obvious so the fees charged by
financiers can appear exorbitant. On the other hand, sometimes the fees financial institutions
charge are indeed a function of their monopoly power. Identifying the difference between a
reasonable fee and an extortionate fee for service is difficult.
The aim of this week’s tutorial questions is to help you identify and appreciate the costs of lending
money and how access to finance can make a big difference to people. Why is this important?
Because, if you intend to have a career in finance, you need to understand just what kind work is
involved and why it is a useful activity. The cases described below about the costs of lending
money illustrate that simple economic principles are relevant to both “low” finance and “high”
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finance. I suspect the questions are very different to the kind you are used to answering in tutorials.
They are not aimed at tricking you but rather simply to get you to think about the economics of
finance and to give you practice in expressing your reasoning and develop your critical thinking
skills.
Case 1 The Deposit Collector (from The Poor and their Money by Stuart Rutherford pages x to xiv,
available in LMS. You will need to read at least the five pages to get more clues on the answers to
the tutorial questions. Ch. 7 The Economics of Lending to the Poor - also on LMS - will prove helpful
as well)
We travel to India, in the slums of the south-eastern town of Vijayawada. Here we find Jyothi
doing her rounds. Jyothi is a middle-aged semi-educated woman who makes her living as a
peripatetic (i.e., wandering) deposit collector. Her clients are slum dwellers, mostly women.
This is how she works. She gives each of her clients a simple card, divided into 220 boxes (eleven
rows and twenty columns). Clients commit themselves to saving a certain amount per box, in a
certain period. For example, one client may agree to save five rupees, at the rate of one box a day.
This means that at the end of 220 days (since there are 220 boxes) she will have deposited 220
times 5 rupees, or 1,100 rupees (that’s about $25 US). Having made this agreement, it is now
Jyothi’s duty to visit this client each day to collect the five rupees. In the card reproduced here the
client has got as far as saving 47 times, for a total of 235 rupees to date. When the contract is
fulfilled – when the client has saved 5 rupees 220 times (which may actually take more or less than
220 days, because slum dwelling women are human beings and not slot machines), the client takes
her savings back. However, she doesn’t get it all back, since Jyothi needs to be paid for the service
she provides. These ‘fees’ vary, but in Jyothi’s case it is 20 out of the 220 boxes - or 100 rupees
out of the 1,100 rupees saved up by the client in our example.
Questions:
1. What is Jyothi’s fee for the service she provides, expressed in percentage terms?
2. Why would a slum-dweller wish to use Jyothi’s services?
3. Do you think Jyothi’s fee is excessive, too low or just right? By way of comparison, a major Australian
bank was offering personal rates at around 14% per annum. To answer this question, identify the costs
that Jyothi has bear to provide her service and compare them to relative to the revenue she is likely to earn.
You should also consider the scale of a loan.
4. What is the opportunity cost to Jyothi’s clients, ie, if they didn’t use her services, how else would they use
their money?
5. Do you think it would be profitable for a large, commercial bank to enter the business of lending to slumdwellers? If so, why? If not, why? You should give specific reasons expressed in economic terms. For
example: Yes, they should because a bank would make significant profits: their expected profit would be
2x but their costs would be just 1x. Of course, you won't be able to give precise estimates of costs but you
can make a good guess whether it is likely to be profitable or not.
Case 2 The Urban Moneylender
There are many kinds of moneylender. Among them there is one kind that is common in many
urban slums of the sort where deposit collectors like Jyothi work. Indeed, the next example is from
Vijayawada again it helps in making a comparison with Jyothi. This moneylender’s clients are in a
slum not far from the one where Jyothi works.
His working method is simple. He gives loans to poor people without any security (or ‘collateral’),
and then takes back his money in regular instalments over the next few weeks or months. He
charges for this service by deducting a percentage (in his case 15%) of the value of the loan at the
time he disburses it. One of his clients reported the deal to me as follows. ‘I run a very small shop’
(it’s a small timber box on stilts on the sidewalk inside which he squats and sells a few basic
household goods) ‘and I need the moneylender to help me maintain my stock of goods. I borrow
1,000 rupees from him from which he deducts 150 as interest. He then visits me weekly and I
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repay the 1,000 rupees over ten weeks, at 100 rupees a week. As soon as I have paid him off he
normally lets me have another loan.’ This client - Ramalu - showed me the scruffy bit of card
which the moneylender had given him and on which his weekly repayments are recorded.
It was quite like the cards Jyothi hands out. There are many other similarities between Jyothi and
the moneylender.
The main difference – the fact that the pay-out comes first, as a loan, is immediately apparent. But
let us look at the similarities. In each case the client is using the service to swap a series of small
regular pay-ins (or savings) for a usefully big pay-out. In other words, these are both forms of basic
personal financial intermediation. With the urban moneylender, the pay-out comes first, and can
be understood as an advance against future savings. Indeed, very many loans to poor people are actually
advances against savings, as we shall see. Another similarity is that clients often proceed straight
into a second cycle - and then a third and soon. When you have done several cycles it can hardly
make much difference whether in the first cycle the loan or the savings came first - you may not
even be able to remember. You have got into a rhythm. Every day (or week or month or whatever)
you make a small pay-in and every now and then (every 220 days or every ten weeks or whatever)
you get a usefully big pay-out. This is the essence of basic personal financial intermediation.
As in all cases of basic personal financial intermediation, the size of the pay-out is directly linked
to the size of the pay-ins. In the case of Jyothi, the client makes the decision, by choosing the size
of the pay-in. In the case of the moneylender, the moneylender makes the decision, by choosing
the size of the loan (or at least its maximum size). To do this, he has to judge the client’s capacity
to save, and in this he is often helped by a history of previous similar deals with the same client or
with people in similar situations.
Question:
1. What is the moneylender’s fee, expressed in percentage terms?
2. Is the moneylender’s fee different to that charged by Jyothi? If so, why do think the difference arises?
In answering this question, ask yourself, why would a slum-dweller wish to use a moneylender services on
the terms provided above rather than access the services of Jyothi? If the money-lender is more expensive
and people still use his services then there must be something more attractive about the terms of his loan.
What is that difference?
3. Why don’t more people compete with the moneylender? If his business is more profitable than Jyothi then
you would expect more money-lenders to enter the business. Why don’t they? Does the money-lender have
higher risk or greater costs (or both)?
4. If the money-lender had a reliable way of enforcing his contracts (say, by hiring thugs to threaten borrowers
who don’t pay up), would he generate more or less business? Would potential borrowers be better or worseoff?
Case 3 Ethical Lending: Partner, Predator, Parasite or Pet?
Case-Study drawn from
Royal Commission into Misconduct in the Banking, Superannuation and Financial Services
Industry
28 September 2018 Interim Report Volume 2 Case Studies pp. 104-105
“Mr Harris obtained his first credit card from CBA towards the end of 2014. Not long after
obtaining that credit card, he began to gamble beyond his means, including by obtaining cash
advances on his credit card, transferring that money to another CBA account, and then using that
money for gambling purposes. In the course of 2015, Mr Harris obtained two further credit cards
from CBA, with limits of $7,000 and $8,000 respectively, and obtained a credit card limit increase
in respect of the first credit card that he obtained from CBA.
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In about April 2016, Mr Harris consolidated his three CBA credit cards into one card, with a credit
limit of $27,100.That month, Mr Harris also incurred his first directly gambling-related expenses
on his CBA credit card.
In October 2016, during a call to CBA about an unrelated matter, a CBA staff member informed
Mr Harris that he was conditionally approved for a credit limit increase. During that phone call,
Mr Harris informed CBA of his gambling problem.
Mr van Horen [Executive General Manager, Retail Products within the Retail Banking Services
Business Unit of CBA] admitted [to the Royal Commission] that the information CBA received
from Mr Harris about his gambling problem was 'not in any way passed through to credit
decisioning systems' at CBA, or to CBA's 'credit models'. At the time of the hearings, CBA's
systems remained unchanged in that regard, although Mr van Horen recognised that developing
this level of sophistication was 'clearly something that [CBA] need[ed] to do'. Mr van Horen also
accepted that CBA did not use the information provided by Mr Harris about his gambling problem
when assessing whether to make the subsequent credit offer referred to below.
Ten days after the phone call, CBA sent Mr Harris a letter inviting him to increase his credit limit.
Another similar letter was sent soon after. In early 2017, Mr Harris applied for, and was offered, a
credit limit increase of $8,000, taking his credit limit to $35,100.”
Question
1. In your opinion, was CBA acting as a Partner, Predator, Parasite or Pet in its transactions with Mr
Harris? Justify your answer.
2. If you are borrowing money from a bank to buy a house, do you think the bank has a responsibility
to assess whether or not you can repay that loan? Justify your answer.
Case 4. Negative Interest Rates
Steve Schwarzman is the CEO & co-founder of Blackstone, a company with $545 billion of assets
under management. In September 2019, he was quoted as saying the following about negative
interest rates:
"My strong view is I don't think it makes any sense whatsoever," Schwarzman said at the Economic
Club of New York. "Why would I take my money and pay somebody to take it? It's hard enough to
make it. I really just don't understand the theory behind negative interest rates."1
On 26 February 2020, the Australian Financial Review reported the experience of Michael Simonetta,
chief executive of Perfection Fresh who wanted to raise $40 million to finance the expansion of
high-tech greenhouse operations near Adelaide. He wasn’t successful in getting funding from an
Australian bank. Mr Simonetta said:
"The Australian finance community just doesn't understand horticulture, they don't get the risk, they can't value or
understand the industry and they are looking for fast returns. But with our industry you need to play the long game.
There are a lot of vagaries from drought and flood, to plague infestations, to yield implications caused by low average
sunlight hours. A lot of these people just don't have the patience."2
Questions
1. Answer Mr Schwarzman, why would anyone pay someone to take their money?
2. If interest rates are negative or very close to zero, what sensible reason might the Australian banks have for not
funding Mr Simonetta’s greenhouse operations?
“BlackRock's Wiedman joins Schwarzman blasting negative rates” by Annie Massa & John Gittelsohn Australian
Financial Review Sep 19, 2019
2 Why this 'wellness revolutionary' was shunned by banks, super funds” AFR 26 Feb 2020
1
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Case 5. Factoring in finance
Factoring is a form of finance (look it up). Butn is a three-year old fintech company that is
competing with the large, well established banks in lending money to small businesses. This may
seem surprising, which leads to the following questions:
Questions
1. How would a small start-up company be able to compete with the likes of CBA, NAB, ANZ and
Westpac?
2. What is the source of its comparative advantage?
3. What exactly does Butn do and how does it do it?
4. Is Butn making the economy more efficient? If so, how? If not, why not?
Fintech funding start-up banks $12.5m ahead of IPO
By Paul Smith Australian Financial Review Feb 21, 2021
Butn, a three year old fintech start-up founded by a 38-year-old serial entrepreneur and a 74-yearold banker, has closed a $12.5 million funding round and now plans to go public on the Australian
Securities Exchange in the first half of this year.
The company was spun out of small business transactional lending company AFC (Australian
Factoring Company), and has built a technology platform that lets it offer a number of lending
and financing options to clients including a buy-now-pay-later product, advances on commissions,
advance invoice payments and business loans.
The funding round was led by Canaccord Genuity, which is also going to be the lead manager for
its IPO. The company said the round was over-subscribed, with cornerstone institutional investors
Wilsons Asset Management and Regal Funds.
The company has co-chief executives in its two co-founders Rael Ross, an accountant and
entrepreneur and Walter Rapoport, a banking, finance and consulting industry veteran, former
research economist and knitwear manufacturer.
The pair also run cashflow financing and supply chain financing operation called Action Funding
as well as AFC and have created Butn after spending two years automating their existing client
establishment, credit and risk management and funding processes.
Rather than selling services direct to business operators, it works with partners who add the ‘Butn’
button to their own platforms and online marketplaces. Existing clients include road freight
platform Ofload, online wine marketplace Winescape and a number of fintech lenders including
Lend.com.au.
Mr Ross said the company was challenging incumbent banks by allowing users to bypass brokers
and banks, to access instant finance solutions for a range of business needs from within their own
existing trusted ecosystems.
“Walter and I started in a small suburban office with a handful of clients and a couple of million
turnover, then a couple of years ago we realised that if we wanted to continue the growth trajectory,
without putting 1000 boots on the ground, we needed to make technology enable it,” Mr Ross
said.
“So we developed an agnostic technology that overlays any third party platform or cloud-based
solution. Butn is literally that .. a button that people can click to sort out funding. we’ve digitised
the whole process. So before when it would take 24 to 48 hours to onboard a client, it can now be
done just as robustly in five minutes.”
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Mr Rapoport said the transition to life as a public company would be smooth, as Butn had been
run with all the rigour required of a publicly listed company already. This included being fully
audited by BDO during COVID-19 lockdown.
He said he was confident that ASX investors will see the potential for significant growth given the
fact that a third of the Australian labour market is comprised of independent contractors, who
have been left under-served by banks and other financial intitutions when it comes to transactional
lending.
Butn asserts that it is too costly for large institutions to properly service high touch SME clients,
especially in the sub $250,000 loan range, leaving them relying on expensive and inefficient forms
of funding including credit cards, overdrafts and mortgages on their residential houses.
It claims its digital origination and distribution platform can do it more efficiently as its processes
are largely automated.
AFC has funded over $600 million in transcactions since 2015, with Butn facilitating $166.6 million
in total lending for fiscal 2020, up from $105.4 million in 2019 and $93.9 million in 2018. The
company as a whole will now rebrand as Butn.
There have been a regular stream of fintech start-ups bagging venture funding rounds, and even
going public in recent times, but the age differences between Mr Ross and Mr Rapoport marks
them out as a fairly unique founding team.
Mr Rapoport insists he is fighting fit, saying he regularly runs the 2.2 kilometres around
Melbourne’s Caulfield Park in 12 minutes and that he and Mr Ross make a good team. Whereas
Mr Ross has the edge in the tech savvy stakes, Mr Rapoport has the kind of experience money
can’t buy.
“Rael and I often say to each other that he doesn’t see me as twice his age and nor do I see him as
half my age, we tend to think that we are more or less on the same wavelength,” he said.
“Of course you can’t escape the fact that he is more au fait with the technology than I am, but you
know, sometimes you fall into an industry by chance and Rael and I have just identified markets
that needed change and we have taken it full steam ahead.”
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